The major silver miners’ stocks have been thrashed, pummeled to brutal multi-year lows. They suffered serious collateral damage as silver plunged on gold’s breakdown, driven by crazy-extreme all-time-record silver-futures short selling. All this technical carnage left investors reeling, devastating sentiment. The silver miners’ recently-reported Q2’18 results reveal whether their anomalous plunge was justified fundamentally.
Four times a year publicly-traded companies release treasure troves of valuable information in the form of quarterly reports. Companies trading in the States are required to file 10-Qs with the US Securities and Exchange Commission by 45 calendar days after quarter-ends. Canadian companies have similar requirements. In other countries with half-year reporting, many companies still partially report quarterly.
Unfortunately the universe of major silver miners to analyze and invest in is pretty small. Silver mining is a tough business both geologically and economically. Primary silver deposits, those with enough silver to generate over half their revenues when mined, are quite rare. Most of the world’s silver ore formed alongside base metals or gold. Their value usually well outweighs silver’s, relegating it to byproduct status.
The Silver Institute has long been the authority on world silver supply-and-demand trends. It published its latest annual World Silver Survey covering 2017 in mid-April. Last year only 28% of the silver mined around the globe came from primary silver mines! 36% came from primary lead/zinc mines, 23% copper, and 12% gold. That’s nothing new, the silver miners have long supplied less than a third of world mined supply.
It’s very challenging to find and develop the scarce silver-heavy deposits supporting primary silver mines. And it’s even harder forging them into primary-silver-mining businesses. Since silver isn’t very valuable, most silver miners need multiple mines in order to generate sufficient cash flows. Traditional major silver miners are increasingly diversifying into gold production at silver’s expense, chasing its superior economics.
So there aren’t many major silver miners left out there, and their purity is shrinking. The definitive list of these companies to analyze comes from the most-popular silver-stock investment vehicle, the SIL Global X Silver Miners ETF. In mid-August at the end of Q2’s earnings season, SIL’s net assets were running 6.7x greater than its next-largest competitor’s. So SIL continues to dominate this small niche contrarian sector.
While SIL has its flaws, it’s the closest thing we have to a silver-stock index. As ETF investing continues to eclipse individual-stock picking, SIL inclusion is very important for silver miners. It grants them better access to the vast pools of stock-market capital. Differential SIL-share buying by investors requires this ETF’s managers to buy more shares in its underlying component companies, bidding their stock prices higher.
In mid-August as the silver miners were finishing reporting their Q2’18 results, SIL included 23 “Silver Miners”. Unfortunately the great majority aren’t primary silver miners, most generate well under half their revenues from silver. That’s not necessarily an indictment against SIL’s stock picking, but a reflection of the state of this industry. There aren’t enough significant primary silver miners left to fully flesh out an ETF.
This disappointing reality makes SIL somewhat problematic. The only reason investors would buy SIL is they want silver-stock exposure. But if SIL’s underlying component companies generate just over a third of their sales from silver mining, they aren’t going to be very responsive to silver price moves. And most of that ETF capital intended to go into primary silver miners is instead diverted into byproduct silver miners.
So silver-mining ETFs sucking in capital investors thought they were allocating to real primary silver miners effectively starves them. Their stock prices aren’t bid high enough to attract in more investors, so they can’t issue sufficient new shares to finance big silver-mining expansions. This is exacerbating the silver-as-a-byproduct trend. Only sustained much-higher silver prices for years to come could reverse this.
Every quarter I dig into the latest results from the major silver miners of SIL to get a better understanding of how they and this industry are faring fundamentally. I feed a bunch of data into a big spreadsheet, some of which made it into the table below. It includes key data for the top 17 SIL component companies, an arbitrary number that fits in this table. That’s a commanding sample at 95.8% of SIL’s total weighting!
While most of these top 17 SIL components had reported on Q2’18 by mid-August, not all had. Some of these major silver miners trade in the UK or Mexico, where financial results are only required in half-year increments. If a field is left blank in this table, it means that data wasn’t available by the end of Q2’s earnings season. Some of SIL’s components also report in gold-centric terms, excluding silver-specific data.
The first couple columns of this table show each SIL component’s symbol and weighting within this ETF as of mid-August. While most of these stocks trade on US exchanges, some symbols are listings from companies’ primary foreign stock exchanges. That’s followed by each miner’s Q2’18 silver production in ounces, along with its absolute year-over-year change. Next comes this same quarter’s gold production.
Nearly all the major silver miners in SIL also produce significant-to-large amounts of gold! That’s truly a double-edged sword. While gold really stabilizes and boosts silver miners’ cash flows, it also retards their stocks’ sensitivity to silver itself. So the next column reveals how pure these elite silver miners are, approximating their percentages of Q2’18 revenues actually derived from silver. This is calculated two ways.
The large majority of these top SIL silver miners reported total Q2 revenues. Quarterly silver production multiplied by silver’s average price in Q2 can be divided by these sales to yield an accurate relative-purity gauge. When Q2 sales weren’t reported, I estimated them by adding silver sales to gold sales based on their production and average quarterly prices. But that’s less optimal, as it ignores any base-metals byproducts.
Next comes the major silver miners’ most-important fundamental data for investors, cash costs and all-in sustaining costs per ounce mined. The latter directly drives profitability which ultimately determines stock prices. These key costs are also followed by YoY changes. Last but not least the annual changes are shown in operating cash flows generated and hard GAAP earnings, with a couple exceptions necessary.
Percentage changes aren’t relevant or meaningful if data shifted from positive to negative or vice versa, or if derived from two negative numbers. So in those cases I included raw underlying data rather than weird or misleading percentage changes. This whole dataset together offers a fantastic high-level read on how the major silver miners are faring fundamentally as an industry. Was their recent plunge righteous?
Production is naturally the lifeblood of the silver-mining sector. The more silver and increasingly gold that these elite miners can wrest from the bowels of the earth, the stronger their fundamental positions and outlooks. These top 17 SIL silver miners failed to increase their mining tempos over this past year. Their collective silver and gold production deteriorated 4.4% and 2.1% YoY to 75.1m and 1327k ounces mined.
According to the Silver Institute’s latest WSS, total world silver mine production averaged 213.0m ounces per quarter in 2017. So at 75.1m in Q2, these top 17 SIL components were responsible for 35.3% of that rate. And their overall production decline last quarter is misleading, heavily skewed by two outliers with unusual situations. Tahoe Resources and SSR Mining reported huge 100.0% and 46.3% YoY production plunges!
Without TAHO and SSRM, the rest of these elite silver miners were able to grow their collective silver production by a decent 2.0% YoY. That’s impressive considering the miserable silver-price environment. Between Q2’17 and Q2’18, the average quarterly silver price slumped 3.9% to $16.51. That was really weak compared to gold, which actually rose 3.9% in quarterly-average terms to $1306 across these quarters.
Silver has always been driven by gold, effectively acting like a gold sentiment gauge. Generally big silver uplegs only happen after gold has rallied long enough and high enough to convince traders its gains are sustainable. Then the way-smaller silver market tends to start leveraging and amplifying gold’s moves by 2x to 3x. But gold sentiment was so insipid over this past year that no excitement was sparked for silver.
Yet the top 17 SIL silver miners excluding TAHO and SSRM were able to buck those silver headwinds to still grow production. That is setting up these companies for stronger profits growth once silver’s price inevitably mean reverts higher. It’s important to understand what’s going on with TAHO and SSRM though, as these are long-time favorites among American investors. TAHO’s silver production should return.
Tahoe was originally spun off by Goldcorp to develop the incredible high-grade Escobal silver mine in Guatemala, which went live in Q4’13. Everything went well for its first few years. By Q1’17, Escobal was a well-oiled machine producing 5700k ounces of silver. That provided 1000+ great high-paying jobs to locals and contributed big taxes to Guatemala’s economy. Escobal was a great economic boon for this country.
But a radical group of anti-mining activists managed to spoil everything, cruelly casting their fellow countrymen out of work. They filed a frivolous and baseless lawsuit against Guatemala’s Ministry of Energy and Mines, Tahoe wasn’t even the target! It alleged this regulator had not sufficiently consulted with the indigenous Xinca people before granting Escobal’s permits. And they don’t even live around this mine site.
Only in a third-world country plagued with rampant government corruption would a regulator apparently not holding enough meetings be a company’s problem. Instead of resolving this, a high Guatemalan court inexplicably actually suspended Escobal’s mining license in early Q3’17! Tahoe was forced to temporarily mothball its crown-jewel silver mine, and thus eventually lay off its Guatemalan employees.
That license was technically reinstated a couple months later, but the activists appealed to a higher court. It required the regulator to study the indigenous people in surrounding areas and report back, and now needs to make a decision. The government also needs to clear out an illegal roadblock to the mine site by violent anti-mine militants, who have blockaded Escobal supplies and physically attacked trucks and drivers!
So Escobal has been dead in the water with zero production for an entire year, an unthinkable outcome. This whole thing is a farce, a gross miscarriage of justice. Sooner or later the Guatemalan bureaucrats will get all their useless paperwork done and Escobal will come back online. After a few quarters or so of spinning back up, Escobal’s silver production should return to pre-fiasco levels around 5700k ounces a quarter.
That would boost SIL’s top 17 components’ current overall silver production by 7.6%. In my decades of intensely researching and actively trading mining stocks, I’ve never seen anything like this Escobal debacle. While TAHO’s cashflows are really impaired without this silver mine which was actually the world’s largest primary, it can weather this nightmare because of its other gold mines that yielded 102.6k ounces in Q2’18.
Thankfully SSR Mining’s silver-production plunge is far less dramatic. This company used to be known as Silver Standard Resources, and its old Pirquitas silver mine is simply depleting as forecast. SSRM is exploring in the area trying to extend the life of this old mine, which was joint-ventured and renamed the Puna Operations. But most of SSRM’s resources are being poured into its far-more-profitable gold mines.
That gold focus among these top silver miners is common across SIL’s components. As the silver-percentage column above shows, most of these elite silver miners are actually primary gold miners by revenue! Only 3 of these 17 earned more than half of their Q2’18 sales from mining silver, and they are highlighted in blue. WPM, PAAS, and TAHO are also top-34 components in the leading GDX gold miners’ ETF!
While they only comprised 7.8% of GDX’s total weighting in mid-August, this highlights how difficult it is to find primary silver miners. SIL’s managers have an impossible job these days with the major silver miners increasingly shifting to gold. They are really scraping the bottom of the barrel to find more silver miners. In Q3’17 they added Korea Zinc, and it’s now SIL’s 3rd-biggest holding with a hefty 11.9% total weighting.
That was intriguing, as I’d never heard of this company after decades deeply immersed in this small silver-mining sector. So I looked into Korea Zinc and found it was merely a smelter, not even a miner! Its English-language disclosures are atrocious, starting with its homepage reading “We are Korea Zinc, the world’s one of the best smelting company”. The latest production data I can find in English is still 2015’s.
That year Korea Zinc “produced” 63.3m ozs of silver, which averages to 15.8m quarterly. That is largely a byproduct from its main businesses of smelting zinc, lead, copper, and gold. The fact SIL’s managers included a company like this that doesn’t even mine silver as a top SIL component shows how rare major silver miners have become. The economics of silver mining at today’s prices are way inferior to gold mining.
The traditional major silver miners are painfully aware of this, and have spent years actively diversifying into gold. In Q2’18, the average percentage of revenues these top 17 SIL miners derived from silver was only 36.3%. That’s right in line with the recent trend, with the prior four quarters seeing 36.1%, 39.3%, 35.3%, and 36.4%. This relatively-low silver exposure is why SIL isn’t as responsive to silver as investors expect.
Silver mining is every bit as capital-intensive as gold mining, requiring similar large expenses for planning, permitting, and constructing mines and mills. It needs similar heavy excavators and haul trucks to dig and move the silver-bearing ore. Similar levels of employees are necessary to run these mines. But silver generates much lower cash flows due to its lower price. Consider hypothetical mid-sized silver and gold mines.
They might produce 10m and 300k ounces annually. At last quarter’s average prices, these silver and gold mines would yield $165m and $392m of yearly sales. Unfortunately it is far easier to pay the bills mining gold these days. So primary silver miners are increasingly becoming a dying breed, which is sad. The traditional major silver miners are adapting by ramping their gold production often at silver’s expense.
This industry’s flagging silver purity and thus deteriorating responsiveness to silver price trends will be hard to reverse. Silver would need to far outperform gold, rocketing higher in one of its gigantic uplegs while gold lags. And it would have to stay relatively strong compared to gold for years after that to entice big capital spending back into primary silver mines. While possible, that seems like a stretch in today’s markets.
Unfortunately SIL’s mid-August composition was such that there wasn’t a lot of Q2 cost data reported by its top component miners. A half-dozen of these top SIL companies trade in the UK, South Korea, Mexico, and Peru, where reporting only comes in half-year increments. There are also primary gold miners that don’t report silver costs, and a silver explorer with no production. So silver cost data remains scarce.
Nevertheless it’s always useful to look at what we have. Industrywide silver-mining costs are one of the most-critical fundamental data points for silver-stock investors. As long as the miners can produce silver for well under prevailing silver prices, they remain fundamentally sound. Cost knowledge helps traders weather this sector’s occasional fear-driven plunges without succumbing to selling low like the rest of the herd.
There are two major ways to measure silver-mining costs, classic cash costs per ounce and the superior all-in sustaining costs. Both are useful metrics. Cash costs are the acid test of silver-miner survivability in lower-silver-price environments, revealing the worst-case silver levels necessary to keep the mines running. All-in sustaining costs show where silver needs to trade to maintain current mining tempos indefinitely.
Cash costs naturally encompass all cash expenses necessary to produce each ounce of silver, including all direct production costs, mine-level administration, smelting, refining, transport, regulatory, royalty, and tax expenses. In Q2’18, these top 17 SIL-component silver miners that reported cash costs averaged just $3.95 per ounce! That plunged a whopping 37.6% YoY, making it look like these miners are getting more efficient.
But that’s misleading. Because of hefty byproduct credits from gold and base metals, Hecla Mining and Fortuna Silver Mines both reported negative cash costs in Q2. They are an accounting fiction, as mining silver still costs a lot of money. But crediting byproduct sales to silver can slash reported cash costs. In the comparable quarter a year earlier, there were no negative cash costs at any of SIL’s top 17 miners.
Those super-low cash costs offset SSR Mining’s crazy-high $14.73 per ounce. That’s not normal either, the result of that winding down of its lone silver mine. Excluding these extreme outliers, the remaining handful of silver miners had average cash costs of $4.83 per ounce. As long as silver prices stay above those levels, the silver miners can keep the lights on at their mines. Sub-$5 silver is wildly inconceivable!
Way more important than cash costs are the far-superior all-in sustaining costs. They were introduced by the World Gold Council in June 2013 to give investors a much-better understanding of what it really costs to maintain silver mines as ongoing concerns. AISCs include all direct cash costs, but then add on everything else that is necessary to maintain and replenish operations at current silver-production levels.
These additional expenses include exploration for new silver to mine to replace depleting deposits, mine-development and construction expenses, remediation, and mine reclamation. They also include the corporate-level administration expenses necessary to oversee silver mines. All-in sustaining costs are the most-important silver-mining cost metric by far for investors, revealing silver miners’ true operating profitability.
In Q2’18 these top 17 SIL miners reporting AISCs averaged just $10.93 per ounce! That was down 6.3% YoY, and was way below silver’s average price of $16.51 last quarter. Even if the two extreme outliers are thrown out, SSRM’s abnormally-high mine-depletion $17.66 AISC and SVM’s incredibly-low huge-byproduct-credit $0.41 AISC, the remaining average is similar at $11.56. Silver mining remains very profitable!
Even at worst in August’s plunge driven by speculators’ crazy-extreme all-time-record silver-futures short selling, silver merely hit $14.44 on close. That’s still way above this industry’s total production costs any way you slice it. That implies even at peak fear the elite top silver miners of SIL were still earning hefty 24% profit margins! So there’s no doubt the recent frantic silver-stock selling wasn’t fundamentally righteous.
SIL getting hammered to deep 2.5-year lows in mid-August was the product of irrational fear run amok, it had nothing to do with how the silver miners are faring. At Q2’s average silver price and AISCs, these miners were earning $5.58 per ounce. Most other industries would die for such 34% margins. And those are going to explode higher as silver inevitably mean reverts back up again, probably violently given this setup.
Silver stocks plunged in August because silver did. That was driven by truly-extreme silver-futures short selling by speculators. They ramped their shorts to a wild new all-time record high of 114.5k contracts in mid-August! All that short selling is guaranteed proportional near-future buying, as excessive shorts must be closed by buying offsetting long contracts. Short-covering rallies are self-feeding, catapulting silver higher.
The more speculators buy to cover, the faster silver surges. The faster it surges, the more they have to buy to cover or face catastrophic losses due to the extreme leverage inherent in silver futures. It would take 73.0k contracts of buying to return spec shorts to their 52-week low seen in mid-September 2017. That’s the equivalent of 364.9m ounces, or nearly 43% of last year’s entire global mined supply! Talk about big.
And today’s silver prices are super-low relative to prevailing gold levels, portending huge mean-reversion upside. The long-term average Silver/Gold Ratio runs around 56x, which means it takes 56 ounces of silver to equal the value of one ounce of gold. Silver is greatly underperforming gold so far in 2018, with the SGR averaging a stock-panic-like 80.2x thus far in August! So silver is overdue to catch up with gold.
At a 56x SGR and $1200 gold, silver is easily heading near $21.50. That’s 30% above its Q2 average. Assuming the major silver miners’ all-in sustaining costs hold, that implies profits per ounce soaring 89% higher! And the record silver-futures short covering necessary after record silver-futures short selling is very likely to fuel a massive mean-reversion overshoot, making the silver-mining-profits upside much greater.
And silver miners’ AISCs generally don’t change much regardless of prevailing silver prices, since silver-mining costs are largely fixed during mine planning and construction. The top 17 SIL miners’ AISCs in the past four quarters averaged $11.66, $9.73, $10.16, and $10.92. So Q2’18’s $10.93 was right in line. Costs aren’t going to rise much as silver recovers, and higher production may even push them lower still.
While all-in sustaining costs are the single-most-important fundamental measure that investors need to keep an eye on, other metrics offer peripheral reads on the major silver miners’ fundamental health. The more important ones include cash flows generated from operations, GAAP accounting profits, revenues, and cash on hand. They were all decent to healthy in Q2’18 despite the low silver prices and weak sentiment.
These SIL-top-17 silver miners’ collective revenues only fell 1.5% YoY to $3114m. That reflects higher gold prices which offset the lower silver ones. That drove operating-cash-flow generation of $758m, which was 27.0% lower YoY. That’s not unreasonable given the 3.9% lower average silver prices from Q2’17 to Q2’18 and the 4.4% lower silver production among these elite silver majors. Cash flows remain fine.
These silver miners’ balance-sheet cash and short-term investments still powered 18.0% higher YoY to $3637m. The bigger their cash hoards, the easier the elite silver miners can weather these weak silver prices. Big treasuries also give them more capital to expand existing mines and buy or build new ones. A fundamental surprise seemed to come in hard GAAP accounting profits though, which soared 110.6% YoY!
But the $343m total earnings in Q2’18 were wildly skewed by a huge $246m non-recurring gain Wheaton Precious Metals reported. 77% of its massive $318m in profits came from gains on the sale of one of its silver streams. Back that out of overall top-17-SIL-component earnings, and they actually plunged 40.3% YoY. But they were still positive at $97m, and have incredible upside potential as silver’s price inevitably recovers.
The silver-mining stocks are doing way better fundamentally than they’ve been given credit for. Their mining costs remain far below prevailing silver levels, driving strong profitability even at August’s deep silver-price lows. That capitulation silver-stock plummeting fueled by cascading selling as stop losses were sequentially run wasn’t justified fundamentally. It was an extreme sentiment anomaly that can’t persist.
So a big mean-reversion rebound higher is inevitable and imminent. While traders can play that in SIL, that’s mostly a bet on primary gold miners with byproduct silver production. The best gains by far will be won in smaller purer mid-tier and junior silver miners with superior fundamentals. A carefully-handpicked portfolio of these miners will generate much-greater wealth creation than ETFs dominated by non-primary miners.
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The bottom line is the major silver miners’ fundamentals remain solid based on their recently-reported Q2’18 results. They continue to mine silver at all-in sustaining costs far below even mid-August’s deep silver lows. Their still-impressive profits will multiply as silver rebounds higher violently on record futures short covering. Investment capital will flood back into this tiny sector, catapulting silver stocks up sharply.
So traders need to look through the recent frightened herd sentiment to understand the silver miners’ hard fundamentals. These forsaken stocks are radically undervalued even at today’s low silver prices, let alone where silver heads during the next major gold upleg. Silver is poised to rocket higher soon as that mandatory extreme short covering gets underway. So the opportunities to buy dirt-cheap miners are fleeting.
Adam Hamilton, CPA
August 31, 2018
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