Silver Miners' Deep Bearishness Fundamentally Justified?

Gold's sharp plunge in the wake of the FOMC spilled into silver, which amplified it. That selling and the resulting bearish psychology has...

by Adam Hamilton of Zeal LLC

Silver Miners' Q2'21 Fundamentals

The silver miners' stocks have been pounded lower this summer, collateral damage from gold's selloff on distant-future-Fed-rate-hikes fears. That has devastated this tiny contrarian sector's psychology, leaving it mired in deep bearishness. But that dark sentiment pall certainly isn't justified fundamentally based on these companies' recently-reported Q2'21 operational and financial results, which proved outstanding.

Primary silver miners that derive over half their revenues from producing the white metal are increasingly rare. Most major silver miners have diversified into gold with its superior economics. With such a small population, there are only a handful of silver-stock ETFs. The SIL Global X Silver Miners ETF remains the leader, and this tiny sector's best benchmark. Its net assets were still just a trivial $1.1b in late August.

The silver stocks were enjoying a nice young upleg from late March to early June, with SIL rallying 27.5%. That would've continued powering higher if not for an anomalous event slamming gold. The mid-June FOMC meeting unleashed frenzied gold-futures selling. The Fed didn't start slowing its massive $120b per month of quantitative-easing money printing, nor did it start hiking rates from their zero-lower-bound.

Neither QE tapering nor rate hikes were even hinted at in the FOMC statement or the Fed chair's press conference. But he did warn to dismiss the accompanying dot plot, where individual Fed officials' future rate projections are collated. Just a third of those guys expected to see two quarter-point rate hikes way out into year-end 2023! That ridiculous distant-future-rate-hikes scare spawned a huge gold-futures puking.

Silver is slaved to gold's fortunes, usually acting like a sentiment gauge for its dominant metal. So gold's sharp plunge in the wake of the FOMC spilled into silver, which amplified it. That selling and the resulting bearish psychology has festered since, hammering silver 18.5% lower between mid-May to late August. That blasted the silver stocks per SIL down 28.1% in recent months, as they leverage material silver moves.

So naturally the silver miners are really out of favor now, plagued with serious fear and apathy. But once a quarter these companies report their latest operational and financial results, hard fundamental data that burns through obscuring sentiment fogs. For 21 quarters in a row now, I've painstakingly analyzed all this released from each of the top 15 SIL holdings to better understand how silver miners are actually faring.

This table summarizes the operational and financial highlights from the SIL top 15 during Q2'21. These major silver miners' stock symbols aren't all US listings, and are preceded by their rankings changes within SIL over the past year. The shuffling in their ETF weightings reflects changing market caps, which reveal both outperformers and underperformers since Q2'20. The symbols are followed by current SIL weightings.

Next comes these miners' Q2'21 silver and gold production in ounces, along with their year-over-year changes from the comparable Q2'20. Output is the lifeblood of this industry, with investors generally prizing production growth above everything else. After that is a measure of silver miners' relative purity, their percentage of quarterly sales actually derived from silver. Most silver miners also produce gold or base metals.

Generally the more silver-centric a miner, the more responsive its stock price is to changing silver prices. So traders looking for leveraged silver exposure via its miners' stocks should stick to the purer producers. Then the costs of wresting that silver from the bowels of the earth are shown in per-ounce terms, both cash costs and all-in sustaining costs. The latter subtracted from silver prices help illuminate profitability.

That is followed by these miners' hard quarterly revenues and earnings reported to securities regulators. Blank data fields mean companies hadn't reported that particular data as of mid-August when Q2's earnings season was winding down. And annual percentage changes are also excluded if they would prove misleading, like comparing two negative numbers or data shifting from positive to negative or vice versa.

The silver miners should have reported fantastic results last quarter, and they truly did. Silver's average price skyrocketed 63.1% YoY to $26.68 in Q2'21! And the year-earlier comparable Q2'20 was plagued with extensive mine shutterings from governments' pandemic lockdowns. That combined to make last quarter one of the strongest and most-profitable ever for the silver miners, despite their battered stock prices.

Since there aren't many major silver miners, their relative rankings within SIL usually only see minor shuffling. This ETF is heavily-concentrated, as Wheaton Precious Metals, Polymetal, and Pan American Silver commanded a staggering 47.0% of its total weighting in mid-August! While SIL has 40 holdings, its top 15 components account for 88.3% of it. Interestingly that is on the lower end of the last 21 quarters' range.

The largest changes over this past year were big advancements from Korea Zinc and SSR Mining. The former is a giant South Korean smelter, which has no place in a "Silver Miners ETF". I don't follow that country's stock markets, but assume they soared like the rest of the world's on epic central-bank money printing to stave off pandemic-lockdown depressions. That's likely why Korea Zinc's market cap blasted higher.

Touting itself as "THE WORLD'S ONE OF THE BEST SMELTING COMPANY", surprisingly Korea Zinc finally started reporting results in English for the first time. So both Q2'21 and Q2'20 results now include this smelter, keeping this particular year-over-year comparison comparable. But Korea Zinc still hasn't released numbers for the other 19 quarters of this research thread, muddying longer-term comparisons.

SSR Mining, which was a primary silver miner called Silver Standard Resources for most of its life, is the other hard charger higher in SIL's rankings. Like most of its peers SSRM is increasingly diversifying into gold. In mid-2020 it acquired the gold miner Alacer Gold, dramatically growing SSR Mining's gold production. That greatly boosted SSRM's market capitalization, but left it as the least-pure major silver miner.

Overall these SIL-top-15 silver miners enjoyed super-strong production growth last quarter, with their total silver output surging 16.9% YoY to 84,962k ounces! That is the highest by far in the last 21 quarters, but only because of the 18,165k ounces Korea Zinc smelted. But output growth was still strong excluding Korea Zinc from both Q2'21 and Q2'20, soaring 23.8% YoY to 66,797k. Yet that remains on the lower side.

Without that smelter that sure doesn't belong in this ETF, last quarter's SIL-top-15 silver output was only about a third up into its range over the past 21 quarters. Global silver mining has been waning for years, mainly for a couple key reasons. Large economically-viable silver-centric deposits are increasingly harder to find in this picked-over world. And lower silver prices often left silver much less economical to mine than gold.

Definitive global silver supply-and-demand data is only published once a year by the Silver Institute in its awesome World Silver Surveys. They are released around early May, covering the prior calendar year. Worldwide silver mined plunged 5.9% YoY in 2020 to just 784.4m ounces. That decline was anomalously-large due to pandemic lockdowns, which slammed leading silver-producing countries disproportionally hard.

Some of the most heavy-handed business restrictions to slow COVID-19's spread came in Mexico and Peru, shuttering many silver mines. These countries led the world in silver output in 2019, accounting for 22.5% and 16.3% of the global mined supply! But 2020's troubles just exacerbated a secular trend of lower silver production. After peaking at 899.4m ounces in 2016, silver mined has been declining ever since.

The world's silver mined fell 4.1% YoY in 2017, another 1.7% in 2018, and still another 1.8% in 2019. So peak silver may very well be upon us. While 2021 will likely enjoy a strong rebound from the lockdown-suppressed 2020, the overall trend should remain lower. For years traditional major silver miners have allocated much of their exploration and development capital to gold instead, and that shift isn't slowing at all.

The SIL top 15's gold output surged 20.2% YoY to 1,536k ounces in Q2'21, outpacing the growth in silver production. But excluding Korea Zinc's gold smelting, gold production only grew 17.3% YoY to 1,415k ounces lagging silver's 23.8%. That's mostly the result of the pandemic-lockdown rebound though, as the gold mines these companies operate aren't as heavily concentrated in Mexico and Peru as their silver operations.

With silver miners back online, as well as silver-price gains far outpacing gold ones, the SIL top 15's silver purity improved averaging 38.8% in Q2'21. This was mostly calculated by multiplying companies' silver production by silver's average price, then dividing that by their quarterly revenues. In cases where Q2 sales weren't reported, they were approximated using gold and silver outputs and their average prices.

But 38.8% of their sales from silver still remained on the lower end of the SIL-top-15's 21-quarter range from 34.4% to 56.8%. That peak came way back in Q3'19. Since last quarter's average silver price soared by 63.1% YoY compared to gold's mere 5.8%, it is surprising silver purity wasn't higher. Korea Zinc's new data was one reason, as silver smelting's small percentage of its business dragged down the average.

Ex-Korea Zinc, that SIL-top-15 number ran a better 40.1%. Just four of these miners derived over half their Q2'21 sales from silver, and their purities are boldfaced in blue above. And they themselves merely averaged 58.0%, still far from being pure silver plays. And together they accounted for just 34.4% of this ETF's entire weighting, of which nearly 3/4ths came from WPM alone. So SIL's leverage to silver is fairly weak.

This leading silver-stock ETF is more gold-centric, more dependent on gold prices than silver ones. That isn't an indictment on SIL's managers, as there simply aren't enough primary silver miners left to build an ETF out of. Some big silver mines in development including a joint venture between Fresnillo and MAG Silver should improve that. But they won't overcome the yellowing trend of silver miners diversifying into gold.

Long-term silver-stock price levels ultimately depend on miners' profitability, which is directly driven by the difference between prevailing silver prices and mining costs. In per-ounce terms these are generally inversely proportional to silver production. That's because silver mines' operating costs are largely fixed during planning stages. Their designed throughputs limit the amounts of silver-bearing ore they can process.

That doesn't change quarter to quarter, and requires about the same levels of infrastructure, equipment, and employees. The only real variable is the ore grades run through the fixed-capacity mills. Richer ores yield more silver ounces to spread the big fixed costs of mining across, lowering unit costs which boosts profitability. With their production surging, the SIL top 15 should've reported sharply-lower unit costs in Q2'21.

Cash costs are the classic measure of silver-mining costs, including all cash expenses necessary to mine each ounce of silver. But they are misleading as a true cost measure, excluding the big capital needed to explore for silver deposits and build mines. So cash costs are best viewed as survivability acid-test levels for the major silver miners. They illuminate the minimum silver prices necessary to keep the mines running.

Despite much-higher silver production last quarter, the SIL-top-15 silver miners still saw their average cash costs blast 15.2% higher YoY to $8.67. But that was skewed high by a couple big outliers. Peru's Buenaventura reported staggering $19.93 cash costs, after long struggling with all kinds of operational issues. First Majestic Silver, which trades under its Canadian symbol FR in this ETF, also saw soaring costs.

For many years First Majestic was the go-to silver stock with the highest silver purity. In Q2'20 that ran a fantastic 86.0%! But for better or worse, this company heavily diversified into gold by buying a dedicated mine last quarter. Unfortunately it is unoptimized and super-high-cost. Those are feeding into overall costs, which this company still reports in silver-equivalent-ounce terms. So its cash costs more than doubled.

All-in sustaining costs are far superior than cash costs, and were introduced by the World Gold Council in June 2013. They add on to cash costs everything else that is necessary to maintain and replenish silver-mining operations at current output tempos. AISCs give a much-better understanding of what it really costs to maintain silver mines as ongoing concerns, and reveal the major silver miners' true operating profitability.

The SIL top 15's AISCs climbed a far-more-moderate 1.8% YoY in Q2'21 to $12.42 per ounce. And First Majestic's expensive new gold mine contributed. Its AISCs last quarter ran a terrible $1,679, compared to the mid-tier gold miners' average of $1,125. Without this company, the SIL-top-15 average last quarter would've retreated to $11.26. But mining silver at $12.42 is still wildly-profitable at these prevailing prices.

A great proxy for silver miners' collective profitability is found by subtracting quarterly SIL-top-15 average AISCs from average silver prices, showing unit earnings. Silver again averaged an excellent $26.68 in Q2'21 despite June's distant-future-Fed-rate-hikes-scare selloff. That less those $12.42 average AISCs yields fat profits of $14.26 per ounce! That is the second-highest in the last 21 quarters, trailing Q3'20's $14.77.

Those sector unit earnings skyrocketed an immense 243.3% YoY! And that just extended a long trend of big-to-enormous profits growth to seven consecutive quarters. The SIL top 15's unit earnings rocketed up 1,191.0%, 18.2%, 23.1%, 137.2%, 65.6%, 253.4%, and 243.3% YoY between Q4'19 to Q2'21! That is one heck of a streak. The bearishness and apathy plaguing silver stocks certainly isn't fundamentally-justified.

And silver-mining profitability should continue marching higher on balance as gold's secular bull continues driving silver's parallel one. Gold and silver are riding a tidal wave of money printing. Since March 2020's pandemic-lockdown stock panic, the Fed has expanded its balance sheet by an absurd 93.5% or $4,031b in just 17.3 months! And the FOMC continues to conjure up another $120b monthly to directly monetize debt.

The Fed nearly doubling the US-dollar supply in such a short span of time is wildly-unprecedented. This monetary hyper-inflation is directly driving the spiraling price inflation Americans are facing everywhere. As investors increasingly realize the Fed can't unwind that extreme monetary excess without collapsing the stock markets it artificially inflated, they will increasingly flock back to gold, silver, and their miners' stocks.

The SIL top 15's hard financial results just reported to securities regulators under Generally Accepted Accounting Principles or other countries' equivalents confirmed their awesome fundamental strength last quarter. Production rebounding from Q2'20's forced mine shutterings, much-higher average silver prices, and diversifying into gold radically improved the silver miners' financial results. They reported an amazing Q2'21!

Korea Zinc finally starting to report in English isn't a factor, as its results are now included in both Q2'21 and comparable Q2'20 totals. Overall SIL-top-15 revenues soared 58.5% YoY to $7,229m. That was the highest in the last 21 quarters by far, but again the other 19 of those don't include Korea Zinc. Backing it out, sales blasted up virtually the same 58.2% YoY to $5,110m. Big revenues growth drives huge profits growth.

The SIL top 15's hard accounting earnings reported to securities regulators skyrocketed an immense 472.9% YoY to $918m last quarter! Ex-Korea Zinc it was even more extreme up 975.1% YoY to $745m. And while wading through these miners' income statements, there weren't big one-off non-cash gains or losses that caught my eye. These fat profits look like normal operating ones not skewed by unusual items.

Such incredibly-strong earnings in the face of sentiment-battered stock prices have fueled extraordinarily-cheap valuations in some of these silver miners. Out of the 12 companies in the SIL top 15 that have cumulative earnings over this past year, 5 now have trailing-twelve-month price-to-earnings ratios way down in the teens or even single-digits! High-flying silver stocks almost never get this undervalued, it is amazing.

The SIL top 15's cashflows generated from operations also soared 62.0% YoY to $1,320m in Q2'21, also reflecting this incredibly-strong environment for silver mining. That helped catapult these companies' cash treasuries up 124.4% YoY to a staggering $7,031m! This is a huge warchest that will help finance higher future production through existing-mine expansions, new-mine builds, and buying operating mines.

So contrary to the ubiquitous bearish sentiment dogging this tiny contrarian sector today, the silver miners are thriving. They are enjoying some of their best fundamental performances ever, and their stocks have rarely been cheaper! And despite silver's recent weakness spawned by gold-futures selling on distant-future-Fed-rate-hikes fears, prevailing silver prices are still quite high in Q3 averaging $24.88 quarter-to-date.

So the silver stocks are poised to soar as gold and silver soon reverse and mean revert sharply higher. Both metals have suffered outsized highly-leveraged futures selling since mid-June, leaving those traders' positioning with massive room to buy to normalize their positions. The silver miners will amplify silver's gains like usual, with upside concentrated in the purer ones. They are better to own individually than SIL.

While we've taken our lumps in stoppings with these anomalous rate-hike-scare gold and silver selloffs, the trading books in our newsletters remain full of fundamentally-superior smaller gold and silver miners. That includes a rare new pure silver miner spinning up its maiden operation. So there are still awesome silver-stock opportunities for those who do their homework, despite most silver miners diversifying into gold.

At Zeal we walk the contrarian walk, buying low when few others are willing before later selling high when few others can. We overcome popular greed and fear by diligently studying market cycles. We trade on time-tested indicators derived from technical, sentimental, and fundamental research. That has already led to realized gains in this current young upleg as high as +51.5% on our recent newsletter stock trades!

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The bottom line is the major silver miners of the leading silver-stock ETF reported fantastic results in Q2. Their silver production rebounded dramatically from year-earlier pandemic lockdowns. That combined with much-higher prevailing silver prices to drive explosive earnings growth. That extended a long streak of massive profits increases, forcing silver-stock valuations even deeper into incredibly-undervalued territory.

Yet sentiment-blinded traders are ignoring silver miners' outstanding fundamentals, pretending their herd bearishness is righteous. The resulting anomalous disconnect between poor stock prices and awesome corporate performances can't last long. As gold and silver rebound from recent months' heavy futures selling, the battered silver stocks should really amplify their gains. Their setup here is super-bullish.

Adam Hamilton, CPA

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