Adam Hamilton: Silver Miners' Q4'17 Fundamentals

The silver miners' stocks have really languished since mid-2016, relentlessly grinding sideways to lower. With gold out of favor, silver and its miners have largely been left for dead and forgotten. This sector is deeply mired in universal apathy and bearishness. But since silver stocks can skyrocket when silver decisively rallies again, it's important to keep an eye on silver miners' fundamentals like their recent Q4'17 results.

Four times a year publicly-traded companies release treasure troves of valuable information in the form of quarterly reports. Required by securities regulators, these quarterly results are exceedingly important for investors and speculators. They dispel all the sentimental distortions surrounding prevailing stock-price levels, revealing the underlying hard fundamental realities. They serve to re-anchor perceptions.

Normally quarterlies are due 45 calendar days after quarter-ends, in the form of 10-Qs required by the SEC for American companies. But after the final quarter of fiscal years, which are calendar years for most silver miners, that deadline extends out up to 90 days depending on company size. The 10-K annual reports required once a year are bigger, more complex, and need fully-audited numbers unlike 10-Qs.

So it takes companies more time to prepare full-year financials and then get them audited by CPAs right in the heart of their busy season. The additional delay in releasing Q4 results is certainly frustrating, as that data is getting stale approaching the end of Q1. While most silver miners report their Q4 and/or full-year results by 7 to 9 weeks after year-ends, some disrespect their investors by pushing that 13-week limit.

And some silver miners only publish full-year results without breaking out Q4, masking what happened in the latest quarter. All this unfortunately makes Q4 results the hardest to analyze out of all quarterlies. But delving into them is still well worth the challenge. Quarterly results offer a very valuable true snapshot of what's really going on, shattering all the misconceptions bred by the ever-shifting winds of sentiment.

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, and their value usually well outweighs silver's. So typically in any given year, less than a third of the global mined silver supply actually comes from primary silver mines!

The world authority on silver supply-and-demand fundamentals is the Silver Institute. Back in mid-May it released its latest annual World Silver Survey, which covered 2016. That year only 30% of silver mined came from primary silver mines, a slight increase. The remaining 70% of silver produced was simply a byproduct. 35% of the total mined supply came from lead/zinc mines, 23% from copper, and 12% from gold.

As scarce as silver-heavy deposits supporting primary silver mines are, primary silver miners are even rarer. Since silver is so much less valuable than gold, most silver miners need multiple mines in order to generate sufficient cash flows. These often include non-primary-silver ones, usually gold. More and more traditional elite silver miners are aggressively bolstering their gold production, often at silver's expense.

So the universe of major silver miners is pretty small, 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. This week its net assets are running 6.8x greater than its next-largest competitor's, so SIL really dominates this space. As investors buy SIL, it in turn buys shares in the companies it holds.

Back in mid-March as the major silver miners were finishing reporting their Q4'17 results, SIL included 25 "silver miners". This term is used loosely, as SIL holds plenty of companies which can't be described as primary silver miners. Most generate well under half their revenues from silver, which really limits their stock prices' leverage to silver rallies. Nevertheless, SIL is today's leading silver-stock ETF and benchmark.

The higher the percentage of sales any miner derives from silver, naturally the greater its exposure to silver-price moves. If a company only earns 20%, 30%, or even 40% of its revenues from silver, it's not a primary silver miner and its stock price won't be very responsive to silver itself. But as silver miners are increasingly actively diversifying into gold, there aren't enough big primary silver miners left to build an ETF alone.

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 94.6% of SIL's total weighting.

While most of these top-17 SIL components had reported on Q4'17 by late March, 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 Q4's earnings season. Some of SIL's components also report in gold-centric terms, excluding silver-specific data.

In this table the first couple columns show each SIL component's symbol and weighting within this ETF as of mid-March. While most of these silver stocks trade in the States, not all of them do. So if you can't find one of these symbols, it's a listing from a company's primary foreign stock exchange. That's followed by each company's Q4'17 silver production in ounces, along with its absolute year-over-year change.

After that comes this same quarter's gold production. Pretty much every major silver miner in SIL also produces significant-if-not-large amounts of gold! While gold stabilizes and augments the silver miners' cash flows, it also retards their stocks' sensitivity to silver itself. Naturally investors and speculators buy silver stocks and their ETFs because they want leveraged upside exposure to silver's price, not gold's.

So the next column reveals how pure the elite SIL silver miners are. This is mostly calculated by taking a company's Q4 silver production, multiplying it by Q4's average silver price, and then dividing that by the company's total quarterly sales. If miners didn't report Q4 revenues, I approximated them by adding the silver sales to gold sales based on their quarterly production and these metals' average fourth-quarter prices.

Then comes the most-important fundamental data for silver miners, cash costs and all-in sustaining costs per ounce mined. The latter determines their profitability and hence ultimately stock prices. Those are also followed by YoY changes. Finally comes the YoY changes in cash flows generated from operations and GAAP profits. But there are a couple exceptions where YoY changes just wouldn't yield useful results.

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 results instead of weird or misleading percentage changes. This whole dataset offers a great high-level read on how the major silver miners are faring today as an industry. They're doing pretty well in this weak-silver-price environment.

That's reassuring given silver's serious underperformance relative to gold. As a far-smaller market, silver usually amplifies gold's advances by 2x to 3x. Yet in 2017, silver only rallied 6.4% despite a much-bigger 13.2% gold rally. That vexing trend has continued in 2018, with silver down 3.8% year-to-date while gold is 1.8% higher. With silver itself really sucking wind, investors sure aren't motivated to buy silver stocks.

Production is the lifeblood of miners, and thus the best place to start fundamental analysis. In Q4'17, these top-17 SIL components collectively produced an impressive 78.6m ounces of silver. If 2016's world-silver-mining run rate is applied to last year's fourth quarter, that implies 221.5m ounces of silver mined. Thus these top SIL silver miners would account for nearly 36% of that total, they truly are major silver players.

Their collective silver production looks solid, climbing 3.0% YoY. But unfortunately that's misleading, as huge growth in a couple mining conglomerates is masking sharp-to-catastrophic declines for some of the rest of these SIL-component miners struggling with low silver prices. Fresnillo and Industrias Pe??oles enjoyed major 20% and 19% YoY gains in silver production off their already-gigantic world-leading bases!

Fresnillo and Industrias Pe??oles have an incestuous relationship, as the former used to be wholly owned by the latter. Industrias Pe??oles spun off Fresnillo back in May 2008 on the London Stock Exchange. While Fresnillo's financial reporting is decent, Industrias Pe??oles' is murky. Neither my decades studying financial statements as a Certified Public Accountant nor my rudimentary Spanish can penetrate very deep.

So I haven't been able to track down how much of Fresnillo that Industrias Pe??oles still owns, nor whether the silver production reported by these silver-mining behemoths is actually mutually exclusive. I'm assuming it is for this analysis, but I'm skeptical. Both companies reported their huge YoY growth in silver production was the result of Fresnillo's new San Juli??n silver mine coming online, which is a big one.

San Juli??n produced 4057k ounces of silver in Q4'17 alone, along with fairly-large gold, zinc, and lead byproducts. It's anticipated to produce 11.6m and 63.7k ounces of silver and gold annually for 12 years. Without San Juli??n, which could be double-reported between Fresnillo and Industrias Pe??oles, the top SIL silver miners' production would look very different. These elite silver miners have had a challenging year.

Excluding Fresnillo and Pe??oles, the rest of these top SIL components saw their collective silver production fall a sizable 6.8% YoY to 44.5m ounces! It's been quite ugly out there in silver-land, for both industry-wide and company-specific reasons. Between Q4'16 and Q4'17, the average silver price retreated 2.5% to just $16.69. That was far worse than average gold's 4.8% YoY gain, testing silver's economics.

With silver prices so weak, sentiment so bearish, and silver-stock prices so darned low, silver miners are both starved of capital for expansions and reluctant to invest heavily in the silver side of their businesses. Mining gold is far more profitable at today's precious metals' prices, so they continue to allocate scarce resources to growing their gold production. That certainly isn't helping the purity of the major silver miners.

A couple long-time favorites of American investors saw silver production plummet over this past year. Tahoe Resources was originally spun off by Goldcorp to develop the incredible high-grade Escobal silver mine in Guatemala. Over the past year that country's corrupt government shut this mine down after a frivolous and baseless lawsuit by anti-mining activists. They sued the government regulator, not Tahoe itself!

That lawsuit claimed Guatemala's Ministry of Energy and Mines did not properly consult with the Xinca indigenous people before granting Escobal's permits! That shouldn't even be Tahoe's problem if the government bureaucrats didn't hold enough meetings, yet Escobal's mining license was still suspended. The dishonorable Guatemalan government has been dragging its feet ever since, so Escobal is frozen in stasis.

The government's lack of respect for the rule of law shows why third-world countries stay that way. For many months it allowed violent anti-mine militants to illegally blockade the road to Escobal and physically attack trucks and their drivers! Tahoe eventually had to fire about half of the 1000+ local employees who had high-paying jobs at that mine. Tahoe's silver production cratered 100% YoY from 4827k ounces to zero.

SSR Mining saw a similar sharp 60% YoY plummet in silver production to just 877k ounces in Q4'17. It had nothing to do with geopolitics like Tahoe's mess, but is simply due to the forecast depletion of its old Pirquitas silver mine. SSR Mining, which used to be called Silver Standard Resources, is exploring in the area trying to extend the life of this mine. But most of its financial resources are being poured into its 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 Q4'17 sales from mining silver, and they are highlighted in blue. WPM, CDE, PAAS, TAHO, and HL are also top-34 components in the leading GDX gold miners' ETF.

While they only comprised 8.3% of GDX's total weighting in late March, 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 2nd-largest holding with a large 12.7% total weighting.

That was intriguing, as I'd never heard of this company after decades of intensely studying and actively trading silver stocks. So I looked into Korea Zinc and found it was merely a smelter, not even a miner! The latest financial data I could find in English was 2015's. That year Korea Zinc "produced" 63.3m ounces of silver, which was largely a byproduct from its main business of smelting zinc, lead, copper, and gold.

I ran the numbers for the heck of it, and silver was implied as 32% of Korea Zinc's 2015 revenues. 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 inferior to gold mining. Thus the average silver-purity percentage of revenues of these SIL miners is only 35.8%.

That's right in line with the downtrend over this past year, with Q4'16, Q1'17, Q2'17, and Q3'17 seeing SIL's top-component silver purity averaging 40.6%, 38.5%, 37.6%, and 40.1%. Silver mining is 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.

But silver generates much lower cash flows due to its lower price. Consider hypothetical mid-sized silver and gold miners, which might produce 10m and 300k ounces annually. At last quarter's average metals prices, these silver and gold mines would yield $167m and $383m of yearly sales. It's far easier to pay the bills mining gold than silver, which is unfortunate. But until silver surges again, that's the way things are.

While I understand this, as a long-time silver-stock investor it saddens me primary silver miners have apparently become a dying breed. When silver starts powering higher in one of its gigantic uplegs and way outperforms gold again, this industry's silver-purity percentage will rise. But unless silver not only shoots far ahead but stays there while gold lags, it's hard to see major-silver-mining purity significantly reversing.

Unfortunately SIL's mid-March composition was such that there wasn't a lot of Q4 cost data reported by its top component miners. A half-dozen of these top SIL companies trade in South Korea, the UK, 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. Industry wide 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 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 Q4'17, these top-17 SIL-component silver miners that reported cash costs averaged $4.66 per ounce. That plunged a whopping 11.6% YoY, making it look like silver miners are far more efficient.

But that's misleading. This past quarter SIL's 17th-largest component was Silvercorp Metals, which enjoys big lead and zinc byproducts at its China silver mines. These base metals are sold and used to offset the costs of silver mining. That forced SVM's cash costs down to negative $5.92 per ounce, which dragged down SIL's overall average. Hecla Mining also enjoyed negative cash costs due to byproduct credits.

Those super-low cash costs help offset SSR Mining's super-high $16.36 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 $5.69 per ounce. As long as silver prices stay above those levels, the silver miners can keep the lights on at their mines. Sub-$6 silver is 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 a silver mine as an ongoing concern. AISC 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 Q4'17 these top-17 SIL components reporting AISCs averaged just $10.16 per ounce. That was down 3.8% YoY, and far below last quarter's average silver price of $16.69. Again SVM's incredible byproduct production dragged down the average though. Ex-Silvercorp, these top SIL silver miners' AISCs ran at an average of $11.33 in Q4. That's still way below prevailing silver prices, generating nice operating profits.

All-in sustaining costs and production are inversely related. Lower silver production, which many of SIL's top components suffered last quarter, leaves fewer ounces to spread the big fixed costs of mining across. Yet average AISCs still retreated, showing these top silver miners are getting more efficient at producing their metal. That will grant the silver miners more upside profits leverage to rising silver as this metal recovers.

At $10.16 AISCs, the major silver miners still earned big profits in the fourth quarter. Once again silver averaged $16.69, implying fat profit margins of $6.53 per ounce or 39%! Most industries would kill for such margins, yet silver-stock investors are always worried silver prices are too low for miners to thrive. That's why it's so important to study fundamentals, because technical price action fuels misleading sentiment.

Today's silver price remains crazy-low relative to prevailing gold levels, portending huge mean-reversion upside. The long-term average Silver/Gold Ratio runs around 56, which means it takes 56 ounces of silver to equal the value of one ounce of gold. Silver is really underperforming gold so far in 2018, with the SGR averaging a stock-panic-like 79.5 YTD as of late March. So silver is overdue to catch up with gold.

At a 56 SGR and $1325 gold, silver is easily heading near $23.66. That's 42% above its Q4 average. Assuming the major silver miners' all-in sustaining costs hold, that implies profits per ounce soaring 107% higher! Plug in a higher gold price or the usual mean-reversion overshoot after an SGR extreme, and the silver-mining profits upside is far greater. Silver miners' inherent profits leverage to rising silver is incredible.

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, actual accounting profits, revenues, and cash on hand. They generally corroborated AISCs in Q4'17, proving silver miners are weathering low prices fine.

The collective operating cash flows generated by these top-17 SIL silver miners grew 2.2% YoY to $590m. That's not bad considering the 2.5% YoY drop in quarterly average silver prices and the 6.8% YoY lower silver production not including Fresnillo and Pe??oles. These strong positive OCFs prove the major silver mines are generating much more cash than they cost to run even at these depressed silver prices.

But the elite silver miners' GAAP accounting profits looked horrendous, weighing in at a huge $703m loss in Q4'17 compared to $157m earned a year earlier! The vast majority of that is due to a single colossal $547m loss from a company that newly climbed into SIL's top 17 components over the past year. In the table above these new companies that weren't among SIL's leading stocks a year ago are highlighted in light blue.

Volcan Compa??ia Minera mines base metals, silver, and gold in the central highlands of Peru. In Q4 it reported a gargantuan net loss of $547m, driven entirely by a negative $570m "Exceptional adjustments". This was described in the management discussion and analysis of quarterly results as necessary "to meet the corporate policies and accounting standards of Glencore", which bought 55% of Volcan's stock in November.

Pulling out that one-time Volcan loss to consolidate its financial results with its new parent's, the top-17 SIL silver miners lost $156m in Q4'17. That's still a major YoY drop, but is reasonable given the weak silver prices and their resulting ongoing non-cash writedowns of silver mines and deposits that look less economical. With lower silver prices and lower production, it wouldn't have surprised me to see far-bigger losses.

The revenue front was interesting, with these top-17 SIL silver miners reporting overall sales of $3331m in Q4'17. That soared 26.6% YoY despite generally-lower production and prices. Pe??oles was definitely a factor, but Fresnillo doesn't break out Q4 sales so they weren't included in Q4'17 or Q4'16. The primary driver was the UK's Polymetal reporting $586m in sales in Q4'17 after breaking out none a year earlier.

These top SIL components' collective cash on hand at the end of Q4 was largely flat at $3715m. That means the strong cash flows generated from operations were plowed back into exploring for more silver and gold to mine, expanding existing mines, and developing new ones. That's still a big pile of cash for this small industry, giving silver miners flexibility to grow their production and ride out any unforeseen challenges.

Silver miners' earnings power and thus stock-price upside potential will only grow as silver mean reverts higher. In mining, costs are largely fixed during the mine-planning stages. That's when engineers decide which ore bodies to mine, how to dig to them, and how to process that ore. Quarter after quarter, the same numbers of employees, haul trucks, excavators, and mills are generally used regardless of silver prices.

So as silver powers higher in coming quarters, silver-mining profits will really leverage its advance. And that will fundamentally support far-higher silver-stock prices. The investors who will make out like bandits on this are the early contrarians willing to buy in low, before everyone else realizes what is coming. By the time silver surges higher with gold so silver stocks regain favor again, the big gains will have already been won.

While investors and speculators alike can certainly play the silver miners' long-stalled mean-reversion bull with this leading SIL ETF, individual silver stocks with superior fundamentals will enjoy the best gains by far. Their upside will trounce the ETFs, which are burdened by companies that don't generate enough of their sales from silver. A handpicked portfolio of purer elite silver miners will yield much-greater wealth creation.

At Zeal we've literally spent tens of thousands of hours researching individual silver stocks and markets, so we can better decide what to trade and when. As of the end of Q4, this has resulted in 983 stock trades recommended in real-time to our newsletter subscribers since 2001. Fighting the crowd to buy low and sell high is very profitable, as all these trades averaged stellar annualized realized gains of +20.2%!

The key to this success is staying informed and being contrarian. That means buying low before others figure it out, before undervalued silver stocks soar much higher. An easy way to keep abreast is through our acclaimed weekly and monthly newsletters. They draw on my vast experience, knowledge, wisdom, and ongoing research to explain what's going on in the markets, why, and how to trade them with specific stocks. For only $12 per issue, you can learn to think, trade, and thrive like contrarians. Subscribe today, and get deployed in the great gold and silver stocks in our full trading books!

The bottom line is the major silver miners fared fine in Q4 despite some real challenges. A combination of silver continuing to seriously lag gold, along with anomalous company-specific problems, weighed on miners' collective results. Yet they continued to produce silver at all-in sustaining costs way below Q4's low prevailing silver prices. And their ongoing diversification into gold leaves them financially stronger.

With silver-stock sentiment remaining excessively bearish, this sector is primed to soar as silver itself resumes mean reverting higher to catch up with gold's young bull market. The silver miners' profits leverage to rising silver prices remains outstanding. After fleeing silver stocks so relentlessly over the past 19 months, investors will have to do big buying to reestablish silver-mining positions. That will fuel major upside.

Adam Hamilton, CPA

March 30, 2018

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