Silver SIL Mining Stocks Fundamentals / Commodities / Gold & Silver 2019

The silver miners’ stockshave been pummeled in recent months, plunging near major secular lows in late May.  Sentiment in this tiny sector is miserable,reflecting silver prices continuing to languish relative to gold.  This has forced traditional silver miners toincreasingly diversify into gold, which has far-superior economics.  The major silver miners’ ongoing shift fromsilver is apparent in their recently-released Q1’19 results.

Four times a yearpublicly-traded companies release treasure troves of valuable information inthe form of quarterly reports.  Requiredby the US Securities and Exchange Commission, these 10-Qs and 10-Ks contain thebest fundamental data available to traders. They dispel all the sentiment distortions inevitably surrounding prevailingstock-price levels, revealing corporations’ underlying hard fundamentalrealities.

The definitive list ofmajor silver-mining stocks to analyze comes from the world’s most-popular silver-stockinvestment vehicle, the SIL Global X Silver Miners ETF.  Launched way back in April 2010, it hasmaintained a big first-mover advantage. SIL’s net assets were running $294m in mid-May near the end of Q1’searnings season, 5.6x greater than its next-biggest competitor’s.  SIL is the leading silver-stock benchmark.

In mid-May SIL included24 component stocks, which are weighted somewhat proportionally to their marketcapitalizations.  This list includes theworld’s largest silver miners, including the biggest primary ones.  Every quarter I dive into the latest operatingand financial results from SIL’s top 17 companies.  That’s simply an arbitrary number that fitsneatly into the table below, but still a commanding sample.

As of mid-May thesemajor silver miners accounted for fully 94.4% of SIL’s total weighting.  In Q1’19 they collectively mined 70.9m ouncesof silver.  The latest comprehensive dataavailable for global silver supply and demand came from the Silver Institute inApril 2019.  That covered 2018, whenworld silver mine production totaled 855.7m ounces.  That equates to a run rate around 213.9mounces per quarter.

Assuming that miningpace persisted in Q1’19, SIL’s top 17 silver miners were responsible for about33% of world production.  That’s relativelyhigh considering just 26% of 2018’s global silver output was produced atprimary silver mines!  38% came fromlead/zinc mines, 23% from copper, and 12% from gold.  Nearly 3/4ths of all silver produced worldwide is just a byproduct.  Primary silver mines and miners are fairlyrare.

Scarce silver-heavydeposits are required to support primary silver mines, where over half their revenue comes fromsilver.  They are increasingly difficultto discover and ever-more expensive to develop. And silver’s challenging economics of recent years argue against minerseven pursuing it.  So even traditional majorsilver miners have shifted their investment focus into actively diversifyinginto far-more-profitable gold.

Silver price levels arebest measured relative to prevailing gold prices, which overwhelmingly drive silverprice action.  In late May the Silver/Gold Ratio continuedcollapsing to its worst levels witnessed in 26.1 years, since April 1993!  These secular extremes of the worst silver pricelevels in over a quarter century aremultiplying the endless misery racking this once-proud sector.  This silver environment is utterly wretched.

The largest silverminers dominating SIL’s ranks are scattered around the world.  10 of the top 17 mainly trade in US stockmarkets, 3 in the United Kingdom, and 1 each in South Korea, Mexico, Peru, and Canada.  SIL’s geopolitical diversity is good forinvestors, but makes it difficult to analyze and compare the biggest silver miners’results.  Financial-reportingrequirements vary considerably from country to country.

In the UK companies reportin half-year increments instead of quarterly. Some silver miners still publish quarterly updates, but their data islimited.  In cases where half-year datais all that was made available, I split it in half for a Q1 approximation.  Canada has quarterly reporting, but thedeadlines are looser than in the States. Some Canadian miners really drag their feet, publishing theirquarterlies close to legal limits.

The big silver companiesin South Korea, Mexico, and Peru present other problems.  Their reporting is naturally done in theirown languages, which I can’t decipher.  Somerelease limited information in English, but even those translations can be difficultto interpret due to differing accounting standards and focuses.  It’s definitely challenging bringing all thequarterly data together for the diverse SIL-top-17 silver miners.

But analyzing them in the aggregate is essential to understandhow they are faring.  So each quarter Iwade through all available operational and financial reports and dump the datainto a big spreadsheet for analysis.  Somehighlights make it into this table.  Blankfields mean a company hadn’t reported that data by mid-May, as Q1’s earningsseason wound down.  Some of SIL’s componentsreport in gold-centric terms.

The first couplecolumns of this table show each SIL component’s symbol and weighting withinthis ETF as of mid-May.  While most ofthese stocks trade on US exchanges, some symbols are listings from companies’primary foreign stock exchanges.  That’sfollowed by each miner’s Q1’19 silver production in ounces, along with itsabsolute year-over-year change.  Nextcomes this same quarter’s gold production.

Nearly all the majorsilver miners in SIL also produce significant-to-large amounts of gold!  That’s truly a double-edged sword.  While gold really stabilizes and boostssilver miners’ cash flows, it also retards their stocks’ sensitivity to silveritself.  So the next column reveals how pure these elite silver miners are,approximating their percentages of Q1’19 revenues actually derived fromsilver.  This is calculated one of twoways.

The large majority ofthese top SIL silver miners reported total Q1 revenues.  Quarterly silver production multiplied bysilver’s average price in Q1 can be divided by these sales to yield an accuraterelative-purity gauge.  When Q1 salesweren’t reported, I estimated them by adding silver sales to gold sales basedon their production and average quarterly prices.  But that’s less optimal, as it ignores anybase-metals byproducts.

Next comes the majorsilver miners’ most-important fundamental data for investors, cash costs andall-in sustaining costs per ounce mined. The latter directly drives profitability which ultimately determines stockprices.  These key costs are alsofollowed by YoY changes.  Last but notleast the annual changes are shown in operating cash flows generated and hardGAAP earnings, with a couple exceptions necessary.

Percentage changes aren’trelevant 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 ormisleading percentage changes.  Companieswith symbols highlighted in light-blue have newly climbed into the elite ranksof SIL’s top 17 over this past year.  Thisentire dataset together is quite valuable.

It offers a fantastic high-levelread on how the major silver miners are faring fundamentally as an industry and individually.  The crazy-low silver prices really weighed onoperating cash flows and earnings in Q1, and the silver miners’ years-old shiftinto gold continued.  These companies arehaving no problem just surviving this silver-sentiment wasteland, but they probablywon’t be thriving again before silver recovers.

SIL’s poor performancecertainly reflects the challenges of profitably mining silver with its price sodarned cheap.  Year-to-date in late May,SIL had already lost 12.2%.  Silver itselfwas down 7.2% YTD at worst, starting to threaten mid-November 2018’s 2.8-yearsecular low of $13.99.  And that justextended last year’s losing trend, where SIL plunged 23.3% amplifying silver’sown 8.6% loss by 2.7x.  This sector looksugly.

Silver’s weakest pricesrelative to gold in over a quarter century have continued to devastatesilver-mining sentiment.  Investors understandablywant nothing to do with the forsaken silver miners, so their stock priceslanguish near major lows.  Even their ownmanagements seem really bearish, increasingly betting their companies’ futureson gold rather than silver.  Silver’s Q1price action further supports this decision.

During Q1’19 silver groundanother 2.3% lower despite a 0.8% gold rally, bucking its primary driver.  Q1’s average silver price of $15.54 fell 7.1%YoY from Q1’18’s average.  That was wayworse than gold’s mere 1.9% YoY average-price decline.  The silver-mining industry is laboring undera pall of despair.  Although productiondecisions aren’t made quarter by quarter, the chronically-weak silver pricesare choking off output.

Production is thelifeblood of silver miners, and it continued to slide.  The SIL top 17 that had reported their Q1results by mid-May again mined 70.9m ounces of silver.  That was down 3.1% YoY from Q1’18’s silverproduction, excluding Silvercorp Metals. SVM’s fiscal years end after Q1s, and it doesn’t report its longer more-comprehensiveannual results until well after Q1’s normal quarterly earnings season wraps up.

It’s not just thesemajor silver miners producing less of the white metal, the entire industry isaccording to the Silver Institute’s latest World Silver Survey.  2018 was the third year in a row of waningglobal silver mine production.  Thisshrinkage is accelerating too as silver continues to languish, running 0.0% in2016, 1.8% in 2017, and 2.4% in 2018!  Peak silver may have been seen with thismetal so unrewarding to mine.

The traditional majorsilver miners aren’t taking silver’s vexing fading lying down.  They’ve spent recent years increasinglydiversifying into gold, which has way-superior economics with silver prices sobombed out.  The SIL top 17’s total goldproduction surged 10.9% YoY to 1387k ounces in Q1!  This producing-less-silver-and-more-goldtrend will continue to grow as long as silver prices waste away in the gutter.

Silver mining is ascapital-intensive as gold mining, requiring similar large expenses to plan,permit, and construct new mines, mills, and expansions.  It needs similar fleets of heavy excavatorsand haul trucks to dig and move the silver-bearing ore.  Similar levels of employees are necessary torun silver mines.  But silver generates much-lower cash flows than gold due itslower price.  Silver miners have been forcedto adapt.

This is readily evidentin the top SIL miners’ production in Q1’19. SIL’s largest component in mid-May as this latest earnings season endedwas the Russian-founded but UK-listed Polymetal.  Its silver production fell 15.0% YoY in Q1,but its gold output surged 41.1%!  Just17.5% of its Q1 revenues came from silver, making it overwhelmingly a primarygold miner.  Its newest mine ramping upis another sizable gold one.

SIL’s second-largestcomponent is Wheaton Precious Metals.  Itused to be a pure silver-streaming play known as Silver Wheaton.  Silver streamers make big upfront payments tominers to pre-purchase some of their future silver production at far-below-marketunit prices.  This is beneficial tominers because they use the large initial capital infusions to help financemine builds, which banks often charge usurious rates for.

Back in May 2017 Wheatonchanged its name and symbol to reflect its increasing diversification into goldstreaming.  In Q1’19 WPM’s silver outputcollapsed 24.4% YoY, but its gold surged 17.4% higher!  That pushed its silver-purity percentage insales terms to just 38.8%, way below the 50%+ threshold defining primary silverminers.  WPM’s 5-year guidance issued inFebruary forecasts this gold-heavy ratio persisting.

Major silver miners arebecoming so scarce that SIL’s third-largest component is Korea Zinc.  Actually a base-metals smelter, this company has nothing to do with silver mining.  It ought to be kicked out of SIL post-haste,as its presence and big 1/9th weighting really retards this ETF’sperformance.  Korea Zinc smelted about 64.0mounces of silver in 2018, which approximates roughly 17% of its full-year revenue.

Global X was really scrapingthe bottom of the barrel to include a company like Korea Zinc in SIL.  I’m sure there’s not a single SIL investorwho wants base-metals-smelting exposure in what is advertised as a “SilverMiners ETF”.  The weighting and capital allocatedto Korea Zinc can be reallocated and spread proportionally across the other SILstocks.  The ranks of major silver minersare becoming more rarefied.

SIL’s fourth-largestcomponent in mid-May is Pan American Silver, which has a proud heritage miningits namesake metal.  In Q1’19 its silver productionwas flat with a negligible 0.4% YoY increase, yet its gold output soared 74.2%!  Thus PAAS’s silver purity slumped to 40.9%,the lowest by far seen in the years I’ve been doing this quarterly research.  And it’s going to get much more gold-centricin coming quarters.

PAAS acquired troubledsilver miner Tahoe Resources back in mid-November.  Tahoe had owned what was once the world’slargest silver mine, Escobal in Guatemala. It had produced 5.7m ounces in Q1’17 before that country’s government unjustly shut it down aftera frivolous lawsuit on a trivial bureaucratic misstep by the regulator.  PAAS hopesto work through the red tape to win approval for Escobal to restart.

But the real prize inthat fire-sale buyout was Tahoe’s goldproduction from other mines.  Thatdeal closed in late February, so that new gold wasn’t fully reflected in PAAS’sQ1 results.  Now this former silver giantis forecasting midpoint production of 27.1m ounces of silver and 595.0k ouncesof gold in 2019!  That is way intomid-tier-gold territory and a far cry from 2018’s output of 24.8m and178.9k.  PAAS has turned yellow.

Pan American willprobably soon follow in Wheaton’s footsteps and change its name and symbol toreflect its new gold-dominated future. As miserable as silver has been faring, I’m starting to wonder if theword “silver” in a miner’s name is becoming a liability with investors.  The major primary silver miners are going extinct, forced to adapt by diversifying out of silverand into gold as the former languishes deeply out of favor.

In Q1’19 the SIL-top-17miners averaged only 35.4% of theirrevenues derived from silver.  That’salso the lowest seen since I started this thread of research with Q2’16results.  Only two of these minersremained primary silver ones, and their silver-purity percentages over 50% are highlightedin blue.  They are First Majestic Silverand Fortuna Silver Mines, which together accounted for just 7.6% of SIL’s totalweighting.

With SIL-top-17 silverproduction sliding 3.1% YoY in Q1’19, the per-ounce mining costs should’ve risenproportionally.  Silver-mining costs arelargely fixed quarter after quarter, with actual mining requiring the same levelsof infrastructure, equipment, and employees. So the lower production, the fewer ounces to spread mining’s big fixedcosts across.  SIL’s major silver minersindeed reported higher costs last quarter.

There are two majorways to measure silver-mining costs, classic cash costs per ounce and the superiorall-in sustaining costs.  Both are usefulmetrics.  Cash costs are the acid test ofsilver-miner survivability in lower-silver-price environments, revealing theworst-case silver levels necessary to keep the mines running.  All-in sustaining costs show where silverneeds to trade to maintain current mining tempos indefinitely.

Cash costs naturallyencompass all cash expenses necessaryto produce each ounce of silver, including all direct production costs,mine-level administration, smelting, refining, transport, regulatory, royalty,and tax expenses.  In Q1’19 these SIL-top-17silver miners reported cash costs averaging $7.39 per ounce.  While that surged 23.6% YoY, it still remainsfar below prevailing prices.  Silver minersface no existential threat.

The major silver miners’average cash costs vary considerably quarter-to-quarter, partially depending onwhether or not Silvercorp Metals happens to have edged into the top 17.  This Canadian company mining in China has negative cash costs due to massive byproductcredits from lead and zinc.  So over thepast couple years, SIL-top-17 average cash costs have swung wildly ranging allthe way from $3.95 to $6.75.

Way more important thancash costs are the far-superior all-in sustaining costs.  They were introduced by the World GoldCouncil in June 2013 to give investors a much-better understanding of what itreally costs to maintain silver mines as ongoing concerns.  AISCs include all direct cash costs, but thenadd on everything else that is necessary tomaintain and replenish operations at current silver-production levels.

These additionalexpenses include exploration for new silver to mine to replace depletingdeposits, mine-development and construction expenses, remediation, and minereclamation.  They also include thecorporate-level administration expenses necessary to oversee silver mines.  All-in sustaining costs are themost-important silver-mining cost metric by far for investors, revealing silverminers’ true operating profitability.

The SIL-top-17 silverminers reporting AISCs in Q1’19 averaged $12.70 per ounce, 7.2% higher YoY.  That remained considerably below last quarter’saverage silver price of $15.54, as well as late May’s ugly silver low of $14.34.  So the silver-mining industry as a whole is still profitable even with silver driftingnear quarter-century-plus lows relative to gold.  And those AISCs are skewed higher by SSRMining’s outlying read.

Another traditionalsilver miner that changed its name, this company used to be known as Silver StandardResources.  SSRM has shifted into goldtoo, gradually winding down its old Pirquitas silver mine resulting inabnormally-high AISCs of $19.76 per ounce. Excluding these, the SIL-top-17 average in Q1 falls to $10.94 which is amuch-more-comfortable profits cushion between production costs and low silverprices.

Interestingly SSRM hasbeen ramping up a new mine close to its old Pirquitas mill, and is starting torun that ore through.  That makes SSRMining one of the rare silver miners that’s going to see growing output thisyear.  It is forecasting a midpoint of 4.9mounces of silver production in 2019, a 74% jump from last year’s levels!  Higher production should lead to lower AISCs goingforward, pulling the average back down.

As hopeless as silverhas looked in recent months, it won’t stay down forever.  Sooner or later gold will catch a major bid, probablyon surging investment demand as these dangerous stock markets rollover.  Capital will start migrating backinto silver like usual once gold rallies long enough and high enough toconvince traders its uptrend is sustainable. Since the silver market is so small, that portends much-higher prices.

At Q1’19’s averagesilver price of $15.54 and average SIL-top-17 AISCs of $12.70, these minerswere earning $2.84 per ounce.  That’s notbad for a sector that investors have left for dead, convinced it must bedoomed.  Being so wildly undervaluedrelative to gold, silver has the potential to surge much higher in the next goldupleg.  The average Silver/Gold Ratio since Q1’16 right after today’sgold bull was born was 77.1x.

At $1400 and $1500 goldwhich are modest upleg gains, silver mean reverting to recent years’ averageSGR levels would yield silver targets of $18.16 and $19.46.  That’s conservative, ignoring the high oddsfor a mean-reversion overshoot, andonly 16.9% and 25.2% above Q1’s average price. Yet with flat AISCs that would boost the SIL top 17’s profits by 92.3%and 138.0%!  Their upside leverage tosilver is amazing.

The caveat is thedegree to which silver miners’ earnings amplify this metal’s upside is dependenton how much of their sales are still derived from silver when it turnsnorth.  If the SIL top 17 are still getting35% of their sales from silver, their stocks should surge with silver.  But the more they diversify into gold, themore dependent they will be on gold-price moves.  Those aren’t as big as silver’s since gold isa far-larger market.

On the accounting frontthe top 17 SIL silver miners’ Q1’19 results highlighted the challenges of super-lowsilver prices.  These companiescollectively sold $3.0b worth of metals in Q1, which actually clocked in at animpressive 10.8% YoY increase.  That wastotally the result of these companies mining 10.9% more gold in Q1.  Though it dilutes their silver-priceexposure, shifting into gold really strengthens them financially.

But operating-cash-flowgeneration looked much worse, collapsing 55.1% YoY to $237m across the SIL top17 that reported them for Q1.  There wasno single-company disaster, but Q1’s average silver prices being 7.1% lower YoYeroded OCFs universally.  That led to theseminers’ collective treasuries shrinking 22.9% YoY to $2.3b.  That’s plenty to operate on, but not that muchto fund many mine builds or expansions.

Hard GAAP profits reportedby the SIL top 17 silver miners were very weak too in Q1’19, plunging 54.9% YoYto $123m.  But there were no major writedownsfrom these low silver prices impairing the value of silver mines and deposits.  Investors don’t buy silver stocks for howthey are doing today, but for what they are likely to do as silver mean reverts higher.  Silver-mining earnings surge dramatically assilver recovers.

Silver’s last majorupleg erupted in essentially the first half of 2016, when silver soared 50.2%higher on a parallel 29.9% gold upleg.  SIL blasted 247.8% higher in just 6.9 months,a heck of a gain for major silver stocks. But the purer primary silver miners did far better.  The purest major silver miner First Majestic’sstock was a moonshot, skyrocketing a staggering 633.9% higher in that sameshort span!  SIL’s gains are muted.

The key takeaway here is avoid SIL.  The world’s leading “Silver Miners ETF” is increasinglyburdened with primary gold miners with waning silver exposure.  And having over 1/9th of your capitalallocated to silver miners squandered in Korea Zinc is sheer madness!  If you want to leverage silver’s long-overduenext mean reversion higher relative to gold, it’s far better to deploy in smallerpurer primary silver miners alone.

One of my core missionsat Zeal is relentlessly studying the silver-stock world to uncover the stockswith superior fundamentals and upside potential.  The trading books in both our popular weekly and monthly newsletters arecurrently full of these better gold and silver miners.  Mostly added in recent months as these stocks recovered from deep lows,their prices remain relatively low with big upside potential as gold rallies!

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The bottom line is themajor silver miners are still struggling. With silver continuing to languish at quarter-century-plus lows relativeto gold, the economics of extracting it remain challenging.  That led to slowing silver production andhigher costs in Q1.  The traditionalmajor silver miners continued their years-long trend of increasinglydiversifying into gold.  Their percentageof sales derived from silver is still shrinking.

There aren’t enough majorprimary silver miners left to flesh out their own ETF, which is probably whySIL is dominated by gold miners.  While itwill rally with silver amplifying its gains, SIL’s upside potential is justdwarfed by the remaining purer silver stocks. Investors will be far-better rewarded buying them instead of settlingfor a watered-down silver-miners ETF.  Theirstocks will really surge as silver mean reverts much higher.

Adam Hamilton, CPA

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