Silver Minersí Q1í17 Fundamentals

Adam Hamilton     May 26, 2017     3265 Words


The silver minersí stocks have been slowly grinding higher this year, but itís been a volatile ride.  This sectorís alternating surges and plunges have spawned outsized swings in sentiment, really distorting investorsí perceptions of the major silver miners.  But once a quarter earnings season arrives, revealing their hard fundamental realities which dispel the obscuring sentiment fogs.  The silver miners reported a solid Q1.


Four times a year publicly-traded companies release treasure troves of valuable information in the form of quarterly reports.  These are generally due by 45 days after quarter-ends in the US and Canada.  They offer true and clear snapshots of whatís really going on operationally, shattering the misconceptions bred by the ever-shifting winds of sentiment.  Thereís no silver-miner data that is more highly anticipated than quarterlies.


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 worldís silver ore formed alongside base metals or gold, and their value usually well outweighs silverís.  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.  It recently released its highly-anticipated World Silver Survey 2017, which covers 2016.  Last 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 silverís 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 5.5x greater than its next-largest competitorís, so SIL really dominates this space.  With ETF investing now the norm, SIL is a boon for its component miners.


While there arenít many silver miners to pick from, major-ETF inclusion shows silver stocks have been vetted by elite analysts.  Due to fund flows into top sector ETFs, being included in SIL is one of the important considerations for picking great silver stocks.  When the vast pools of fund capital seek silver-stock exposure, their SIL inflows force it to buy shares in its underlying companies bidding their prices higher.


Back in mid-May as the major silver miners finished reporting their Q1í17 results, SIL included 29 ďsilver minersĒ.  This term is used rather loosely, as SIL includes plenty of companies which canít be described as primary silver miners.  Most generate well under half their revenues from silver, which greatly limits their stock pricesí leverage to silver rallies.  Nevertheless, SIL is todayís 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, itís not a primary silver miner and its stock price wonít be very responsive to silver itself.  But as silver miners are increasingly actively diversifying into gold, there arenít 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 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 is a commanding sample at 93.8% of SILís total weighting.


While most of these top 17 SIL components had reported on Q1í17 by mid-May, 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 usually means that data wasnít available by the end of Q1ís earnings season.  Some percentage changes are also blank if their data went from positive to negative.


In these tables the first couple columns show each SIL componentís symbol and weighting within this ETF as of mid-May.  Just under a third of these stocks donít trade normally in the States.  So if you canít find a symbol, itís a listing from a companyís primary foreign stock exchange.  Thatís followed by each SIL componentís Q1í17 silver production in ounces, along with its absolute percentage change from Q4í16.


Quarter-on-quarter changes offer a more-granular read on companiesí ongoing operating and financial performance trends than year-over-year comparisons.  QoQ changes are also included for the key data in this tableís right half of cash costs per ounce of silver mined, all-in sustaining costs per ounce, and operating cash flows generated.  Together costs and cash flows reveal the financial health of silver miners.


The Q1í17 silver production is followed by this same quarterís gold production.  Almost every major silver miner in SIL also produces significant-if-not-large amounts of gold!  While gold stabilizes and augments the silver minersí cash flows, it also retards their stocksí sensitivity to silver itself.  Naturally investors and speculators buy silver stocks and their ETFs because they want leveraged exposure to silverís price, not goldís.


So a final column reveals how pure the elite SIL silver miners are.  This is mostly calculated by taking a companyís Q1 silver production, multiplying it by the average silver price in Q1, and dividing that by the companyís total quarterly sales.  If miners didnít report Q1 revenues, I approximated them by adding the silver sales to gold sales based on their quarterly production and these metalsí average first-quarter prices.


After spending lots of time digesting these elite silver minersí latest quarterly results, itís fully apparent their stocksí sharp selloff from mid-April to early May wasnít fundamentally-righteous at all!  The major silver miners remain fundamentally strong, which isnít reflected in their fear-battered stock prices these days.  The silver miners are poised to see exploding profits as silver mean reverts higher with gold this year.



Production is the lifeblood of mining companies, and thus the best place to start fundamental analysis.  In Q1í17, these top 17 SIL components collectively produced an impressive 75.9m ozs of silver.  If 2016ís world-silver-mining run rate is applied to this yearís first quarter, that implies 221.5m ozs of silver mined.  Thus these top SIL silver miners would account for over 34% of that total, so they truly are major silver players.


This big Q1í17 silver production was nearly perfectly stable with Q4í16ís, off a trivial 0.6%.  This is rather remarkable considering the example of gold miners.  As discussed a couple weeks ago in my analysis of the first-quarter results of the major gold miners, gold production has long contracted sharply from Q4s to Q1s.  The silver miners bucked this seasonal trend, and unfortunately I donít know if this is unusual or typical.


Unlike goldís quarterly frequency, comprehensive silver fundamental data from the Silver Institute is only published once a year.  That resolution is obviously insufficient to discern quarter-to-quarter production trends for this industry.  But these silver minersí Q1 gold production did follow the gold minersí, with a collective plunge of 15.9% QoQ to 1.4m ounces.  That was well beyond the top GDX gold minersí -8.5% average.


Many of these elite major silver miners donít just mine gold as a silver byproduct, but actually operate at least one primary gold mine.  The silver miners have collectively decided to diversify into gold due to its superior economics.  Consider hypothetical mid-sized silver and gold miners, which might produce 10m and 300k ounces annually.  What would those cash flows look like at last quarterís average metalsí prices?


In Q1í17, silver and gold averaged $17.44 and $1220.  Those were up a slight 1.9% and 0.2% QoQ.  At 10m ounces, that silver miner would generate $174m in sales.  But the similar-sized gold minerís sales of $366m more than doubles that.  At recent yearsí prevailing prices, the cash flows from gold mining are much more robust than those from silver mining.  That makes it much easier to pay the bills and expand.


Silver mining is often as capital-intensive as gold mining, requiring similar large expenses for planning, permitting, and constructing mines and mills to process ore.  Similar heavy excavators and haul trucks are necessary to dig and haul the ore, along with similar staffing levels to run mines.  So silverís lower cash flows to support all this activity make silver mining harder than gold mining, which isnít lost on silver miners.


Silver-mining profits do skyrocket when silver soars occasionally in one of its massive bull markets.  But during silverís long intervening drifts at relatively-low price levels, the silver miners often canít generate sufficient cash flows to finance expansions.  So the top silver miners are increasingly looking to gold, a trend that isnít likely to reverse given the relative economics of silver and gold.  Primary silver miners are getting rarer.


The silver-streaming giant formerly known as Silver Wheaton is a great example of this.  It was started as a pure-play silver streamer, which silver-stock investors loved.  But in recent years it has brought more and more gold online, and was on the verge of becoming a primary gold play in Q4.  So it just changed its name to Wheaton Precious Metals to reflect its big shift in focus!  The best silver miners are chasing gold.


Technically a company isnít a primary silver miner unless it derives over half its revenues from silver.  In Q1í17, the average sales percentage from silver of these top SIL components was just 38.5%!  That is right on trend over this past year, with Q1í16, Q2í16, Q3í16, and Q4í16 weighing in at 44.9%, 45.3%, 42.8%, and 40.6%.  In Q1í17, only 4 of the top SIL component companies qualified as primary silver miners!


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 massive uplegs and well outperforms gold again, this industryís silver percentage will rise.  But unless silver not only shoots way ahead but stays there while gold lags, itís hard to see major-silver-mining purity significantly reverse.


Unfortunately SILís mid-May composition was such that there wasnít a lot of Q1 cost data reported by its top component miners.  3 of its top 4 companies trade in the UK and Mexico, where reporting only comes in half-year increments.  Lower down the list there were more half-year reporters, an explorer with no production, primary gold miners that donít report silver costs, and a company forced to delay its Q1 results.


Nevertheless, itís always useful to look at the data 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 sectorís 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 Q1í17, these top 17 SIL-component silver miners that reported cash costs averaged $6.75 per ounce.  That was a colossal 28.0% QoQ jump from Q4ís $5.28, which seems like a troubling omen.


But itís not.  Flighty silver-stock investors are always on the verge of panicking, fleeing this volatile and psychologically-challenging sector.  But the only event worthy of such extreme bearishness would be prevailing silver prices falling near cash costs.  And even at $6.75-per-ounce cash costs and todayís low silver, a vast buffer exists.  Thereís no way silver is going to plunge down under $7 in any conceivable scenario.


These high cash costs are actually an anomaly driven by two individual companies.  First Silver Standard is now winding down its rapidly-depleting silver mine as planned.  It produced 10.4m ounces of silver in 2016, but only 5.0m is forecast this year!  As silver throughput drops each quarter, the per-ounce costs are rising.  Without SSRIís outlying super-high cash costs, the rest of these top SIL miners averaged just $5.77.


Another company Silvercorp Metals had slid out of SILís top 17 components as of mid-May.  It was the 18th one, removing it from this particular calculation.  Due to SVMís massive lead and zinc byproducts, its costs are the lowest in the industry.  In Q4í16, it reported cash costs of negative $5.48 per ounce!  That really dragged down the average.  So the major silver minersí collective cash costs were just fine in Q1.


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 minersí true operating profitability.


In Q1í17, these top 17 SIL components reporting AISC averaged $11.50 per ounce.  That was up 8.9% QoQ from Q4ís $10.56.  But again SSRIís collapsing depletion production and surging costs were the dominant reason.  Ex-SSRI, this average ran $10.84 which was much closer to Q4ís levels.  And that Q4 number was artificially low since it included SVMís incredible $1.87 AISC due to its huge base-metals byproducts.


At $11.50 AISC, the major silver miners still earned big profits in the first quarter.  Silver again averaged $17.44 per ounce, implying fat profit margins of $5.94 per ounce or 34%!  Most industries would kill for such margins, yet silver-stock investors are always worried silver prices are too low for miners to thrive.  Thatís why itís so important to study fundamentals, because technical price action fuels misleading sentiment!


Todayís silver price is indeed really low relative to prevailing gold levels, which portends huge upside as it mean reverts higher.  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 2017, with the SGR averaging just 71 year-to-date as of mid-May.  So silver is overdue to catch up with gold.


At a 56 SGR and $1250 gold, silver is easily heading over $22.25.  Thatís 28% above its Q1 average.  Assuming the major silver minersí all-in sustaining costs hold, that implies profits per ounce soaring 82% higher!  Plug in a higher gold price or the typical mean-reversion overshoot after an SGR extreme, and the silver-mining profits upside is far greater.  Silver minersí inherent profits leverage to rising silver is incredible.


The silver minersí strong fundamentals even in Q1 are evident in their collective cash flows generated from operations.  They surged 29% QoQ to $712m despite slightly-lower silver production and average silver prices only up 1.9% from Q4.  Operating cash flows will skyrocket too as silver regains lost ground relative to its dominating primary driver gold.  That will finance mine expansions leading to higher production.


Silver-mining was actually quite profitable in Q1, despite all investorsí worries about prevailing silver price levels.  These top 17 SIL components reporting hard GAAP quarterly profits actually earned a collective $346m in the first quarter, a whopping 131% higher than Q4ís levels!  The popular idea that silver-mining fundamentals just arenít favorable near $17.50 silver is flat-out wrong.  The silver miners are already thriving.


And their earnings power and thus stock-price potential will only grow as silver mean reverts higher.  In silver mining, costs are largely fixed during the mine-planning stages.  Thatís 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 minersí ongoing 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 ETFsí, which are burdened by companies that donít generate much of their sales from silver.  A handpicked portfolio of purer elite silver miners will yield much-greater wealth creation.


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The bottom line is the major silver miners were fundamentally strong in Q1í17, despite investors fretting about silver prices languishing.  The miners were actually still earning fat profits, thanks to industry cost levels remaining well under prevailing silver prices.  And silver minersí operating cash flows have been really augmented by their increasing diversification into gold, which now has superior economics to silver.


With silver-stock sentiment remaining excessively bearish, this sector is primed to soar as silver itself continues mean reverting higher to catch up with goldís new upleg.  The silver minersí profits leverage to rising silver prices remains outstanding.  After fleeing silver stocks so aggressively in Q4, investors and speculators alike will have to do big buying to reestablish silver-mining positions.  These inflows will fuel major upside.


Adam Hamilton, CPA     May 26, 2017     Subscribe