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Silver Miners Strong in Grim Q4

Adam Hamilton
Apr 29, 2016

The silver miners showed impressive fundamental strength during 2015's grim fourth quarter. That was the worst silver suffered in many years, a perfect-storm trough with major secular lows fueling extreme bearish sentiment. Traders feared this entire industry faced an existential threat, so they fled in terror from silver stocks. But silver miners' strong operational performances aced that severe trial with flying colors.

Q4'15 may seem like ancient history now, but it was exceedingly important for the entire precious-metals realm. Gold slumped to a miserable 6.1-year secular low in mid-December, on the day after the Fed hiked rates for the first time in 9.5 years. That was wildly irrational based on market history, which has proven gold thrives during Fed-rate-hike cycles with big average gains. Gold hadn't seen lower prices since Q4'09.

Since silver's overwhelmingly-dominant driver is gold, the white metal followed the yellow metal lower. Just several days before gold's secular low in mid-December, silver dropped to a dismal 6.4-year secular low of its own. Q4'15's average silver price of $14.77 was the worst since Q3'09's $14.72. Silver was perfectly fulfilling its traditional role of acting like a gold sentiment gauge, tracking its driver into the abyss.

With silver spiraling lower with gold and the vast majority of analysts predicting that trend to continue indefinitely, the silver miners were assumed to be fighting for their very survival. As dismal silver prices squeezed their operations, hyper-bearish sentiment and the resulting super-low stock prices made it almost impossible for them to raise capital. Q4'15 was one of the roughest quarters silver miners ever faced!

Thus it's important to understand how the silver miners actually fared operationally during their darkest quarter. Just as fierce storms prove the mettle of sailors, so do extreme market situations reveal the true health of companies. Was the silver-mining industry on the verge of bankruptcy in Q4'15 as widely feared? Or were the silver miners stalwartly weathering that super-storm without even taking on water?

I've wondered about the silver miners ever since silver's deep secular lows in December, but couldn't investigate properly until they had fully reported their Q4 operational results. While quarterly results are normally due out 45 days after quarter ends, Q4 is an exception with a 90-day deadline. That's because Q4 results must be fully audited by CPA firms to feed into the massive and challenging-to-prepare 10-K reports.

With auditors universally swamped, many silver miners didn't get around to reporting their Q4s until late March. I carved out the time to start wading into their voluminous 10-Ks in mid-April, prompted by a subscriber urging me to get on it. Even though Q1'16 reporting is now upon us, Q4'15 remains a very important baseline quarter to consider before analyzing Q1 results. It was an acid test for the silver miners.

Silver mining is a difficult sector to analyze. Pure silver deposits are fairly rare, with the vast majority of the world's silver production coming as a byproduct from base-metals and gold mining. So primary silver mines are relatively scarce compared to all the mines that produce silver. And most companies billing themselves as silver miners produce gold in such quantities that they really aren't primary silver miners.

The logical way to classify miners' primary metal is by the percentages of revenues they derive from the metals they mine. If a majority of a miner's sales come from a single metal that isn't silver, then it really isn't a primary silver miner. Of course this definition is fluid with silver prices. The lower silver falls, the less weight silver sales have within overall revenues. And Q4'15 certainly hit an extreme on that front.

At that trough quarter's average silver and gold prices of $14.77 and $1105, the cash flows from silver mining lagged far behind gold mining. Compare a mid-sized silver miner with a mid-sized gold miner, which might produce 10m ounces and 300k ounces a year respectively. At Q4'15's average prices, this silver miner only yields annual sales of $148m while the gold miner brings in a far-higher $331m a year.

Most silver miners also produce gold, both because it is naturally found with their silver deposits and because its strong cash flows greatly improve the economics of silver mining. So any list that anyone constructs of "primary" silver miners at these low prevailing silver prices is going to include lots of gold. Silver miners have even diversified into gold in recent years by purchasing new gold-dominated mines.

The least-controversial roster of silver miners to analyze comes from the leading silver-mining ETFs. The flagship one is the SIL Global X Silver Miners ETF. It contained 20 holdings in mid-April, and had almost an order of magnitude more assets than its distant-second-place competitor the SLVP iShares MSCI Global Silver Miners ETF. And all but 1 of SLVP's 10 component companies are also included in SIL.

This table looks at the operational fundamentals of SIL's top 17 holdings in that grim Q4'15. Together they comprise nearly 97% of SIL's weighting. Each company's symbol, exchange, weighting in SIL, and mid-April market capitalization is noted. Unlike the leading gold-stock ETFs, SIL really isn't market-cap weighted. That's perfectly understandable, given its components' varying fractions of revenues from silver.

The next column shows the approximate percentage of each company's Q4'15 sales actually derived from silver. I had to compute this in several different ways depending on what each company reported. Some broke out actual Q4 silver production, gold production, and revenues individually, while some simply lumped it all in to full-year-2015 results. In the latter case, those full-year numbers were divided by 4.

With Q4'15 being the worst quarter for silver prices in over 6 years, the degree to which all these miners are primary silver miners was abnormally low at that trough. As silver continues rallying and naturally outpaces gold, these percentages should generally rise in future quarters. Nevertheless, all these main SIL components that truly qualified as primary silver miners with 50%+ of their sales from silver are highlighted.

The next columns are cash costs per ounce, all-in sustaining costs per ounce, and AISC outlooks for 2016. These numbers weren't always available for silver since about a quarter of SIL's components consider themselves primary gold miners. The fact that SIL's managers chose to include them in their silver-miner ETF emphasizes what a rare breed actual primary silver miners have become these days.

That's followed by each component's cash balance at the end of Q4'15, the operating cash flows that were generated in that trough quarter, and the actual silver and gold produced that quarter. Again if a company didn't break out its Q4 results from its full-year 2015's, I divided by 4 for an approximation. The variability in the way silver miners report results makes getting comparable numbers somewhat complicated.

Of these top 17 SIL components, just 6 were actually primary silver miners in Q4 as defined by earning over 50% of their revenues from silver. The purest silver plays were the mighty silver streamer Silver Wheaton, First Majestic Silver, Fortuna Silver Mines, Endeavour Silver, and Pan American Silver. But with an overall average of 47.5% silver sales even with Q4's extreme silver lows, SIL's list is impressive.

Once again as silver prices recover, these percentages of revenues from silver should generally rise in future quarters. But that's not true universally. Some of these SIL silver miners are buying or merging with primary gold miners, which will further dilute silver's importance to their revenues and therefore their stock price's leverage to silver gains. Tahoe Resources, SIL's largest component, is the prime example.

Tahoe was originally a spinoff from Goldcorp to create an amazing totally-pure primary silver miner to develop its fantastic Escobal deposit in Guatemala. That was advanced into the world's third-largest silver mine. But with Tahoe since buying Rio Alto Mining and its Peruvian La Arena gold mine just over a year ago, and Lake Shore Gold and its Canadian Timmins West mine a month ago, it's now a different company.

Tahoe's latest 2016 outlook projects midpoint gold production of 400k ounces in 2016, along with 19.5m ounces of silver. At $1250 and $17 prices, that yields projected revenues of $500m and $332m. While Tahoe's evolution into a primary gold producer makes it a much stronger company, it is definitely a lot less attractive for investors looking for silver-centric exposure. True primary silver miners are becoming rarer.

Q4'15's sub-$15 average silver prices were believed at the time to be putting severe stress on silver mining's viability. But that was just the extremely-bearish sentiment talking, as that quarter's operating results proved that was far from the fundamental truth. The silver miners in SIL reporting cash costs had an average of just $6.68 per ounce! Some of these numbers are silver-only, some are after byproducts.

Cash costs are the acid-test measure of silver-mining survivability. They are the direct costs, excluding corporate-level management, necessary to continue operating existing mines. Theoretically the silver miners could've continued paying the bills in Q4'15 even if silver had catastrophically cratered into the $7s! So $15 silver wasn't even remotely close to being an existential threat, that misguided thesis was dead wrong.

Far more interesting were the all-in sustaining costs the silver miners reported in that grim trough Q4. They are way more relevant since they include all costs necessary to sustain and replenish current silver-production levels. This is critical since silver mines are constantly depleting. If companies can't find new mineable economic deposits to offset the exhaustion of existing ones, their businesses aren't durable.

AISC include all direct cash costs of mining silver, as well as corporate-level administration that always should've been included in misleading cash costs. They also include exploration for new silver to mine, mine-development and construction expenses, remediation, and reclamation. All-in sustaining costs are a far-superior measure to cash costs, as they reveal the true costs for silver miners to continue as going concerns.

Amazingly the elite silver miners of SIL reported average Q4'15 all-in sustaining costs of just $13.14 per ounce! Again since these silver miners report so differently, some of these numbers are silver-only while some use gold as a byproduct credit. Nevertheless, that was well below Q4's average silver price of $14.77. It was even considerably under silver's dismal 6.4-year secular low of $13.69 in mid-December!

Such low AISC are simply stunning, shattering Q4'15's myth that silver miners were on the ropes. Even in that grim trough quarter, silver miners earned an average of $1.63 per ounce even after all of the big costs they needed to maintain current production levels! That's actually a profit margin of 11%, which certainly isn't high but is still better than plenty of other industries. Silver miners never faced an existential threat!

And if silver miners fared so well even in Q4 with all the cards stacked against them, their profits are going to explode as silver recovers. While silver lagged gold's recovery in Q1 and only averaged $14.90, it started to catch up in March as silver investors returned. Like gold, silver's price is overdue to mean revert dramatically higher as markets recover from the Fed's gross distortions running rampant in recent years.

In 2015, 2014, 2013, and 2012, silver averaged $15.68, $19.05, $23.80, and $31.19. Since the costs of mining silver are largely fixed during the mine-planning stages when specific ore bodies are targeted and recovery methods defined, silver-price increases generally flow right through to the bottom line. As silver mean reverts back to these recent-year average levels, silver-mining profits will literally explode.

At Q4'15's $13.14 all-in sustaining costs, silver-mining profits would catapult to $2.54, $5.91, $10.66, and $18.05 per ounce at recent years' average silver prices in reverse order. Those represent enormous 56%, 263%, 554%, and 1008% skyrocketings in operating profits for mere 6%, 29%, 61%, and 111% gains in silver prices! Silver miners' upside profits leverage to silver-price increases is mind-boggling.

Since profits ultimately drive stock prices, this profits leverage is the main reason why investors in the beaten-down silver stocks are going to earn great fortunes in the coming years as silver mean reverts higher with gold. Interestingly silver miners are still working hard to lower costs too, so their potential jumps in profits will be even larger. SIL components' average projection for silver AISC in 2016 is just $12.86.

Snapping back to that grim reality of Q4'15, these silver miners generally had plenty of cash on hand even emerging from that miserable trough quarter. Even better, they generated positive cash flows from operations in Q4 even with silver languishing near those major secular lows. And in many cases, these operating cash flows were relatively fairly large and contributed substantially to growing cash balances.

As long as any company can generate positive cash flows from operations, it can remain in business indefinitely. And with the exception of the one silver explorer in this table, MAG Silver which doesn't have any producing mines yet, all these silver miners generated positive cash flows in Q4'15. This yet again proves that the extreme bearish sentiment plaguing silver miners late last year was totally unfounded.

The final couple columns in this table look at each company's quarterly silver and gold production. At Q4'15's average prices of $14.77 and $1105, each ounce of gold produced was worth nearly 75 ounces of silver! Every single silver producer in SIL also mined gold. Although this dilutes their exposure to silver upside, it certainly makes these companies stronger and more resilient from a fundamental perspective.

Silver miners' Q4'15 results were very strong considering silver's deep secular lows. Contrary to what the epically-low silver-stock prices suggested, the silver-mining industry was actually quite healthy even at sub-$15 silver. Fundamentals always trump sentiment in the end, so investors should be flocking back to the still-cheap silver miners' stocks before their extreme pricing anomalies of Q4 fully reverse.

Silver itself remains a coiled spring, ready to explode higher out of its recent deep lows. Silver fell far behind gold in recent years as the Fed's artificial stock-market levitation sucked investment capital away from alternative investments led by gold. And history has shown that after silver falls behind gold, it tends to blast higher as both recover with gains soon surpassing and ultimately far exceeding those in gold.

Gold is silver's dominant primary driver, and back in late February silver fell to its lowest levels relative to gold seen since 2008's first stock panic in a century. After that previous extreme-low pricing anomaly, silver soon started soaring. Over the next 2.4 years, it would skyrocket an astounding 443% higher as silver mean reverted from deeply out of favor to overshoot into euphoric widespread popularity once again!

But in order to see utterly massive gains on the order of 10x in silver miners' profits and therefore stock prices, all we need to see is a mere double in silver again. $30 silver is not particularly high in the grand scheme at all. Remember silver averaged $31.19 in 2012 before the Fed's unprecedented open-ended QE3 campaign radically distorted the markets. And 2012 was a correction year far below silver's peak $48 levels.

So silver miners' upside from here remains vast. Investors can certainly deploy capital in this sector via the SIL and SLVP ETFs, which are due for outstanding gains in the coming years. But these leading silver-stock ETFs are heavily diluted with gold exposure. So an expertly-handpicked portfolio of the best silver miners with superior fundamentals and silver leverage will really outperform this sector's leading ETFs.

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The bottom line is silver miners were fundamentally strong even in silver's grim trough Q4'15. Despite the metal's major secular lows fueling hyper-bearish sentiment, the silver miners were still producing at all-in sustaining costs well under prevailing silver prices. This naturally generated healthy operating cash flows, feeding growing treasuries. The silver miners never faced the widely-feared existential threat.

But their stock prices plumbed deep secular lows, acting like these miners were on the verge of failure. Despite their mean reversions out of those anomalous extremes already being well underway, silver stocks still have far higher to run as silver recovers with gold. Silver miners' profits should soar by an order of magnitude in coming years, resulting in similar fundamentally-righteous gains in their still-low stock prices.


Apr 29, 2016
Adam Hamilton, CPA

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