 Valuation of Silver Stocks
Sean Rakhimov
May 4, 2005
Editor: Silver Strategies
Silver is correcting again
after a run to last year's high at $8.30. There seems to be
a general consensus among silver gurus and commentators alike
(David Morgan, Doug Casey, Jim Dines and others) that silver
price has broken out of its 20 year downturn. Since silver equities
typically outperform the metal, investor interest is slowly being
drawn to silver mining stocks, which for variety of reasons aside
from the rising price of the metal, present a unique investment
opportunity. We are at the dawn of a new era for silver (and
other "things" vs. "paper").
Perception Is King
Silver is both precious and
industrial metal. Therefore it is a potential beneficiary of
ascending prices we are witnessing in industrial and base metals
as well as precious metals. Another unique characteristic of
investing in silver stocks is that there are few choices available
amongst publicly-traded companies, and even fewer that are primary
silver plays. One could make the argument that buying a basket
of silver equities will provide leverage to silver and portfolio
diversification. Yet the universe of public silver companies
is so small that buying 20 or so stocks covers the entire sector.
Even adding silver miners with significant exposure to other
metals that often accompany silver in the ground, such as gold,
copper, lead and zinc, we still come up with a very short list
of silver stocks. Best proof of this thesis is the companies
with assets primarily in lead, zinc, copper and even gold, which
are presenting themselves as leveraged plays on silver.
On the other hand it has become
apparent that for short term investing the merits of company's
assets are irrelevant. It is the perception that matters in
the short term, not the fundamentals. That said, expect that
over the short to medium term all sorts of companies will do
well "even turkeys fly in a hurricane". Some
do, because they are real companies with solid fundamentals,
and others, whose main asset is an aggressive marketing policy
or a smartly picked name. This leaves a lot of room for "market
dislocations" where some sound investment opportunities
are overlooked.
To date the average precious
metal investor has been a slave to the same emotional approach
and desire to "make a killing" that are present in
any market, amply encouraged and exploited by pseudo experts.
So much for hard-money supporters whom today's gold and silver
investors deem themselves to be. In that respect current precious
metal investment sentiment is hardly different from that of nanotech
or even real estate sector.
In the last two years in US
and Canada only there has been $11 billion (with a "B")
raised in financings by mining and exploration companies. I
would speculate that if only 3% of that money was used to buy
silver bullion, silver price would be above $10 today. Instead
we have a year-long correction in mining stocks. So all those
investors choosing paper only and no bullion are shooting themselves
in the foot. Don't get me wrong, I own silver stocks. But I
do own bullion and continue to buy it regularly something
all investors should be doing.
What is your measuring stick?
Interesting phenomenon about
silver and, perhaps, mining stocks in general, is the various
benchmarks investors develop in order to try and value these
stocks, which present unique challenges in valuation as opposed
to say banking stocks. Here is an instance where an ethical
and experienced mining analyst, newsletter writer or website
editor can be of immense value. Presumably, they engage in much
more research than the average investor is able to do. But again,
caution is in order: mining is an inherently risky and speculative
business. On the surface high-risk carries a promise of high
reward but there is more to it. To demonstrate the point I will
use this rhetoric between Doug Casey and Rick Rule in relation
to the matter at hand. The story was conveyed to yours truly
by Rick Rule at one of the investment conferences so I apologize
for any incorrect details. Yet I think I got the gist of it
right.
Back in the day before the
internet, when resource investing was as challenging as ever
Doug Casey wrote a piece on investing in junior resource stocks.
Doug made a point that because investing in these stocks was
so risky and the success rate so miniscule one would be well
advised to buy a basket of 30 of stocks to participate in the
sector. Such an approach, Casey explained, would provide for
better risk management and increase the chances for success.
Upon reading that Rick Rule responded. Rick reasoned that if
it was known going in that success rate among these stocks was
so truly dismal, which it was, perhaps a better strategy would
be to short those same 30 stocks!
Obviously neither one of these
two gentlemen needs introduction. There are few if any resources
investors who can rival their respective track records in the
last three decades. In the story above, both make compelling
arguments, yet the solutions they offer oppose one another.
Indeed, there is but one path to profits.
Investors should look at all
the different methods of valuing these stocks and make their
investment decision based on an all-around approach. But here's
the tricky part. Wonder why there are so few commentators on
silver? Simply put, there are so few silver stocks, and even
fewer that will ever produce silver, that precious metal analysts
will almost always gravitate to gold. Plus, generally speaking,
gold is more economic to mine than silver. FOR NOW it is.
Leverage to Silver
Leverage to silver is one factor
that silver investors often refer to as motivation to buy silver
stocks. The question is - how does one measure such leverage,
particularly for companies with resource or reserve studies?
One method widely used today
is silver ounces per share of stock. However, questions arise
about the quality of their resources: What are projected production
costs? What will it take to put their properties in production?
All ounces are not created equal. The definition of resources
is an estimate of silver in the ground for which advanced study
has not been completed proving the (profitable) economics of
mining that silver.
But wait you say, we all know
how expensive it is to build a mine and infrastructure. If so
shouldn't companies that are producing silver or nearing production
carry a premium?
I would think so. Thus we enter the realm of the few companies
that are primary producers: Coeur d'Alene Mines, Hecla Mining
Company, Pan American Silver, First Silver Reserve and recently
Genco Resources, Endeavor Silver, Sterling Mining and First Majestic
have begun producing, though much smaller amounts of silver currently.
The list can be expanded to consider companies that appear to
have a rapidly growing production potential: Apex Silver, Excellon
Resources, Scorpio Mining, Macmin Silver and Silvercorp Metals
(formerly SKN Resources) come to mind.
Since silver is often mined
along with gold, lead, zinc, copper and sometimes other minerals
there are no "pure" silver companies, (with the exception
of Silver Wheaton which a royalty company). Perhaps the next
step is to find out what percentage of each company's assets
is represented by silver. This is a tough one because few of
these companies are primarily silver companies.
In fact if one measures by
a percentage of silver to total mineral resources, only a handful
of principally known silver companies have 90% of their assets
in silver Silver Wheaton, IMA Exploration, Sterling Mining,
Pan American Silver, Silver Standard and Coeur D'Alene Mines.
Leverage to Silver Versus Other Metals
Here the discussion becomes
interesting, because there are several companies whose overall
metal content in other metals is close to or higher than silver
content. Plus with metal prices rising across the board some
of them offer significant leverage to both silver and other metals.
Companies in this category include Mines Management (fantastic
exposure to copper), Minefinders (gold exposure), Canadian Zinc
(zinc), Apex Silver (zinc/lead exposure), Gammon Lake (gold),
Western Silver (copper/lead/zinc), Genco Resources (copper),
Kimber Resources (gold) and so on. Even Hecla Mining should
be included in this group as more than half of its revenue comes
from gold. There is nothing wrong with these companies and a
lot of things are right. Some of them are extremely well run.
And the sole fact that they stress their exposure to silver
should tell you volumes about the potential they see in silver.
One advantage these companies
have over "pure" silver plays, at least in theory,
is the fact that their stock price is less dependent on wild
fluctuations of silver price and therefore offers less heartache
and more stability to investors.
Name Recognition
It's almost fashionable to
be a silver company these days (a little less than uranium or
moly, but still). As silver prices rise you will see more and
more companies portraying themselves as "silver companies
or projects". You will see old ventures dug up and re-packaged.
You will be dazzled by the geological terms and maps and the
invariable pictures of helicopters. Curiously, I could never
figure out why having to use a helicopter to get to one's property
was considered a positive by mining companies and widely used
in marketing materials. Even more puzzling is the fact that
investors must like it if companies continue to use such pictures
for decades. But I digress.
For the shorter term investors,
name recognition can dictate the market price, as well as recommendations
by newsletter writers and website writers, more so than the intrinsic
value. This is an important point: why bother with merits of
the investment when all you need to do is understand what motivates
others to buy the stock. Newsletter writers, website writers
will not appreciate this way of valuing a stock, but frankly
it is almost as valid as any other, at least in the short run.
However, the operating strategy
of the company should be combined with marketing and capitalization
strategy at once, and some companies do a great job of establishing
and maintaining their names as well recognized silver plays.
Hecla Mining and Coeur d'Alene Mines as NYSE companies come
to mind. Silver Standard has done a superb job for itself and
the industry, with a consistent marketing message on the merits
of buying the few silver stocks out there as un-expiring call
option on silver. Pan American Silver is obviously a name most
investors recognize. Those investors who only trust hard-cold
bullion in their hands will now have a chance to get it from
Pan American, as the company announced minting its own bullion
products last week. This move should further bolster the image
of Pan American as the premier silver company.
Management
Perhaps this is the least tangible
but most important factor in valuing a company, and this is where
knowledgeable commentators with experience in the sector and
industry can truly help you make informed decisions. Unfortunately,
any analysis of the management is highly subjective and there
is no way around it. Personally, I found it very helpful to
go to mining shows and meet the management of the companies of
interest. There is no substitute to face to face conversation.
The next best thing is calling the company on the phone. Unlike
most other types of businesses, most mining companies will gladly
talk to you. Regular communication can help you stay on top
of your investments, especially if you know the right questions
to ask.
Can They Make a Profit?
This may come as a surprise
to you, but there aren't any companies making money by producing
silver. Not on an annual basis anyway, sure a few have shown
quarterly earnings, but no primary silver producer has shown
a profit on an annual basis yet, even with higher silver prices.
One would think that a mining
company cannot keep issuing new shares forever and eventually
will have to show some earnings. Those companies that have a
chance to be profitable from silver production at current prices
represent a small group indeed. While they may not have the
upside potential of early stage exploration plays, on a risk-adjusted
basis they are better plays for the longer-term investors. Keep
in mind it is very difficult for a producing company to stick
with silver alone in the long run. Due to the paucity of primary
silver mines, companies almost invariably add non-silver assets.
There are exceptions like Pan American Silver.
Investors should be aware of
this and choose equities based on their investment goals and
risk tolerance. Of course, the good news is that when the silver
price goes up, way up, most silver producers are likely to become
top dividend payers and turn into "conservative investments".
At least that is how things played out in the last bull market.
Blue Sky Exploration Potential
This is the category where
junior stocks can excel, but one of the hardest to evaluate for
those outside the industry. Even experienced newsletter writers
often do not have the time to thoroughly investigate each company.
But the potential for very high investment returns, although
with high risk, is so appealing that eventually it grabs almost
every precious metals investor by the collar.
Every company claims upside
potential, how does the average investor see the real deal, and
even if it is a real deal as they say, the business is so risky,
no one can guarantee exploration success. Assuming that bonanza
is in the ground, can the management translate that into profits
in your account?
Several juniors are focusing
primarily on silver exploration these days. But that number
is nothing compared to gold and base metal explorers. Some companies
become "silver stories" by virtue of their projects
even if they were looking for other minerals to begin with.
Of course, when a junior company makes a discovery the up side
potential is only limited by the size of the project.
Investment philosophy
Investors develop their own
investment philosophy. Most in the precious metals sector become
quite proud of their philosophy and woe to anyone who tells them
different! Any stock broker will tell you that the biggest obstacle
to consistent investment returns is the clients' investment philosophy.
The silver story so compelling,
that I believe, long term investor in silver and silver stocks
will see truly spectacular returns. Silver represents a unique
investment opportunity that is supported by the economic trends
both for the metal itself and the world economy. Silver equities
represent the best way to play the future price increases in
silver, and because of the small universe of silver stocks, one
can build a diverse portfolio to cover most if the whole silver
sector.
Lastly, don't forget that the
day when your silver investments will start paying off for the
time being depends on YOUR BUYING OF PHYSICAL SILVER. Pan American
figured out. Hopefully other movers and shakers of the sector
as well as investors, large and small, figure it out soon enough.
It's that simple: you buy silver and your silver stocks will
go up.
May 3, 2005
Sean Rakhimov
editor: Silver
Strategies
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Information
contained herein is obtained from sources believed to be reliable,
but its accuracy cannot be guaranteed. It is not intended to constitute
individual investment advice and is not designed to meet your
personal financial situation. The opinions expressed herein are
those of the author and are subject to change without notice.
The information herein may become outdated and there is no obligation
to update any such information. The author, entities in which
he has an interest, family and associates may from time to time
have positions in the securities or commodities discussed. No
part of this publication can be reproduced without the written
consent of the author. ©Copyright 2004-2010 by Sean Rakhimov.
All Rights Reserved.
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