Valuation of Silver Stocks

May 3, 2005

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.


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.

Sean Rakhimov


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 2005 by Sean Rakhimov.

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