Silver…Junior Struggles

January 31, 2014

It’s been an incredibly tough last couple years for the miners. Not only have they had to endure sharply falling metals prices, they’ve had to battle continually rising operating costs. For the producer companies this combination has been a margin killer. And for the non-producers it’s been flat-out devastating.

Mining companies that are non-producers obviously don’t generate any revenue. They are junior-level companies in various stages of exploration and/or development. And they primarily rely on investor capital to fund their operations. In some cases they are able to procure bank loans, but this is the exception.

If it costs more to operate, and the prospects of juniors’ metals of focus fade via falling prices, investors lose incentive to subscribe to their shares. And if investors aren’t subscribing to their shares, then capital quickly runs dry. This is a major problem in a capital-intensive business!

Perhaps no group has suffered more than the silver juniors, for the simple reason that silver has seen more carnage than the other metals. In 2013 alone silver was down a brutal 36%. And since its April 2011 high, it was down a staggering 60% to the end of last year. If the metal took this much of a beating, you can only imagine how the miners have fared.

Last month I looked at the SIL Silver Miners ETF, which is comprised of the stocks of the world’s best-of-the-best silver miners. And indeed this ETF took it on the chin. As bad as it’s been for these elites though, it’s been far worse for the small juniors. A powerful sentiment maelstrom has sent investors running for the hills, leaving hardly anybody left to buy their shares.

To no surprise the juniors lack representation in SIL’s underlying index. In fact, as of this week only two of this ETF’s constituents were of junior ilk. Without an index and/or ETF, it’s of course difficult to measure group performance for the juniors. But as any investor who has owned silver juniors the last couple years will tell you, the going has been incredibly rough. They’ve leveraged silver to the downside, and have left us in a sea of despair.

Perhaps more prudent than measuring performance at this stage is measuring health. With their stocks pulverized, there’s little arguing that the juniors are on life support. And since it is so difficult to find a pulse, we need to be creative in getting their vitals.

At Zeal we have a research arm that delves into various sub-sectors of the commodities markets. We dig deep into companies’ fundamental underpinnings via the examination of such things as financial statements, technical reports, and management histories in hopes of identifying stocks with the highest probability for success. And our latest undertaking took us into the silver realm, specifically companies that explore for and/or produce this shiny-white metal.

The particular universe of companies we focus on are those that list their stocks in the US and Canada. And since the US/Canadian exchanges are the world’s premier destinations for resource companies seeking to raise capital in the public markets, this universe offers an excellent representation of industry trends.

When analyzing these companies it’s important to categorize them into different peer groups, as it wouldn’t do any good scrubbing up a 5m-ounce-per-year producer with a single-drill-rig explorer. Thus the most logical dividing line is between those that produce the metal, and those that don’t. Producers versus non-producers, or in our case juniors.

Interestingly when it comes to producers, the population is pretty thin. In fact, there are only a couple dozen in our universe. But though these companies number few, they’re responsible for a big chunk of the world’s mined supply that comes from primary silver mines. And it is these bigger, safer, revenue-generating companies that dominate SIL.

On the periphery of the producers are the juniors, exploration companies seeking to discover and develop silver-centric mineral deposits. At a high level juniors end up traveling one of three roads. First, and most common, is the road to failure. It is incredibly difficult to prove up an economically-feasible silver deposit. Second, they sell their companies and/or successful projects to producers for development. And third, they go down the road of development themselves, becoming producers.

All three of these roads traveled have one thing in common, the need for capital. And yes, in this business even failure requires money. You really don’t know if a project is a dud until after you’ve paid staff, spent money on acquiring claims, and funded expensive exploration programs.

Cash is king, all juniors need it. And since they don’t generate revenue, the nearly 100 juniors in our universe are scraping and clawing for every dollar from a limited pool of investor capital. Silver juniors must sell their stories to investors. And these stories must be compelling if they want to attract enough capital to be productive in their exploration endeavors.

So with cash as king, one surefire way to measure the health of these juniors is to have a look at their balance sheets. As part of our research we pulled the balance sheets from these juniors’ latest filings in order to catalogue their working-capital positions. And with cash typically the key component of the asset portion of the working-capital formula, especially for junior resource companies, it was also catalogued.

When we ran this data in September, the latest available financial statements were from Q2 2013. And with the two years leading up to these filings pretty rough for this sector, I anticipated some ugliness. But what I found was beyond ugly, it was appalling!

To get a feel for the juniors as a whole, I performed a simple average of these nearly 100 companies’ working-capital and cash positions. And coming in at only $3.4m and $4.7m respectively, we can begin to get an idea of how bad things really are. But sadly, they’re much worse than this initial read.

As would be expected, there are some outliers that skew this data. On the high side there are a handful of companies that have exceptionally large working-capital/cash positions. These juniors have advanced-stage projects that are either being developed, or are on the cusp of development. And they’ve successfully tapped the debt and/or equity markets to raise the capital necessary for their mine builds.

On the bottom side there are a number of companies with negative working-capital positions. Now negative working capital is not always a negative thing depending on the business model, but in the mining business it is usually bad. And since cash is typically the largest current asset for junior explorers, a negative working-capital position means that current cash is not sufficient enough to fund current liabilities.

To smooth out the data I removed the five outliers on both the top side and bottom side. And this put the average working-capital and cash positions at only $1.4m and $1.6m respectively. This would be paltry for a small chain of yogurt shops! How is it supposed to be sufficient for a company that needs to pay for hard-rock exploration?

The reality is, it is not sufficient. It costs a lot of money to pay for the services of professional geologists and engineers, to pay laboratories to assay samples and perform metallurgical work, to buy or rent equipment for surveying, mapping, and drilling, and for other incidentals including transportation (most mineral deposits are off the beaten path). $1.6m doesn’t go very far when it comes to performing meaningful exploration work!

Amazingly this low average is still not the worst of it. Fully 35 silver juniors have negative working-capital positions, with this group sporting an average cash position of only $233k. Talk about being on life support!

The vast majority of silver juniors desperately need capital injections. And if they don’t get them soon, they are at risk of no longer being “going concern” companies. These injections are of course easier said than done though.

As mentioned the sole source of funding for these cash-strapped juniors is proceeds from the sales of their shares. And the buyers of these shares are typically retail investors (some of the larger juniors can attract institutional investment, but they still heavily rely on retail). There’s one problem though, silver-junior investors are currently nowhere to be found.

It’s no secret that equity financings for junior resource companies are way down over the last few years. And this is readily apparent when comparing this balance sheet data with our previous analysis of junior silver stocks in late 2012. With that round of research pulling from Q2 2012 financials, we essentially have a year-over-year comparison of working-capital and cash positions.

In only a single year, working capital and cash were down a whopping 56% and 48% respectively. And this is even with capex burn rates way down as most companies freeze spending. Sadly I suspect these vitals will register even worse in 2013’s year-end financials given the ongoing lack of activity on the equity-financing front.

Overall meaningful equity financings in the silver-junior realm have been few and far between. Sentiment is so poor that these explorers just aren’t able to attract many investors. And the sad reality is meaningful investor interest isn’t likely to return until there’s a meaningful silver upleg.

Silver-junior struggles are not only painful to watch for the remaining contrarian investors, they are painful for the industry. These juniors serve a vital role in the silver production cycle. And with the current capex freeze delaying project advancement while grassroots exploration is all but dead, there will no doubt be pipeline issues down the road. This will adversely affect reserve renewal, and ultimately production.

Now if silver’s secular bull market is over, this junior cleansing won’t be a big deal. But if it’s not, it will serve to build fundamental silver strength down the road. And the surviving juniors will see their stocks soar as silver makes its comeback and investors return.

At Zeal we believe silver is on the verge of making a roaring comeback after an anomalous 2013 sold it off way too hard. And silver’s launch higher will rekindle interest in silver stocks. This interest will eventually filter down to the juniors, and it’ll result in them procuring the capital necessary to resume operations.


Now is the time to buy silver stocks, while the blood is still in the streets. And though the blood is thick in the junior realm, there are still some quality ones available that ought to thrive in a new silver upleg. As a product of our aforementioned research we identified a dozen high-potential silver stocks to fundamentally profile in our latest fascinating 27-page

At Zeal we’ve been layering in silver-stock trades for months now in our newsletters. In both our

The bottom line is junior mining stocks are currently the pariahs of the markets. And perhaps no group has had it worse than the silver juniors. Silver’s collapse has scared away investors, which has greatly tightened the capital pool. These juniors are thus having a heck of a time selling their shares, which has ultimately resulted in appalling health conditions as measured by their balance sheets.

With mineral exploration and development a highly capital-intensive business, most silver juniors have been forced to put a halt to their work programs given their inability to fund them. They are dead in the water until silver’s fortunes turn around. If silver’s bull market is over, it will be the end of the road for these juniors. But if it’s not, they’ll roar higher as investors return. With the latter the most likely scenario, now is the time to buy. Jump on in while junior silver stocks are at bargain-basement prices.


Scott Wright

January 31, 2014

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