Log out

January 24, 2005
A Silver Producer That Produces Results
By Brady Willett

The price of silver fixed above $8 an ounce on December 2, 2004. On December 9, 2004 the price of silver fixed at $6.90. In most markets a 15% price collapse (intraday) inside of a 5-session span would be considered a ‘crash’. However, in the silver/gold markets these types of steep sell-offs have come to be expected.

It goes without saying that a dramatic increase in commercial short interest presaged the sell-off in silver.  Also ahead of the sell-off, two new entries into the 65% club were added (instances when net commercial short interest is higher than 65% of total open interest usually signals a top).




Speculating on the COT statistics alone is not always reliable: as the above statistics show (note the single blue entry) sometimes extreme readings in commercial short interest do not mean an immediate correction in the price of silver. That said, the historic late 2004 COT battle ended, once again, in misery for the silver bulls.

That net commercial short interest as a percentage of open interest has fallen in 6 out of the last 7 weeks makes it increasingly unlikely that another price crash in silver is imminent. Quite frankly, and not unlike the coin flipping conundrum – each flip is an independent trial but after seeing tails come up 6-times in a row you can not help but start thinking heads is due – the severe pounding in silver suggested that rebound was due.  Last week silver rebounded slightly, from an intraweek low of $6.47 an ounce to close at $6.81 (March).  When you combine the current COT situation with last weeks rally, it is increasingly likely that $6.38 (reached on January 4, 2005) marks a reliable low.

Buying silver/gold now may be an excellent way to hedge against a longer-term decline in the US. dollar.  Alternatively, the investor seeking leverage could elect to purchase silver futures/options and/or take a stake in a silver producer.  Silver producers come in many shapes and sizes and – like gold producers – are unequivocally overvalued based upon traditional valuation measures. But alas, and as Silver Standard recently highlighted in its Annual Report, “Investors purchase shares [in silver producers] because the shares represent a call option on silver prices.” Assuming a company has a strong reserve base, you could say that purchasing a silver producer is akin to purchasing a call option on silver that never expires.

Silver Companies Dream Big

In a recent presentation entitled ‘Blast Off’, Apex Silver Mines Limited notes that its main goal is to ‘Make Shareholders Rich’ (pg.4). 10-pages later the company reveals another goal: “raise financing at the right time”.  Welcome to the world of silver mining; an industry that has as much to do with ‘raising financing’ as actually producing silver.

The Apex Story

Apex was founded in 1993, went public in 1997, and has essentially done nothing since. Granted, the Apex believer could argue that the company has voluntarily sat on what could be one of the largest silver resources in the world because silver/zinc/lead prices were depressed (this is what the company claimed it did in its 2003 Letter). However, even shareholders with a great deal of patience must have been shaking their heads in 2004.  Why - with silver briefly surpassing $8 an ounce during two separate rallies in 2004 - wasn’t Apex starting to produce its highly touted reserves for massive profits?

The answer is because the company still needed to ‘raise [more] financing’

Date

Type of 'Financing'

25-Nov-97

$50 million IPO

5-Nov-99

$86.6 Million Equity Offering

9-Nov-99

$10.5 Million Equity Offering

30-Jan-04

$165.6 million equity offering

16-Mar-04

Sale of $150 million 2.875% Convertible Senior Subordinated Notes due 2024

30-Mar-04

Exercise of Initial Purchasers Option

15-Oct-04

Sale of $100 Million 4.0% Convertible Senior Subordinated Notes Due 2024


Industry sources broadly suggest that the Apex story is legitimate.  Moreover, when (if) Apex can start production it will quickly become a solid asset investment that is undervalued compared to its peers. Nevertheless, whereas silver is a store of value that can be bought and sold close to prevailing market prices, Apex can be purchased at 2.3 times book with the promise that the company will use most of its capital to try and start producing returns in 2007 (or the new date Apex has slated for production. 
The old date was 2002). A lot can happen between now and 2007, including a decline in the price of silver and/or unfavorable market conditions for future ‘financings’ that may be required to get production going.

In short, although Apex is probably not another Bre-X, it is nonetheless a highly speculative investment when compared to owning silver itself.  What if Apex starts production and commodity prices are not as strong as the company believes they will be? Apex will not be returning ‘riches’ to its shareholders, but exactly what its peers have been giving shareholders for more than a decade: plenty of dilution, choppy financial results, and stock price stagnation.

The Top Silver Producers


Many silver producers have not been as stubborn as Apex. Rather, companies like Pan American Silver and Hecla Mining are content to produce silver for a loss and ‘raise financing’ whenever losses threaten solvency and/or when ‘the time is right’. Oddly enough, while researching the silver producers Pan American announced that it was lining up yet another offering:

“These filings, when made final, will allow the Company to make offerings of common shares, warrants, debt securities, subscription receipts or any combination thereof of up to $150 million during the next 25 months on similar terms to potential purchasers anywhere in these provinces and the United States.”
PAAS - January 19, 2005

Keeping PAAS’s latest preliminary offering in mind, focus on the lines highlighted in red below. While the outstanding share base grows (currently 72+ million on a diluted basis) the amount of equity per share declines.


Given that 2004 was a breakout year for many silver producers, the filing from PAAS is a little surprising.  After all, only a couple of months ago PAAS CEO, Ross Beaty, had this to
say: “Primary factors influencing the silver price today continue to be the US dollar, global industrial production – particularly in the electronics/electrical sector – and investment demand. The underlying demand/supply fundamentals for silver are sound. It is a great time to be one of the world’s major silver producers.”

If it is such a ‘great time’ to be a silver producer why isn’t Pan American lining up dividends instead of share offerings?

A similar story is seen in Hecla Mining. HL’s net equity position is slightly higher than it was on December 31, 2003, but HL shareholders have lost a dime in equity per share since the end of 2003 thanks to dilution.


As for Coeur d'Alene, the company has not produced an annual profit since 1995, and yet the financing schemes just keep on coming. If an internet company was losing money for this long investors would probably stop funding it.  But alas, silver is a metal that has been around for a long time and has a seemingly endless amount of uses: one day Coeur will earn a profit! Unfortunately, even with a realized selling price of $6.70 an ounce in 3Q04, that day is not today.


Coeur d'Alene closed its latest common share offering on November 24, 2004.  Given that shares were sold for $4.50 a share and the company’s share price is at $3.80 today, the company raised financing at the ‘right’ time. The three latest common share offering bring CDE’s outstanding common share total to nearly 240 million.  Below is what the company has done to keep solvent in recent years.



Suffice to say, the top silver producers are not attractive investments, save for their silver reserves (which represent a long-term call option on the price of silver).  At year end 2003 CDE had 175 million silver ounces in reserve (proven and probable), PAAS had 47 million ounces, and HL had 45 million. As for Apex, their silver ounces in the ground are estimated to be as high as 450 million ounces.  The logic behind owning these companies is that one day the price of silver will rise and the profits will follow.  In 2004 the price of silver rose, yet PAAS, HL, SIL, and CDE shareholders are still waiting for the profits.

Smaller Production, Larger Returns

Like most silver producers, First Silver Reserve lost money in 2003. However, unlike most producers the company quickly turned things around in 2004 and produced three highly profitable quarters in a row. Even while PAAS, HL, and CDE struggled for most of 2004, FSR produced solid returns and free cash flow. This cash generation enabled the company to purchase 100,000 ounces of silver for investment purposes in 2004, and an additional 100,000 ounces in early 2005. With only one mine in operation, First Silver Reserve is easy to understand, and - as the financial statistics below aptly demonstrate (highlighted in yellow) – highly profitable when the price of silver is above $6.20 an ounce.
 


First Silver has kept its share base relatively constant since the 1996 takeover of El Pilon (28,745,000 shares issued to fund takeover). Moreover, its production/grades have remained fairly consistent for nearly a decade. With silver holding around a price area where FSR is profitable, the company has the luxury of not being forced to – at least in the immediate term – tap the equity markets for funding.




The knock against FSR is that it does not have a large reserve base. Indeed, if you go by the latest proven and probably numbers (2001), the company may be at risk of running out of silver in 2005/06.

Another negative is that FSR trades at more than 20-times book value.  If larger reserves do no materialize and earnings start being reduced because of declining grades, a 20-times book figure suggests that there is plenty of downside.

These notable concerns notwithstanding, if current operations can be maintained FSR is in position to dramatically increase shareholder wealth. Quite frankly, if the norm is kept up - $6.50+ an ounce silver and steady operations from FSR’s San Martin Mine – FSR could be trading as low as 7-times book by the end of 2005. In other words, the company is capable of exceptionally strong financial results regardless of whether or not silver rallies from current prices.

These shareholder equity estimates are not set in stone. Rather, a good indicator of how potent FSR’s performance is will be the company’s 4Q04 results. The average silver spot price for the three months ended Dec 31, 2004 was $7.23 an ounce.  In the first quarter of 2004 FSR produced strong results when silver averaged $6.88 an ounce.

Conclusions and Investment Opinions

Many well regarded investors – including Buffett (hard silver), Gates (PAAS), and Soros (SIL) – have exposed part of their holdings to silver in recent years.  Although it should be remembered that the superrich sages are not infallible - see Lynch - in the case of silver following the herd of billionaires may be wise. Quite frankly, the correction in the price of silver in late 2004 is unlikely to mark a new bear market for the metal. Rather, the bullish argument highlights that silver is in a long-term supply deficit, and silver also benefits from being gold’s little brother: as the US. dollar moves lower gold moves higher, and silver tags along for the ride.

The downside in owning hard silver (or owning say CEF), is that you do not acquire the upside leverage that the producers offer. To be sure, silver stocks typically outperform the metal during the best of times.

By contrast, the risk in owning the producers is that they will register poor returns if silver does not continue to rally. Furthermore, during the worst of times the silver producers lose lots of money, and constantly aim to dilute the stockholders’ interest. With silver producers profits, eventually, matter.

First Silver Reserve has some attractive qualities that many of the silver majors do not.  Namely, FSR makes money mining silver. Should silver stay at current prices FSR is one of the few companies that may post strong profits.

The caveat worth reiterating is that FSR desperately needs to expand/update its reserve calculations and/or prove that it can bring another vein into production in a timely and cost effective manner. The company may offer more insights on reserves and mining plans in its upcoming annual report.  FSR has been added to our ‘Watch List’ pending the company’s 4Q04 financial results.

As for Apex, it - along with Silver Standard (which has 508 million ounces of silver measured and indicated) - remains a story in search of a fairy tale ending:

“With the markets demanding the metals that we plan to produce, our shareholders are well positioned to profit from the favorable turnaround in the commodity cycle.” 
Apex - Oct 8, 2004

Should the investor believe that Apex management can foresee exactly how long the current ‘commodity cycle’ will last? In a word, no.  To be sure, if Apex management was really as prescient as they claim to be the company would already be highly profitable today.  Instead, the company is a couple years away from production with the commodities cycle already a couple of years old. 

In summary, when it comes to silver producers it is all about “raising financing at the right time” -- at least until the price of silver can reach and sustain higher price levels. Limited as the COT statistics are, they - along with a structural weak US. dollar and bullish silver supply/demand fundamentals - suggest that higher prices will be sustained in the future.

Silver Producers Yahoo
Silver Production By Quarter GoldSheets
Apex, Hecla, Pan American, Coeur, First Silver. Silver Standard
http://www.silverinstitute.org/
http://www.cpmgroup.com/
http://www.silver-investor.com/

Disclosure: No on at, or associated with FallStreet.com currently owns any investment position in the companies mentioned above.

Members Home