Sunday, 27 February 2011

Silver miners underperforming silver bullion?

As is demonstrated in several articles (1), gold mining majors don’t offer any leverage over gold bullion. Outperformance during gold rallies is largely undone by major swoons during gold retreats. The return for your bravery when investing in gold mining majors is merely additional volatility and underperformance over the long haul. But what about silver miners? Do we observe something similar?

Before even trying to answer, a few observations:
·    Silver in mineral deposits almost always occurs in conjunction with other metals, mostly base metals such as lead, tin or zinc and some of it is also found in gold mineral deposits.
·    Therefore, most silver is mined as a byproduct of base metal mines. Pure silver miners almost don’t exist: we find few silver miners which have over 75% of their revenue from silver sales.
·    Silver is an industrial metal, meaning that much of it is consumed in industrial processes, some is retrieved from scrap.
Since silver is not stockpiled to the extent gold is, the silver price is more volatile and prone to the expectations on the evolution of industrial output. Speculator & investor demand does play a role in contributing to a procyclical behaviour.
A lot of silver being mined as a byproduct, the production quantity is little price sensitive. A lead mine isn’t going to increase output because of its 10% silver revenue stream suddenly rising in value when it has no market for its 90% lead output value. Quite a few base metal miners have sold their silver revenue stream in long term contracts and haven’t even any incentive for producing more.

Since there are few ‘pure’ silver miners, composing an index of silver plays is less evident. The market of silver mining being a lot smaller than the gold mining industry, it makes no sense using as a proxy precious metal mining indices such as the Unhedged Gold Bugs (HUI) or Philadelphia Precious Metal Mining index (XAU). The Silver Mining ETF (SIL) (issued by Global X) has been quoting for over 10 months, not a great time span, but worth a glance:
SIL relative to Silver bullion over six months, daily observations (www.stockcharts.com)
This doesn’t bode well: silver miners were appreciating relative to silver in the fierce run up of silver in November 2010. After silver set a 30 year high in early December, the ratio weakened and went nosediving into precious metal weakness last January. In spite of new silver strength last month and a sequence of new 31 year highs, there was little recovery: silver miners seem to be underperforming the metal much the same way gold mining shares do.

By far the largest Canadian silver producer is Pan American Silver (PAA on Toronto and PAAS on AMEX). With today’s metal prices, about 75% of its metal production is silver. With PAAS we can look back to spring 2008 using weekly observations:
Pan American Silver relative to Silver bullion over three years: weekly observations.
The graph is quite disappointing. Over 3 years silver bullion has risen nearly twice as much as PAAS, making the ratio drop from 2.1 in spring 2008 to 1.14 on February 25. Remarkable is the double dip you notice in October/November 2008 and in March 2009. Apparently PAAS has dropped along with the S&P 500 when it made its low that month. Unlike most gold miners holding up strongly, silver miners went down a second time on expectations of a depressed silver price due to the severe recession. The 2009-2010 recovery of the PAAS:Silver ratio wasn’t half as impressive as what we witnessed for the HUI:Gold ratio. 2010Q4 operational results were not appreciated by the market and aggravated the slide since December last year. The PAAS/Silver ratio dropped nearly back to the panick lows of autumn ‘08.
Yet before jumping to conclusions, one more graph:
Silver Wheaton relative to bullion silver over three year: spring 2008-2011, weekly observations.
Quite astonishing: for Silver Wheaton (SLW) the secondary low in March 2009 is almost absent, the recovery from the November 2008 collaps has been relatively swift. As silver appreciated over 2009-2010, SLW not only could keep pace with silver bullion rising, but even realized some leverage hoped for. Over three years, the ratio of SLW/Silver rose from 0.88 to 1.22.

Silver Wheaton is different from any silver producer because of its business model: as a royalty company, SLW buys silver streams of future production in exchange for upfront financing of investments in mine construction. Silver is later being bought at a contractual price and any margin with the market price is profit. In this perspective, leverage is being built into the SLW business model. On the reverse: some of the silver price leverage is leaking away from the producers of silver and non-ferro metals.

Is PAAS a bad example, underperforming silver bullion dramatically? I checked a few more silver producers with most trending in a similar way (if not worse): Silver Standard (SSRI), Coeur d’Alène (CDE) and Hecla (HL). Endeavour (EXK) is somewhat less bad. Silvercorp (SVM) and First Majestic (AG) are the other bright spots, outperforming silver over the long run, much like SLW does. 


Updates on the Global X Silver mining stocks ETF (SIL) relative to silver bullion can be found on the gold miner pulse page on this blog


References:
(1) Decades of underperformanceDid you say leverage?

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