The battered silver miners’ stocks surged in recent months, staging a strong rebound rally. That overdue turnaround was fueled by silver mean reverting higher on improving sentiment after gold’s decisive bull-market breakout. But silver miners still had a challenging Q2, as most of silver’s gains came after last quarter ended. They continued diversifying into gold to help weather silver’s endlessly-languishing low prices.

Four times a year publicly-traded companies release treasure troves of valuable information in the form of quarterly reports. Required by the U.S. Securities and Exchange Commission, these 10-Qs and 10-Ks contain the best fundamental data available to traders. They dispel all the sentiment distortions inevitably surrounding prevailing stock-price levels, revealing corporations’ underlying hard fundamental realities.

The definitive list of major silver-mining stocks to analyze comes from the world’s most-popular silver-stock investment vehicle, the SIL Global X Silver Miners ETF. Launched way back in April 2010, it has maintained a big first-mover advantage. SIL’s net assets ran $476m in mid-August near the end of Q2’s earnings season, 5.3x greater than its next-biggest competitor’s. SIL is the leading silver-stock benchmark.

In mid-August SIL included 23 component stocks, which are weighted somewhat proportionally to their market capitalizations. This list contains the world’s largest silver miners, including the biggest primary ones. Every quarter I dive into the latest operating and financial results from SIL’s top 17 companies. That’s simply an arbitrary number that fits neatly into the table below, but still a commanding sample.

As of mid-August these major silver miners accounted for fully 94.1% of SIL’s total weighting. In Q2’19 they collectively mined 73.7m ounces of silver. The latest comprehensive data available for global silver supply and demand came from the Silver Institute in April 2019. That covered 2018, when world silver mine production totaled 855.7m ounces. That equates to a run rate around 213.9m ounces per quarter.

Assuming that mining pace persisted in Q2’19, SIL’s top 17 silver miners were responsible for over 34% of world production. That’s fairly high considering just 26% of 2018’s global silver output was produced at primary silver mines! 38% came from lead/zinc mines, 23% from copper, and 12% from gold. Nearly 3/4ths of all silver produced worldwide is just a byproduct. Primary silver mines and miners are quite rare.

Scarce silver-heavy deposits are required to support primary silver mines, where over half their revenue comes from silver. They are increasingly difficult to discover and ever-more expensive to develop. And silver’s challenging economics of recent years argue against miners even pursuing it. So even traditional major silver miners have shifted their investment focus into actively diversifying into far-more-profitable gold.

Silver price levels are best measured relative to prevailing gold prices, which overwhelmingly drive silver price action. In early July the Silver/Gold Ratio continued collapsing to its worst levels witnessed in 26.8 years, since October 1992! Those secular extremes of the worst silver price levels in over a quarter century sure added to the misery racking this once-proud sector. That compounded miners’ challenges in Q2.

The largest silver miners dominating SIL’s ranks are scattered around the world. 11 of the top 17 mainly trade in U.S. stock markets, 3 in the United Kingdom, and 1 each in South Korea, Mexico, and Canada. SIL’s geopolitical diversity is good for investors, but makes it difficult to analyze and compare the biggest silver miners’ results. Financial-reporting requirements vary considerably from country to country.

In the U.K., companies report in half-year increments instead of quarterly. Some silver miners still publish quarterly updates, but their data is limited. In cases where half-year data is all that was made available, I split it in half for a Q2 approximation. Canada has quarterly reporting, but the deadlines are looser than in the States. Some Canadian miners really drag their feet, publishing their quarterlies close to legal limits.

The big silver companies in South Korea and Mexico present other problems. Their reporting is naturally done in their own languages, which I can’t decipher. Some release limited information in English, but even those translations can be difficult to interpret due to differing accounting standards and focuses. It is definitely challenging bringing all the quarterly data together for these diverse SIL-top-17 silver miners.

But analyzing them in the aggregate is essential to understand how they are faring. So each quarter I wade through all available operational and financial reports and dump the data into a big spreadsheet for analysis. Some highlights make it into this table. Blank fields mean a company hadn’t reported that data by mid-August, as Q2’s earnings season wound down. Some of SIL’s components report in gold-centric terms.

The first couple columns of this table show each SIL component’s symbol and weighting within this ETF as of mid-August. While most of these stocks trade on US exchanges, some symbols are listings from companies’ primary foreign stock exchanges. That’s followed by each miner’s Q2’19 silver production in ounces, along with its absolute year-over-year change. Next comes this same quarter’s gold production.

Nearly all the major silver miners in SIL also produce significant-to-large amounts of gold! That’s truly a double-edged sword. While gold really stabilizes and boosts silver miners’ cash flows, it also retards their stocks’ sensitivity to silver itself. So the next column reveals how pure these elite silver miners are, approximating their percentages of Q2’19 revenues actually derived from silver. This is calculated one of two ways.

The large majority of these SIL silver miners reported total Q2 revenues. Quarterly silver production multiplied by silver’s average price in Q2 can be divided by these sales to yield an accurate relative-purity gauge. When Q2 sales weren’t reported, I estimated them by adding silver sales to gold sales based on their production and average quarterly prices. But that’s less optimal, as it ignores any base-metals byproducts.

Next comes the major silver miners’ most-important fundamental data for investors, cash costs and all-in sustaining costs per ounce mined. The latter directly drives profitability which ultimately determines stock prices. These key costs are also followed by YoY changes. Last but not least the annual changes are shown in operating cash flows generated and hard GAAP earnings, with a couple exceptions necessary.

Percentage changes aren’t relevant or meaningful if data shifted from positive to negative or vice versa, or if derived from two negative numbers. So in those cases I included raw underlying data rather than weird or misleading percentage changes. Companies with symbols highlighted in light-blue have newly climbed into the elite ranks of SIL’s top 17 over this past year. This entire dataset together is quite valuable.

It offers a fantastic high-level read on how the major silver miners are faring fundamentally as an industry and individually. The super-low silver prices for most of Q2 really weighed on operating cash flows and earnings last quarter. But the major silver miners’ years-old and still-ongoing diversification into gold helped them weather the brutal low-silver-price storm. They still need silver to power far higher to thrive again.

The silver miners had the cards stacked against them last quarter, so their Q2 results weren’t going to look good. In addition to slumping towards early July’s incredible 26.8-year secular low relative to gold, silver languished for most of Q2. By late May it had fallen 5.0% quarter-to-date, far worse than gold’s own 1.0% QTD loss. While it did rally 6.6% into quarter-end from that nadir, that lagged gold’s 10.2% rebound.

Overall in Q2’19, silver merely eked out a pathetic 1.3% gain despite gold’s blistering 9.1% rally. And silver prices averaged a miserable $14.88 last quarter, plunging 9.9% year-over-year from Q2’18’s levels! Silver was about as deeply out of favor as it can get, which naturally killed any interest at all in the silver-mining stocks. At worst in late May, SIL had dropped 12.2% year-to-date on silver’s own 7.2% YTD loss.

So there weren’t going to be any silver-stock fireworks coming out of such a dismal quarter. Considering that nigh-apocalyptic silver backdrop, the major silver miners fared reasonably well in Q2. They kept on plugging away despite the choking pall of despair. The chronically-weak silver prices continued to justify the years-old shift into gold by traditional silver miners, which was again evident in the top SIL miners’ outputs.

That 73.7m ounces of silver these SIL-top-17 miners produced last quarter fell 1.8% YoY from Q2’18’s levels. Over the 13 quarters since Q2’16 when I started this deep-quarterly-results research thread, the SIL-top-17 peak was 78.6m ounces in Q4’17. Silver production is waning even among traditional major silver miners, its economics have been too constrained. They are increasingly shifting into gold instead.

The collective gold production from these elite silver majors ran 1.5m ounces in Q2’19, shooting up 13.4% YoY! They’ve been increasingly diversifying into gold in recent years as silver languished, since the yellow metal has had way-superior economics. The bombed-out silver prices have heavily impaired silver mines’ generation of operating cash flows and profits. So the silver miners have been forced to adapt.

Silver mining is as capital-intensive as gold mining, requiring similar large expenses to plan, permit, and construct new mines, mills, and expansions. It needs similar fleets of heavy excavators and haul trucks to dig and move the silver-bearing ore. Similar levels of employees are necessary to run silver mines. But at recent years’ average precious-metals prices, silver mines generate far lower returns than gold mines.

So even longtime traditional silver miners have reallocated much of their capital investments into growing gold outputs at silver’s expense. According to the Silver Institute’s latest World Silver Survey, 2018 was the third year in a row of waning global silver mine production. The mined-silver-supply shrinkage is even accelerating, running 0.0% in 2016, 1.8% in 2017, and 2.4% in 2018! Peak silver could really be upon us.

SIL’s top 3 component stocks commanding fully 38.9% of its total weighting sure exemplify the yellowing of the major silver miners. Pan American Silver currently crowns this leading silver-stock ETF, and has a proud heritage of mining its namesake metal. Last quarter its silver output only grew 2.9% YoY, yet its gold production skyrocketed 190.1% higher to 155k ounces! Thus its silver purity collapsed to merely 34.1%.

PAAS acquired troubled silver miner Tahoe Resources back in mid-November. Tahoe had owned what was once the world’s largest primary silver mine, Escobal in Guatemala. It had produced 5.7m ounces in Q1’17 before that country’s government unjustly shut it down after a frivolous lawsuit on a trivial bureaucratic misstep by the regulator. PAAS hopes to work through the red tape to win approval to restart Escobal.

But the real prize in that fire-sale buyout was Tahoe’s gold production from other mines. That deal closed in late February, so that new gold wasn’t fully reflected until PAAS’s latest Q2 results. Now this former silver giant is forecasting midpoint production of 575.0k ounces of gold and 25.8m ounces of silver in 2019. That is actually deep into mid-tier-gold territory and a far cry from 2018’s output of 178.9k and 24.8m!

SIL’s second-largest component in mid-August as this latest earnings season ended was the Russian-founded but UK-listed Polymetal. Its silver production fell 11.8% YoY in Q2, yet its gold output soared 30.2% to 302k ounces. That actually makes this company a major gold miner, exceeding 1m ounces annually! So not surprisingly only 18.1% of its Q2 revenues were derived from silver, among the lowest of SIL.

SIL’s third-largest component is Wheaton Precious Metals. It used to be a pure silver-streaming play known as Silver Wheaton. Silver streamers make big upfront payments to miners to pre-purchase some of their future silver production at far-below-market unit prices. This is beneficial to miners because they use the large initial capital infusions to help finance mine builds, which banks often charge usurious rates for.

Back in May 2017 Wheaton changed its name and symbol to reflect its increasing diversification into gold streaming. In Q2’19 WPM’s silver output collapsed 20.6% YoY, but its gold surged 17.9% higher! That pushed its silver-purity percentage in sales terms to just 38.0%, way below the 50%+ threshold defining primary silver miners. This gold-heavy ratio is forecast to persist, with WPM allocating more capital to gold.

Pan American will probably soon follow in Wheaton’s footsteps and change its name and symbol to reflect its new gold-dominated future. As miserable as silver has fared in recent years, I’m starting to wonder if the word “silver” in a miner’s name has become a liability with investors. The major primary silver miners are a dying breed, as it’s exceedingly difficult to generate sufficient cash flows and profits mining silver alone.

Major silver miners are becoming so scarce that SIL’s fourth-largest component is Korea Zinc. Actually a base-metals smelter, this company has nothing to do with silver mining. It ought to be kicked out of SIL posthaste, as its presence and big 1/11th weighting really retards this ETF’s performance. Korea Zinc smelted about 64.0m ounces of silver in 2018, which approximates roughly 17% of its full-year revenue.

Global X was really scraping the bottom of the barrel to include a company like Korea Zinc in SIL. I’m sure there’s not a single SIL investor who wants base-metals-smelting exposure in what is advertised as a “Silver Miners ETF”. The weighting and capital allocated to Korea Zinc should be reallocated and spread proportionally across the other SIL stocks. The ranks of major silver miners are becoming more rarefied.

In Q2’19 the SIL-top-17 silver miners averaged just 36.4% of their quarterly revenues from that metal! That was on the lower side of the recent years’ range. Only 3 of SIL’s top-17 component stocks were still primary silver miners last quarter, First Majestic Silver, Silvercorp Metals, and Fortuna Silver Mines. SIL is effectively another gold miners’ ETF, where its holdings derive nearly 2/3rds of their revenues from gold!

With SIL-top-17 silver production sliding 1.8% YoY in Q2’19, the per-ounce mining costs should’ve risen proportionally. Silver-mining costs are largely fixed quarter after quarter, with actual mining requiring the same levels of infrastructure, equipment, and employees. So the lower production, the fewer ounces to spread mining’s big fixed costs across. But the major silver miners’ Q2’19 costs surged disproportionally.

There are two major ways to measure silver-mining costs, classic cash costs per ounce and the superior all-in sustaining costs. Both are useful metrics. Cash costs are the acid test of silver-miner survivability in lower-silver-price environments, revealing the worst-case silver levels necessary to keep the mines running. All-in sustaining costs show where silver needs to trade to maintain current mining tempos indefinitely.

Cash costs naturally encompass all cash expenses necessary to produce each ounce of silver, including all direct production costs, mine-level administration, smelting, refining, transport, regulatory, royalty, and tax expenses. In Q2’19 these SIL-top-17 silver miners reported cash costs averaging $6.88 per ounce, which soared 73.9% YoY! While sounding catastrophic, that remains well under Q2’s average silver price.

That means the silver miners faced no existential threat last quarter despite its terrible silver prices. The reason cash costs soared is because Hecla Mining and Silvercorp Metals both reported negative cash costs in Q2’18 due to big byproduct credits. Excluding them, the comparable cash costs a year ago ran $6.49 which is much closer to last quarter’s levels. The silver miners are doing well holding the line on costs.

Way more important than cash costs are the far-superior all-in sustaining costs. They were introduced by the World Gold Council in June 2013 to give investors a much-better understanding of what it really costs to maintain silver mines as ongoing concerns. AISCs include all direct cash costs, but then add on everything else that is necessary to maintain and replenish operations at current silver-production levels.

These additional expenses include exploration for new silver to mine to replace depleting deposits, mine-development and construction expenses, remediation, and mine reclamation. They also include the corporate-level administration expenses necessary to oversee silver mines. All-in sustaining costs are the most-important silver-mining cost metric by far for investors, revealing silver miners’ true operating profitability.

The SIL-top-17 silver miners reporting AISCs in Q2’19 averaged $11.51 per ounce, which was only up 5.3% YoY. That was really impressive considering their waning silver production, and the challenges of producing this metal at such low prices. That was well under late May’s silver low of $14.34, as well as mid-November’s 2.8-year secular low of $13.99. The silver miners are nicely navigating silver’s vexing slump.

At Q2’19’s average silver price of $14.88 and average SIL-top-17 AISCs of $11.51, these miners were earning $3.37 per ounce. That’s not bad for a sector that investors mostly left for dead, convinced it must be doomed. Being so wildly undervalued relative to gold, silver has the potential to surge much higher in this resurgent gold bull. Historically the Silver/Gold Ratio has averaged around 55x, which has big implications.

At early July’s apocalyptic 26.8-year low relative to gold, the SGR plunged all the way to 93.5x! In other words, it took 93.5 ounces of silver to equal the value of a single ounce of gold. But silver was awoken from its zombified stupor soon after, thanks to gold’s decisive bull-market breakout to major new secular highs. So by mid-August as Q2’s earnings season wrapped up, silver had clawed back up to an 88.5x SGR.

By August 15 silver had regained $17.22 at best, which was merely an 18.4-month high. That was still a joke compared to gold though, which at $1524 had soared to its own 6.3-year secular high! In order to mean revert back up to historical norms compared to gold, silver has a long way to go. At $1524 gold, a 55x SGR implies a silver price of $27.71. That’s another 61% higher from silver’s still-weak mid-August levels.

Industry-wide all-in sustaining costs don’t change much regardless of prevailing silver prices. That is because they are largely determined during mine-planning stages, when engineers and geologists decide which ores to mine, how to dig to them, and how to process them to extract the silver. So higher silver prices yield explosive profits growth, which is what makes the volatile silver-mining stocks so alluring to traders.

A silver mean reversion to 1/55th the price of gold at its mid-August prices would catapult silver-mining profits 381% higher at Q2’s AISCs! Capital would deluge into this forsaken sector if these miners were earning $16.20 per ounce on $27.71 silver. And mean reversions out of extreme lows never stop at the historical averages, but their strong upside momentum carries them to proportional upside overshoots.

So the potential silver-miner earnings growth and thus stock-price gains when silver normalizes relative to gold are colossal. But lest that seem like a pie-in-the-sky pipe dream, consider just the first half of Q3’19 already in the books when Q2’s earnings season concluded. As of August 15th, silver had already risen to a $16.10 QTD average. That was 8.2% higher than Q2’s miserable $14.88, and very bullish for the miners.

Assuming Q3’s AISCs stay in line with Q2’s which is highly likely, silver-mining profits could be exploding 36.2% higher QoQ in this current quarter! That of course supports much higher silver-stock prices. All silver and its miners’ stocks need to thrive is for traders to be convinced gold is likely to keep climbing on balance. That necessary shift in overall precious-metals sentiment back to bullish is finally underway.

The caveat is the degree to which silver miners’ earnings amplify this metal’s upside is dependent on how much of their sales are still derived from silver as it reverts north. If the SIL top 17 are still getting 36% of their sales from silver, their stocks should surge with silver. But the more they diversify into gold, the more dependent they will be on gold-price moves. Those aren’t as big as silver’s since gold is a far-larger market.

Back to Q2’19 results, the SIL-top-17 silver miners’ hard accounting metrics mostly weakened. And that makes sense with average silver prices falling 9.9% YoY and these elite silver miners producing 1.8% less. They did manage to achieve a 2.4% gain in total revenues to $3.6b last quarter. That was solely thanks to their collective gold output growing 13.4% YoY. Without that gold, Q2 would’ve looked terrible.

Operating-cash-flow generation was weak, plunging 43.8% YoY to $555m across the SIL top 17. That makes it harder for these miners to invest in future production growth. Their total cash treasuries reported at the end of Q2 also fell 33.9% to $2.4b. Silver needs to rally considerably and stay higher for at least a few quarters before the silver miners can spin off strong cashflows again. Hopefully that’s now underway.

These major silver miners’ hard GAAP earnings in Q2’19 proved really weak, reflecting the miserable prevailing silver prices. Together they reported a collective net loss of $134m, compared to a $463m group profit in Q2’18. Out of the 13 of these SIL-top-17 miners that reported last quarter’s earnings, 8 were losses. Leading the way was the streaming giant Wheaton Precious Metals, which lost $125m alone.

WPM wrote down $166m on a streaming agreement it had overpaid for, a massive non-cash charge that helped torpedo the silver miners’ profits. But I didn’t see any other major writedowns, which was on the impressive side given last quarter’s super-low silver prices. Thankfully traders don’t buy silver stocks for how they’re faring today, but for how they are likely to do as silver mean reverts higher. It’s all about potential.

Silver’s last major upleg erupted in essentially the first half of 2016, when silver soared 50.2% higher on a parallel 29.9% gold upleg. SIL blasted 247.8% higher in just 6.9 months, a heck of a gain for major silver stocks. But the purer primary silver miners did far better. The purest major silver miner First Majestic’s stock was a moonshot, skyrocketing a staggering 633.9% higher in that same short span! SIL’s gains are muted.

The key takeaway here is avoid SIL. The world’s leading “Silver Miners ETF” is increasingly burdened with primary gold miners with waning silver exposure. And having over 1/11th of your capital allocated to silver miners squandered in Korea Zinc is sheer madness! If you want to leverage silver’s long-overdue mean reversion higher relative to gold, it’s far better to deploy in smaller purer primary silver miners alone.

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The bottom line is the major silver miners had a challenging Q2. Silver languished the entire quarter, on its way to horrific quarter-century-plus lows relative to gold. Silver didn’t start perking up until mid-July, after gold’s decisive bull-market breakout had lasted long enough to convince traders gold’s upside was real and sustainable. So silver miners’ operating cash flows and earnings were way down last quarter.

That will really change in Q3 as long as silver doesn’t plummet into quarter-end. It’s incredible how fast silver miners’ fundamentals improve with higher silver prices. And silver’s upside potential is enormous, as it has a vast way to go to normalize relative to prevailing gold prices. The more that precious-metals sentiment improves, the more capital will flow into the tiny silver sector catapulting miners’ stocks far higher.

Adam Hamilton, CPA

September 3, 2019

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