The major silver miners have rallied higher on balance in recent months, enjoying a young upleg. That’s a welcome change after they suffered a miserable 2018. Times are tough for silver miners, since silver’s prices have languished near extreme lows relative to gold. That has forced many traditional silver miners to increasingly diversify into gold. The major silver miners’ recently-released Q4’18 results illuminate their struggles.

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.

While 10-Qs with filing deadlines of 40 days after quarter-ends are required for normal quarters, 10-K annual reports are instead mandated after quarters ending fiscal years. Most silver miners logically run their accounting on calendar years, so they issue 10-Ks after Q4s. Since these annual reports are larger and must be audited by independent CPAs, their filing deadlines are extended to 60 days after quarter-ends.

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 were running $362m in mid-March near the end of Q4’s earnings season, 6.1x greater than its next-biggest competitor’s. SIL is the leading silver-stock benchmark.

In mid-March SIL included 21 component stocks, which are weighted somewhat proportionally to their market capitalizations. This list includes 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-March these major silver miners accounted for fully 97.7% of SIL’s total weighting. In Q4’18 they collectively mined 75.5m ounces of silver. The latest comprehensive data available for global silver supply and demand came from the Silver Institute in April 2018. That covered 2017, when world silver mine production totaled 852.1m ounces. That equates to a run rate around 213.0m ounces per quarter.

Assuming that mining pace persisted to Q4’18, SIL’s top 17 silver miners were responsible for about 35% of world production. That’s relatively high considering just 28% of 2017’s global silver output came from primary silver mines! 36% came from lead/zinc mines, 23% from copper, and 12% from gold. 7/10ths of all silver produced is merely an other-metals-mining byproduct. Primary silver mines and miners are fairly 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. Q4’18 saw the worst Silver/Gold Ratio witnessed in nearly a quarter century! The SGR collapsed to 86.3x in late November, an extreme 23.8-year secular low. The raw silver price fell under $14 in mid-November, a major 2.8-year low. With such a rotten silver environment, silver miners had to struggle.

The largest primary silver miners dominating SIL’s ranks are scattered around the world. 11 of the top 17 mainly trade in US stock markets, 3 in the United Kingdom, and 1 each in South Korea, Mexico, and Peru. 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 Q4 approximation. Canada has quarterly reporting, but the deadlines are looser than in the States. Some Canadian miners trading in the U.S. really drag their feet in getting quarterly results out.

The big silver companies in South Korea, Mexico, and Peru present other problems. Their reporting is naturally done in their own languages, which I can’t read. Some release limited information in English, but even those translations can be difficult to interpret due to differing accounting standards and focuses. It’s definitely challenging bringing all the quarterly data together for the 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-March, as Q4’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-March. 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 Q4’18 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 Q4’18 revenues actually derived from silver. This is calculated one of two ways.

The large majority of these top SIL silver miners reported total Q4 revenues. Quarterly silver production multiplied by silver’s average price in Q4 can be divided by these sales to yield an accurate relative-purity gauge. When Q4 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. This whole dataset together offers a fantastic high-level read on how the major silver miners are faring fundamentally as an industry. They definitely struggled in Q4.

SIL’s performance certainly reflects the challenges of profitably mining silver when its price languishes so darned cheap. In 2018 SIL plunged 23.3%, amplifying silver’s own 8.6% loss by 2.7x. Silver’s weakest prices relative to gold in almost a quarter century wreaked havoc on silver-mining sentiment. Investors didn’t want anything to do with silver miners, and their own managements seemed almost as bearish.

In Q4’18 silver’s average price dropped 12.9% YoY to just $14.53. That was disproportionally worse than gold, which saw its average price decline 3.8% YoY. Such deep lows exacerbated the pall of despair that is plaguing the silver-mining industry. While production decisions aren’t made quarter by quarter, it sure felt like the seriously-weak silver prices were choking off output. Production is the lifeblood of silver miners.

The SIL top 17’s collective silver production fell 3.9% YoY in Q4’18 to 75.5m ounces. Interestingly that’s right in line with what the major gold miners of GDX experienced that quarter, a 4%ish YoY slide when adjusted for mega-mergers. The major silver miners could be experiencing a peak-gold-like decline in their silver production. Peak silver isn’t discussed as much, but world silver mine output has been shrinking.

According to the Silver Institute’s latest annual World Silver Survey current to 2017, world silver mined supply peaked at 895.1m ounces in 2015. It nosed over a slight 0.7% in 2016, but accelerated sharply to another 4.1% drop in 2017. So the SIL top 17’s output contraction in Q4’18 is just continuing this trend. Silver mining has been starved of capital since 2013, when silver plummeted 35.6% on a 27.9% gold collapse!

Silver-mining stocks have been something of a pariah to even contrarian investors for much of the time since then. That’s left their prices largely drifting at relatively-low levels, making it more difficult to obtain financing to expand operations. Investors haven’t been interested in silver-stock shares, leaving miners wary of issuing more to raise capital with stock prices so low. That can really dilute existing shareholders.

With the major silver miners unable or unwilling to invest in developing new silver mines and expansions to offset their depleting output, it has to decline. 11 of the 15 top SIL components reporting Q4’18 silver production mined fewer ounces than in Q4’17. All 15 together averaged silver output shrinkage of 3.4% YoY. That’s a sharp contrast to these same miners’ gold production, which grew an average of 7.9% YoY.

In overall total terms, the SIL top 17’s 1.4m ounces of gold mined in Q4’18 still slipped 1.5% YoY. But with total silver production sliding more than gold, the major silver miners’ long ongoing diversification into the yellow metal continued. At the bombed-out silver prices of recent years, the economics of gold mining are way superior to silver mining. The traditional major silver miners are painfully aware of this and acting on it.

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 silver generates much-lower cash flows than gold due its lower price. Silver miners have been forced to adapt.

The major silver miners continued their trend of diversifying into gold at silver’s expense in Q4’18. SIL’s largest component Wheaton Precious Metals was a great example of this. It used to be known as Silver Wheaton, a pure silver-streaming play. Back in May 2017 it changed its name and symbol to reflect the fact it would increasingly diversify into gold. In Q2’17 WPM streamed 7,192k and 80k ounces of silver and gold.

Back then fully 61.9% of WPM’s sales still came from silver, qualifying it as a primary “miner”. Fast-forward to Q4’18 and WPM’s silver output plunged 27.1% YoY to 5,254k ounces! But its gold mined rose 10.5% YoY to 107k ounces. That pushed the implied percentage of WPM’s revenues down to just 36.8% silver, way below the 50% primary threshold. Like it or not, the silver-mining industry is increasingly turning yellow.

This strategic shift is good and bad. The major silver miners’ growing proportion of gold output is helping these companies weather this long dark winter in silver prices. But lower percentages of sales generated from silver leaves their stock prices and SIL less responsive to silver price moves. Silver stocks’ leverage to silver is the main reason investors buy them and their ETFs. Their shift into gold is really degrading that.

In Q4’18 the top 17 SIL silver miners averaged just 39.6% of their sales from silver. Only Pan American Silver, First Majestic Silver, Silvercorp Metals, and Endeavour Silver qualified as primary silver miners with over half their revenues from the white metal. While still low, that 39.6% average of SIL was actually considerably better than Q4’17’s 36.0% despite the ongoing transition into gold. But that’s not a trend shift.

In Q4’17 SIL’s components included Tahoe Resources, which was bought out by Pan American Silver in mid-November. Tahoe owned what was once the world’s largest silver mine, Escobal in Guatemala. It produced 5,700k ounces in Q1’17! But Guatemala’s government shut it down after a frivolous lawsuit by anti-mining activists. I last discussed the whole Tahoe saga in depth in my Q3’18 essay on silver miners’ results.

By Q4’17 Escobal’s production had dropped to zero, leaving Tahoe’s silver purity at 0.0%. That dragged down the SIL top 17’s average, leaving it artificially low. But Pan American buying Tahoe for both its gold production and hopes of convincing Guatemala to allow Escobal to reopen killed Tahoe’s stock and purged it from SIL’s ranks. Endeavour Silver edged into the top 17 to take its place, with 59.6% of sales from silver.

If Tahoe’s silver purity is excluded from Q4’17’s overall calculation while Endeavour is added, SIL would have averaged 39.9%. So in comparable terms Q4’18’s 39.6% remains a declining trend. Primary silver miners continue to get rarer, they may even be a dying breed. That has forced SIL’s managers to really scrape the bottom of the barrel to find components to fill their ETF. That’s what happened with Korea Zinc.

This is no silver miner, but a base-metals smelter! In mid-March it commanded a hefty 13.2% weighting in SIL, over 1/8th the total. I’ve searched and searched, but can’t find English financial reports for this company. But in 2017 it reported smelting 66.2m ounces of silver, a 16.6m quarterly pace. I bet there’s not a single SIL investor looking for base-metals-smelting exposure! Global X really ought to remove it entirely.

The capital allocated to Korea Zinc could be spread across the remaining SIL components proportionally, reallocating and modestly upping their weightings. But the fact Korea Zinc even ever made it into SIL is a testament to how rarified the ranks of major silver miners have become. That won’t reverse unless silver mean reverts dramatically higher relative to gold and remains at much-better price levels for years on end.

With SIL-top-17 silver production sliding 3.9% YoY in Q4’18, 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. SIL’s major silver miners indeed reported far-higher costs last quarter.

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 Q4’18 these SIL-top-17 silver miners reported cash costs averaging $6.46 per ounce. While that surged 37.0% YoY, it still remains far below prevailing prices. Silver miners face no existential threat.

The major silver miners’ average cash costs vary considerably quarter-to-quarter, partially depending on whether or not Silvercorp Metals happens to be in the top 17 or not. This Canadian company mining in China has negative cash costs due to massive byproduct credits from lead and zinc. So over the past couple years, SIL-top-17 average cash costs have swung wildly ranging all the way from $3.95 to $6.75.

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 reported average AISCs of $13.28 in Q4’18, surging 31.0% higher YoY! That is troubling, climbing vexingly close to silver’s latest major secular low of $13.99 in mid-November. While Q1’19’s average silver price of $15.55 so far is much better, these profit margins are still tight for a long-struggling industry. Thankfully the major silver miners’ cost structure is better than that number implies.

The highest AISCs by far in Q4 came from SSR Mining, which was formerly known as Silver Standard Resources. They climbed another 11.7% YoY to nosebleed levels of $20.45 per ounce! But that’s not a normal situation. SSRM too is shifting into gold, gradually winding down its old Pirquitas silver mine. As it depletes, there are fewer ounces to spread its fixed costs of mining across which drives up per-ounce costs.

Excluding SSRM, the rest of the SIL top 17 reporting AISCs in Q4’18 averaged a more-reasonable $12.48 per ounce. And these major silver miners providing AISC outlooks for 2019 projected similar levels near $12.70. This is still on the high side, as the SIL top 17’s AISCs ran $10.14, $10.92, $10.93, and $13.53 in the preceding four quarters. But $12.48 is still profitable even with silver seriously languishing relative to gold.

Silver-mining profits really leverage higher silver prices, and big earnings growth attracts in investors to bid up stock prices. In Q4’18 silver averaged $14.53 per ounce. At the SIL top 17’s average AISCs ex-SSRM of $12.48, that implies the major silver miners as an industry were earning profits of $2.05 per ounce. Those are going to grow majorly this quarter. The almost-over Q1’19 has seen silver average $15.55.

With Q4’s AISCs among the highest silver miners have reported in years, they could very well decline in Q1. But assume they remain stable near $12.48. That implies the major silver miners earned about $3.07 per ounce in Q1. A mere 7.0% quarter-on-quarter silver rally could catapult silver-mining profits a massive 49.8% higher QoQ! This awesome profits leverage to silver is why silver stocks amplify silver’s upside.

Of course the greater a silver miner’s exposure to silver, the more its stock will surge as silver advances. First Majestic Silver had the highest silver purity in Q4 at 63.7% of its revenues derived from silver. Thus AG’s stock should thrive with higher silver prices. But SSR Mining’s mere 12.5% silver purity pretty much leaves silver irrelevant. As SSRM is overwhelmingly a primary gold miner, higher silver won’t move the needle.

So investors who want classic silver-stock exposure to leverage silver uplegs need to be smart about how they deploy capital. While buying SIL is easy, it is dominated by primary gold miners. And who on earth wants over 1/8th of their investment wasted in a giant base-metals smelter? The greatest gains in future silver uplegs will come in the stocks with the most silver exposure. They are what investors need to own.

Despite slowing silver production and their ongoing diversification into gold, the major silver miners still remain well-positioned to see huge profits growth as silver marches higher. Especially the primary ones. But with silver hammered to major secular lows in Q4’18, the accounting results of the SIL-top-17 silver miners were quite weak. 3.9%-lower production combined with 12.9%-lower average silver prices wasn’t pretty.

The following accounting comparisons exclude SIL’s largest component WPM. For some reason it waits until the end of March to report Q4 results, which is incredibly disrespectful to its shareholders. Q4 data is getting stale with Q1 ending. There’s no excuse to delay reporting with modern automated accounting systems gathering all data in real-time. For workflow reasons I had to write this essay before WPM reported.

Ex-WPM, the SIL top 17 sold $3.4b worth of metals in Q4’18, which was down 10.9% YoY. Given lower silver production and much-lower silver prices that was relatively good. But cash flows generated from operations collapsed 52.5% YoY to $444m in Q4. That means less capital available to finance mine expansions and new mine builds. Overall corporate treasuries at these companies fell 33.0% YoY to $2.6b.

Surprisingly the hard-GAAP-earnings picture actually improved over Q4’17, though still remained weak. Excluding WPM, the SIL-top-17 silver miners lost $202m in Q4’18. That cut in half Q4’17’s total losses of $412m. But both quarters’ accounting profits were skewed by big non-cash impairment charges. When lower-silver-price forecasts reduce economic reserves at mines, those perceived losses must be recognized.

AG wrote off $168m of its mines’ carrying value on its books in Q4’18 due to lower reserves driven by lower metals prices. The grades within individual ore bodies vary widely. Silver that is economic to mine at $20 might not be worth extracting at $15, so companies have to cut their reserves and flush those non-cash losses through their income statements. PAAS reported a smaller $28m impairment charge as well.

Together these two $196m writedowns alone accounted for 97% of the major silver miners’ Q4 losses. But even without them most of the other SIL top 17 still reported mild-to-moderate GAAP losses with the silver prices so darned low. The comparable Q4’17 results had big writedowns too, primarily $547m by Volcan to meet new accounting standards demanded by another company that bought 55% of its stock.

While the major gold miners had no excuse for their huge impairment charges in Q4’18 since gold was stable last year, silver miners did since silver was hammered. As silver mean reverts higher with gold and outpaces its rallying, the major silver miners’ GAAP profits will improve radically. That will attract in a lot more investors, especially to the primary silver miners. Those capital inflows ought to drive massive gains.

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-stock ETF is increasingly burdened with primary gold miners with insufficient silver exposure. And having over 1/8th of your capital allocated to silver miners squandered in Korea Zinc is sheer madness! If you want to leverage silver’s coming huge mean reversion higher relative to gold, it’s far better to deploy in smaller purer primary silver miners alone.

One of my core missions at Zeal is relentlessly studying the silver-stock world to uncover the stocks with superior fundamentals and upside potential. The trading books in both our popular weekly and monthly newsletters are currently full of these better gold and silver miners. Mostly added in recent months as these stocks recovered from deep lows, our unrealized gains are already running as high as 87% this week!

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The bottom line is the major silver miners are struggling. With silver falling to nearly a quarter-century low relative to gold in Q4, the miners’ results were naturally weak. Mining costs surged as production kept waning, reflecting the ongoing trend of major silver miners increasingly diversifying into gold. But silver-mining profits are still primed to explode higher as silver continues climbing in its young upleg with gold.

There aren’t enough major primary silver miners left to flesh out their own ETF, which is probably why SIL is dominated by gold miners. While it will rally with silver amplifying its gains, SIL’s upside potential is just dwarfed by the remaining purer silver stocks. Investors will be far-better rewarded buying them instead of settling for a watered-down silver-miners ETF. Their stocks will really surge as silver continues recovering.

Adam Hamilton, CPA

April 1, 2019

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