Watching the silver (NYSEARCA:SLV) price melt away from $30 ounce down to the low $20s, with only what looks like a low volume dead cat bounce in April, clearly demonstrates the weakness in the overall precious metals markets. The FOMC potential for tapering only adds fuel to the fire for the bearish precious metals camp.
Disregarding the extreme bullish and bearish views on gold, the general consensus suggests the current floor for gold "should be" around the current all-in costs of production for the major producers. Add in extra premium for inflation worries and physical purchases and you arrive at roughly $1300-$1400 ounce. Using the same methodology - Fresnillo's all-in costs are roughly $20/ounce. See Hebba Investments' breakdown: http://bit.ly/11OvGH5
This is a perplexing number; if Fresnillo's profit margin is only $1 or $2 at current price levels then the junior silver miners (NYSEARCA:SIL) must really be feeling the pinch.
Currently there is no GAAP or IFRS accounting standard for this all-in cost calculation. Using the World Gold Council's formula as a starting point provides far greater analysis of the true costs of production.
The all-in cost attempts to reflect the true value of producing 1 ounce of silver. It reflects both the labour intensive costs of mining and the human capital costs of selling an ounce. The all-in costs encompass exploration and mine rehabilitation costs, general and administrative expenses, rent, travel and all other expenses relating to operating activities. This total cost is divided amongst the number of payable ounces to arrive at a true measure of what it costs to produce 1 ounce of silver.
The true all-in costs are shockingly high. This leads us to believe that if these companies total production costs have been misinterpreted then they are potentially overvalued.
We calculated the Enterprise Value per ounce using the standard Enterprise Value formula: (Market Cap - Cash + Debt). Then we divide Enterprise Value by the total silver ounces (Proven + Probable + Measured + Indicated). The meaning of this value represents what $1 of the company is worth in silver ounces - the lower the number, the better.
Somewhat unsurprisingly, some of the valuations are extreme and suggest that the junior silver market has overheated like the junior gold market. However, Silver Standard showed great potential, and Pan American Silver showed great stability, two important factors when choosing mining stocks.
The all-in costs and enterprise value per ounce methodologies answer two of the most important questions when deciding on which mining stock to choose. 1) What are the company's costs and, are they realistic and economically feasible over the long term? 2) Is the stock valued fairly?
Bottom-line: Based on the above criteria, First Majestic (NYSE:FR) is an excellent candidate for investment with its impressive all-in cash cost. Secondly, from a valuation perspective Silver Standard shows excellent potential being valued at $0.30 per contained silver ounce.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.