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Summary

  • SSRI has succeeded in lowering its cost for the production of silver. The total cash costs amounted to $12.87 per ounce for 2013, down 24% from $16.88 from 2012.
  • The long-term outlook of silver contract prices is highly dependent on econometric factors. The recent quantitative easing tapering measures have resulted in great volatility in the prices of precious metals.
  • The Chinese economy is showing signs of an economic slowdown, but demand for silver may rise if further stimulus is undertaken through carious policy measures.

An Overview of Silver Standard's Financial Position

Silver Standard Resources (NASDAQ:SSRI) has performed reasonably well in the past few months up +57.18% YTD, trading at $10.94/share. SSRI is trading over its 200 day SMA and displaying additional bullish signals as the 50 day SMA has crossed over the 200 day SMA. However, SSRI realized a net loss of approximately $224 million for the year ended 2013. This is mainly because of the loss recognized on the impairment of the capital assets as a result of a significant decline in silver price. In calculating the value of these capital assets, SSRI utilized a very high silver price assumption of $35.37 per ounce (2013) (Source: SEDAR). The ultimate question is whether the company's valuation is justified in accordance to its future cash flows. The weighted average cost of capital applied by SSRI is 10%. However, the expected future cash flows are strongly dependent on future prices of silver. That being said, commodities are highly volatile and difficult to predict. Silver Standard has projected the silver price at: $34.03 (2014), $30.00 (2015), $28.15 (2016), 23.11 (2017), and a long-term price of $23.11 (Source: SEDAR). It is safe to state that projected cash flows are valuing the share price at intrinsic value. As silver price is affected day to day, so are the future expected cash flows generated by Silver Standard. There is a positive relation between the two.

On the contrary, SSRI has succeeded in lowering its cost for the production of silver. The total cash costs amounted to $12.87 per ounce for 2013, down 24% from $16.88 from 2012 (Source: SEDAR). Future guidance for silver production cash costs is between $12.50 and $13.50. It is extremely important to realize that if silver prices rise significantly in the year 2014, the gross margin will rise considerably on SSRI's financials. Thus, operating profit will rise from its current level of $5 million and generate more cash flow. The capital assets will have to be revalued on the rise of silver prices, reversing the impairment losses recognized.

If the silver prices decline further, it may tarnish the company's operating income further. However, lower prices will lead to an increase in higher demand for the scarce metal. Since the margins will be lower, many mining companies, including SSRI, may cut back on production as the costs will outweigh the benefits of producing an ounce of silver. With a reference towards the basics of supply and demand, a decrease in the supply will directly cause the market price of silver to increase.

Comparison of Various Competitors

The following chart outlines the operating loss or income for SSRI's major competitors by market capitalizations that are relatively close to SSRI's market cap.

From the data, the analysis that can be extracted is the fact that Coeur Mining Inc. (NYSE: CDE) is a relatively risky company for an investment as its cash costs increased from 2012 to 2013 to $9.84. This is an increase of approximately 30%. This increase in the production cost of silver is a major contributor for the increase in operating loss to 845,159. Similarly, McEwen Mining Inc. (NYSE: MUX) had an operating loss as well but the cash costs associated with silver production were not explicitly stated in the annual financial statement release. But it is one of the few companies that incurred a loss in 2012, at the time period when silver prices were higher. The conclusion that can be drawn from this anomaly is that McEwen Mining failed to reduce its cash costs for the production of silver. Ultimately, SSRI is a strong preference over Coeur and McEwen as it successfully reduced its cash costs from $16.88 to $12.87 (down 24%).

Silver Price Outlook

Recently, silver prices have bounced back from their December 30th, 2013 low of $18.818 currently trading at $20.91. For the year of 2014, the May silver futures contracts are up a total of approximately 7.13%. This sudden spike in the price has been a result of an increase in the physical demand for the commodity. Additionally, sentiment analysis through Commitment of Traders (COT) (Source: Commodities Futures Trading Commission) report portrays that there has been a drastic increase in the futures and options net long positions of silver contracts by large non-commercial speculators. On February 4th, 2014, the net long positions by the large speculators were 6,136. However, as of March 4th, 2014, the number of net long positions outstanding by these speculators increased to 27,390. In contrast to the net positions held by non-commercial speculators, the commercial hedgers have had an increase in net short positions, from -14,359 to -39,799 over the same period of time. The price of silver tends to move directly with the net positions held by non-commercial large speculators and inversely to the net positions held by commercial hedgers. Thus, this gives a strong indication of the recent short-term rally in futures prices.

The long-term outlook of silver contract prices is highly dependent on econometric factors. The recent quantitative easing tapering measures have resulted in great volatility in the prices of precious metals.

Quantitative Easing and Silver Price

Quantitative easing measures have been carried out by the Federal Reserve in the past. The timeline for QE displays that the Federal Reserve has implemented QE1 and QE2, but the tapering for them was short-lived as new policy measures were undertaken to improve the US labour markets.

In November 2008 and March 2009, the Fed initiated an $800 billion plan to bolster lending and a $300 billion plan for purchases of long-term treasury bonds. This continued till June 2010, until economic conditions started to improve and purchases were halted. The taper of QE1 did not have a significant negative effect on the silver price. The reason being that, the growth of the US economy started to slow down. This resulted in a rally in the silver price as the demand for safe haven ballooned. Similarly, QE2 experienced the same effect. In November 2010, the Federal Reserve started another $600 billion bond purchase program which lasted till the second quarter of 2011. During this time, silver prices reached an all-time high of almost $50 per ounce. Although during the winding down of QE2, the commodity price declined sharply on the halt of purchases, the price later on recovered back close to its all-time high as market indices declined across the board. The same consequences worried investors of another economic slowdown.

Comparing the past QE measures to the present QE3, the results seem almost identical. The tapering of QE3 which was introduced in September 2012 is mimicking the same market conditions. Investors are concerned about a new bubble forming as a result of new all-time highs. As the past events have demonstrated, equity market indices tend to decline following the tapering of quantitative easing and the price of safe havens tends to recover. Since the tapering rumors of QE3 in May 2013, silver prices have declined drastically, sending all mining equities into a plummeting frenzy. However, it seems that the majority of the downward move in silver prices has been priced in. Ever since the Fed started to taper from the $85 billion to $65 billion starting in January 2014, the majority of the safe haven commodities are holding on to positive returns. Looking forward to a complete wind-down of QE3, history has tended to repeat itself. Recent econometric data is already starting to show the consequences of tapering: the unemployment rate increased from 6.6% to 6.7% for February 2014, and GDP declined to 2.4%, well below the forecast of 2.6% and previous quarter GDP of 3.2%. Overall, it is very likely that the concern of the US economy will cause markets to decline further, and increase both physical demand and market contract net long positions of silver. The price will likely follow and Silver Standard Resources will gain simultaneously.

Chinese Economy and Silver

The Chinese economy has recently shown signs of economic slowdown, especially after the recent release of the trade balance, consumer price index (CPI), and producer price index (PPI). The monthly trade balance data for February released on March 7th exposed the deteriorating conditions of China's imports and exports. The trade balance for January was at 31.9B, while the forecast for February was merely 13.2B; the actual data was much lower at -23.0B. The reason supporting this drastic change is the sudden fall in exports by 18.1%. However, further weakening signs of China's economy is the CPI and PPI. The CPI missed its estimate of 2.1% and came out at 2.0%, a 0.5% decrease from January - slowest rate in 13 months. Similarly PPI for February was at -2.0%, lower from -1.6% from the previous month.

(click to enlarge)

CNY Trade Balance (Source: Forex Factory)

After a look at these worse than expected statistics, the concern is: How will this impact silver prices? As mentioned previously, that safe haven demand increases as a result of economic slowdown in various countries. China is one of the largest economies; the fear of investors will drive the demand for silver higher on signs of a possible contraction. But China itself is one of the largest purchasers of silver. If China experiences difficulties in promoting growth in their economy, they will likely cut back on purchases. However, recent circumstances may result in China stimulating their economy if needed be through policy easing. According to various analysts, such action is very likely by China (Source: Reuters). Further stimulus in the economy will result in spurring demand for silver by China. An increase in demand by this magnitude will increase silver prices in the long run.

Source: Silver Standard Resources: Further Upside From Lower Cash Costs, Rising Silver Prices