Maximize Your Silver Exposure Through Junior Miners That Trade Like Mispriced Call Options

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 |  Includes: BCEKF, SIL, SSRI, SVBL
by: Ben Kramer-Miller

Summary

Silver is dirt cheap and it has the potential to outperform gold.

Silver investors should look for ways to maximize their exposure by buying miners that are highly leveraged to the silver price for their optionality.

This is difficult since there aren't many primary silver miners and because these companies often have a lot of exposure to other metals.

However there are quality choices out there, and if you buy them while silver is cheap you can do incredibly well as the silver bull market continues.

Recently I wrote an article with a similar title about gold rather than silver. In it I explain why I think it makes sense to make bullish bets on gold and how to pick junior gold miners that are trading like options.

In this article I want to point out similar opportunities in silver. Silver has been one of the weakest markets over the past couple of years, although longer term it has been one of the strongest. While silver trades with gold, and while a bullish stance on gold in many ways implies a bullish stance on silver, there are reasons that I prefer silver to gold.

  • Silver is an industrial metal. But it is more than that. It is a strategic element that has a growing number of usages in new technologies putting it on par with rare earth elements, niobium, tungsten, and graphite. It has poor substitutability considering that it is the best known reflector of light, heat, and electricity.
  • The silver market is tiny--just 750 million ounces are mined each year worth about $15 billion. Compare that with the gold market, which is so much larger that just the three largest primary producers--Barrick Gold (NYSE:ABX), Newmont Mining (NYSE:NEM), and Goldcorp (NYSE:GG)--mine about 15 million ounces or $19.5 billion worth.
  • More than half of the silver that is mined is used industrially while most of the gold that is mined is stored.
  • Silver trades at just 1/66th of the price of gold yet silver reserves yet silver reserves outnumber gold reserves by just 10 to 1 and production outnumbers gold production by 9 to 1.

Given these points it makes sense to be bullish of silver, especially if you are bullish of gold. And I think investors should consider employing a similar strategy whereby they look for mining companies that may not be so appealing with silver trading at $20/oz. but which are far more appealing at $50/oz. or even higher.

Strategies For Finding These Companies

As I said with gold companies your strategy should be to locate companies that maximize leverage to the silver price while minimizing outside risks. So if your bet fails the most likely reason that it fails is continued weakness in the silver market.

With respect to the first point you want to find companies that have the most appreciation potential in the event of a rising silver price. In other words you want to calculate the value of a particular stock at a much higher silver price and compare this valuation with the stock's current value so that you can maximize your leverage.

With respect to the second point you don't want things such as geopolitical tension and environmental regulations getting in the way. Since we're talking about silver you're going to want to stick to Mexico, the U. S.,and parts of Latin America.

Another crucial point in finding the right optionality plays is to minimize your exposure to other metals. This is extremely difficult to do when you are looking to maximize your silver exposure because most silver is mined as a by-product of something else (e.g. copper, gold lead or zinc). And even in the case of a primary silver mine it is rare to find a company whose exposure exceeds 75% silver (for more details on this topic look at my article on the Global X Silver Miners ETF (NYSEARCA:SIL)). Ironically this speaks to silver's relative undervaluation: this wouldn't be the case if silver traded at $50/oz. But at the same time it makes the task at hand that much more difficult.

It also means that part of the selection process is choosing appropriate by-product metals. Of the four metals that I mention above I want to focus on projects that have gold and zinc as by-products. I have already discussed my reasons for wanting gold exposure in my first article. Zinc is a base metal, and while it is not a strategic metal in that it has unique qualities that make it indispensable to modern technologies that are seeing secular growth many investors are projecting a supply deficit in the near future as mine supply is set to decline. While copper can often be used as a zinc substitute copper also trades at three times the price, meaning that if copper is going to be used as a substitute the two prices need to converge, and this benefits zinc.

So What Are Good Companies To Focus On?

Given that there aren't that many silver miners, and given that we are looking for silver miners with particular qualities, there aren't many options, and it follows that you're going to have to make some sort of sacrifice in your selection process.

1--Silver Standard Resources

Silver Standard Resources (NASDAQ:SSRI) has been working towards diversifying away from being a silver optionality play. Over the past year the company sold a couple of properties that focus on silver and it purchased the Marigold Project which is a gold mine in Nevada. But I still think that if you are looking to play much higher silver prices that this is among the best ways to do it. The reason is the company's Pitarrilla Project. This is an enormous silver mine with 700 million ounces of silver. The trouble is that it is going to cost over $700 million to develop, and it is not economical at $20/oz. silver. At the same time the project becomes extremely interesting, and its valuation rises to the billions of dollars once we see $40/oz. silver or higher.

The company also has several other silver focused projects, which I discuss here, although none comes even close in size to Pitarrilla. It also has a large cash position and shares in other mining companies.

This stock doesn't really fit the kind of company that I'm looking for, but if you back out the company's other assets and just look at Pitarrilla there simply is no cheaper silver without taking on enormous risk. So if you don't mind your silver option being bundled with some other investments the is a good way to go about achieving silver price leverage.

2--Silver Bull Resources

Silver Bull Resources (NYSEMKT:SVBL) has cheap silver with over 160 million ounces and a $40 million valuation, giving you an ounce of silver in the ground for every quarter you invest. While you can find cheaper silver it is difficult, and you have to take on other risks. Silver Bull's Sierra Mojada Project has a lot of zinc as well, which brings up one of the risks that I discuss above. But zinc exposure, as I said, isn't the end of the world, especially when you're getting the silver so inexpensively. The project is located in Mexico, and so it is relatively low risk. It fits my description of a small company whose mine isn't really economic now but which will be at a higher silver price. Its too bad that investors will probably never get to see just how much value the Sierra Mojada Project has during the next leg of the silver bull market, as management and key investors are pushing for an acquisition. This isn't the end of the world, and I think the recent stock price weakness is sufficient to merit a position. But because of the potential acquisition I think you need to have other names on your radar even if this is your silver leverage play for the time being.

3--Bear Creek Mining

Bear Creek Mining (OTCPK:BCEKF) has substantial silver resources and while it also has some by-products its 1 billion in silver equivalents with its $240 million NEV makes this an intriguing bet on rising silver prices. Its by-products, which unfortunately comprise nearly half of the company's resources include lead and zinc. The company has two projects of interest. The first is Corani, which is the company's largest and primary project. The second is the Santa Ana Project, which is smaller, but which has been grabbing headlines as it had faced regulatory issues only to get recent approval by the Peruvian government. For leverage seekers this may not be such a great development considering the strong impact this has had on the share price. But at the same time shares are so inexpensive given the awesome size of the company's resources that I think silver bulls looking for leverage and optionality should consider taking a position.

Conclusion

While there aren't many choices out there for investors looking for pure silver leverage we have found a few that are going to perform extraordinarily well in a strong silver price environment.

To summarize, investors looking to get silver leverage through miners should do the following:

  • Find companies that will be worth substantially more at higher silver prices even if their projects may not be economical at $20/oz. silver.
  • Look for companies that minimize other risks that are often associated with mining such as regulator risk. Since it is impossible to avoid exposure to other metals be selective. As I've said I like gold and zinc as by-products.
  • Bet small. Remember that you are buying "options," and options lose value if your thesis doesn't play out in a timely fashion.
  • Have an exit plan. Your math may tell you that your positions should gain 1,000% or more if you hold them through $50/oz. silver but you may want to get out before then.

If you follow this basic advice you should do very well, especially given how inexpensive the stocks I mention above are.

Disclosure: The author is long SSRI, SVBL. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.

Editor's Note: This article covers one or more stocks trading at less than $1 per share and/or with less than a $100 million market cap. Please be aware of the risks associated with these stocks.