My Affair With Silver ... And Where It Goes From Here

by: Stanley Barton

It has only been eight years since I discovered my passion for silver, but it seems like we have been together forever. This article is about my transformation from casual silver collector to full-fledged silver bug, some intriguing mining stocks I discovered along the way and my personal vision for the future of silver.

In 2004, my other love reminded me that it was our 25th anniversary, and I decided I would give her a sterling silver vase of long-stem roses. I got on EBAY and found a 16"-tall vase by the respected US silversmith, Watson Company.

When the package arrived, I placed the pacific-cloth bag on the breakfast table. I pulled loose the satin bow and the purple cloth fell away, revealing my reflection in the mirror-polished cylinder. My heart began to race as I lifted the delicately-sculpted foot from the rumpled fabric and noticed one tiny blemish…".925" struck into the soft metal. I did not get any sleep that night.

In the next two years. I accumulated hundreds of vintage silver beauties, cast off by heirs of dead aristocrats who had treasured them a lifetime. I justified that as long as I could buy scrap sterling silver (92.5% pure silver) for less than $10 an ounce there was little downside in my "investments." I added that, with the inflationary demise of paper currency, the day may come when we would need to trade a Tiffany baby cup for a hamburger. I did make a private oath that I would never pay more than $10 an ounce for scrap silver. Eventually the price of silver did rise well above $10, and I avoided EBAY entirely.

I had survived three decades of stock market ebbs and flows by being a timid money manager, so in my new ROTH IRA I wanted an appropriately diversified portfolio. Reluctantly I decided I should have some exposure to precious metals, although I had developed a mental stop light that flashes whenever I think about investing in something I do not thoroughly understand. With precious metal prices skyrocketing and mining stocks suspiciously dormant, it seemed urgent to learn the facts of life about silver. Despite all the red-light warnings, I ventured into the denizen of "junior miners" from exotic exchanges, following intrepid entrepreneurs into dark jungles and frozen tundra. I was essentially a silver virgin, and I knew I might be a little clumsy before I figured out its dynamics.

I was falling for dazzling investment propositions…each one with attributes that dreams are made of: bonanza discoveries of thick veins of ore, giant jaw crushers ready to gobble mountains of high-grade rock and silver bars daily filling railcars. When it came decision time, I reverted to what I know: earnings growth and fundamental value. My first silver miner…

Revett Minerals Inc. (NYSEMKT:RVM) - $4.45

Revett Minerals owns the Troy mine in Montana, which last year produced 1.3MM ounces of silver and 10.6MM pounds of copper. Their shallow mining operation yields a cost of $2.22 per each ounce of silver or pound of copper. RVM also owns the Rock Creek property in Montana, this country's largest undeveloped silver/copper deposit, including 300MM ounces of silver.

When I found RVM, it clearly satisfied several of my standard value metrics: price less than 2X book and 2X sales, PE less than 15 and lots of cash and no debt. The stock is a dollar a share higher now, but RVM still is close enough to those metrics to qualify as a good value according to traditional analysis.

What I have learned is that precious metal miners are not always evaluated according to traditional methods. Undervalued land makes book value deceptively low, and accounting to amortize mine life reduces profit numbers (the reality may be that exploration is actually extending mine life). Bright earnings reports may blind one to the realities of a voluptuous vein flaming out. Each of these darlings has its charms and complexities, and each must be evaluated according to the idiosyncrasies of each mine.

Now I look at mines in three ways: Prospects, Development mines and Production mines. Prospect mines may be just promising land stakes. I think a company has to be able to spring a minimum of $10MM for evaluation and feasibility studies, permits and mitigation measures, and they need about 2 years to move into development. Development miners have cleared the first hurdle and are in construction. The development and construction costs depend on the circumstances of each mine. A minimum of $100MM and probably three more years must be invested to get the first ounce out of the ground. Obviously, Production miners are selling silver so the concern is "how much…for how long."

Even though I jumped in bed with RVM before I knew what I was doing, it has been a sweet relationship. Shares gently escalated 20% in the first couple months. To my delight, I discovered that RVM has all three of the above operations. The lucrative Troy mine is producing $29MM a year in free cash flow ($.78 per diluted share) and they are putting some of that into the development of their "C and I beds" which will double their production fronts in the Troy Mine in the next 30 months. In the meantime, they are putting about $10MM annually into defining the prospects of the Rock Creek prospect to go into production in 2016. I believe that RVM should have mining operations for decades to come.

Although I think it is an appropriate long-term investment, traders should be advised that RVM may take time to be recognized. Their latest guidance for 2012 is solid but also implies that they are more focused on investing in development than pumping their numbers.

RVM is option-able, so I sold a $5 call, adding another 13% income element to my RVM investment. The Rock Creek project had been tied up in a lawsuit with an environmental group, and recently the judge ruled in favor of RVM in that group's last appeal. The stock shot up over $5. I should have been delighted with a 50%+ profit, right? I was devastated, knowing I was going to lose one of my most enchanting investments to the call option owner. I felt like Judas Iscariot betraying his friend for 30 pieces of…well, you know. There was a possibility the share price would drop back by exercise day (which is what happened), but to assure exposure to the volatile silver market I had to add another miner to the portfolio…

Hecla Mining Company (NYSE:HL) - $4.90

Hecla Mining Company began operations in 1891 by opening the Star Mine in the Idaho Silver Valley. HL produced 9MM ounces last year from two mines. With silver spot prices pushing $40, it was easy for the miners under my microscope to make a profit. For the long term, I wanted a company that could turn a profit even with lower silver prices. What really caught my eye was Hecla's average cash cost of less than $.67 per ounce in the last quarter reported.

Years ago Hecla had been cited for its 100-year orgy in the Silver Valley, and the remediation case was a dark cloud over this stock. The September 2011 settlement of this issue will take a $159MM bite out of their $400MM cash hoard over the next four years, but it will remove a historic drag on this stock.

Their Lucky Friday mine in the Silver Valley has been giving up the goods since 1949. I think of the Lucky Friday like Mother Earth who seems to be saying, "C'mon boys, take what you want…there's more where that came from." Indeed, Hecla indicates that the ore grades at the Lucky Friday are getting better the deeper they go. The mine is currently more than a mile deep and yields a bounteous 13 ounces per ton (OPT). HL is sinking shaft #4 in the Lucky Friday and it will reach a depth of 8800 feet by 2015.

Last month the Mine Safety and Health Administration ordered the Lucky Friday closed for safety concerns after two fatalities in the past year. HL is taking all of 2012 to clean up and reinforce safety measures in the mine with the goal of re-opening early in 2013. The stock, selling above $11 a year before, closed well below $5 per share on panic selling. It has lingered near $5 as lawsuits are being filed and the company reduced 2012 guidance to 7MM ounces per year from 9MM ounces in 2011.

On the positive side, the silver is still there in the Lucky Friday and the year off will allow for production efficiencies to be put into place, as well as the safety improvements. On the other hand, investors must weigh if the bad has been sufficiently priced into the stock, and if there will be further delays in the re-opening. I can say that the fickle market seems to put a lot of value on a piece of land in some questionably-compliant foreign land where the upstart miner only has a few trenches and wheelbarrows of ore to prove the value. Measure that against a 62 year old operation with millions of tons of proven high-grade ore and a clear plan how to get it, and it appears the downside is limited. The 120-year-old US company that owns the mine is betting $200MM to expand its life by decades, and I am willing to "follow suit."

As important as the Lucky Friday is to HL, the real starlet in the Hecla cabaret is Greens Creek Mine in Alaska with 12 OPT of silver and gold to boot. At least 70% of HL revenue is generated by this 22-year old mine. Gold by-product revenue easily pays for the entire operation, including 7mm ounces of silver production. Hecla states that if they do no further exploration in their 27-square-mile land position, the mine will last at least another 10 years. A modest $8MM is budgeted for exploration at Greens Creek in 2012.

HL is considered a production company and their prospects are not given much attention. After the Lucky Friday closure, street rumors surfaced regarding take-over targets so cash-rich Hecla can make up the temporary revenue loss. Management may be playing their cards close to the vest, but they point out that they already own plenty of stakes with huge potential. They note budgeted exploration initiatives at their San Juan, Colorado and San Sebastian, Mexico mines, as well as expanding their producing prospects.

Regarding other development operations, the rise in silver prices now justifies their re-opening expenditures at the legendary Bulldog and Equity mines in Colorado and the Star mine in Silver Valley that started the Hecla story 120 years ago.

Hecla recently initiated a new dividend policy tied to the price of silver…a penny-each-quarter for each $5 increment over $30 spot. For instance, at $50 silver the yield would be about 4% annually at current share price. Instead of declining, the company's reported silver reserves are at an all-time high, and HL projects increasing production about 10% each year after returning to a 10MM-ounce pace in 2013. Investors must decide if Hecla is a has-been or can approach its former glory when it was the top performer in the New York exchange during the silver spike of 1979, as the Hunt Brother tried to corner the market. I think at its depressed price, HL has good value for patient investors.

I was perfectly content with the long-term prospects for HL and RVM, and I really don't know what got into me when I found another small miner I could not resist…

Excellon Resources [EXN.TO] (OTCPK:EXLLF) - $.59

I have been known to watch a stock for months before pulling the trigger to buy it. I impulsively bought EXN the day I found it. Maybe it was the eye-popping 30-OPT ore from their La Platosa Mine in Mexico, the debt free balance sheet, the strong cash flow or the rare earth deposits discovered on their land that made me plunk down my "four-bits" a share (that term derives from the Spanish silver "pieces-of-eight" coins that could be cut into eight "bits" to pay for small purchases, so four bits is a half coin…or 50 cents).

In retrospect, I think what won me over to EXN is that the management makes demure teases about their prospects and production, followed by blowout performance. Unlike most junior miners selling shares every chance they get, EXN actually is buying back millions of their own shares in the open market. The January production just released was 169,259 ounces, a 45% beat over the company's plan, which already was modeled to fund an ambitious exploration program. At a $6.50 production cost, that leaves about $25 per ounce for free cash of $4.2MM in one month or an annualized $50MM ( $.17 per share). Of course, company projections are more conservative but still include a 20% production increase over 2011.

Excellon has done a good job of identifying resources at La Platosa, but they need to keep exploring to increase their reserves. Although geological reports to date support their claim as the "highest grade silver producer in Mexico," I remain skeptical that they can provide that grade of ore for a decade. Their 2012 budget focuses on this goal, as well as advancing the development of their rare earth deposit and their gold properties in Quebec and Ontario, Canada.

Since lately the overall stock market had risen dramatically more than the precious metal segment, metals had become under-weighted in my portfolio. Since I had accumulated cash from dividends and option sales, to rebalance the portfolio, I had to add another miner…

Aurcana Corporation [AUN.V] (OTCPK:AUNFF) - $.84

AUN operates the 92%-owned La Negra silver/copper/zinc mine in Mexico and has essentially doubled the revenue and quadrupled EBITDA in 12 months ending September 2011. In May 2012, they will put into operation their 100%-owned Shafter mine in Texas, projected to be the 16th largest mine operation in the world, and second in the US only to Hecla's Greens Creek mine. On the Vancouver Exchange and US pink sheets, AUN has been under-the-radar, but it looks like that is about to change.

La Negra produces 1.7MM ounces of silver equivalent at $10.48 per ounce cash costs, and Shafter is expected to produce 3.8MM ounces in its first year at $8.27 per ounce. At $30/ounce spot price that equates to more than $.20 cash per diluted share each year. Silver grades are improving at La Negra as exploration continues. A new resource estimate is due during Q1 2012.

Aurcana has made some bold moves, making this one of the more risky investments in my portfolio. It had been flirting with bankruptcy and, in 2008, sold 50% of its silver stream to Silver Wheaton (NYSE:SLW) to buy the Shafter mine. In 2010, it bought back the silver stream. In November 2011, they received $34.4MM in a private placement, which appears to be enough to get the Shafter mine in operation. In its effort to go from a tiny operation to mid-tier status, there have been warrant and option issues, leaving the share structure diluted to 558MM shares. However, it looks like the payoff is this year with significant events in the next few months: adding 33% capacity to La Negra, publication of upwardly-revised resource assessment and opening Shafter.

As I have gotten more comfortable with silver mining operations, I have found myself moving to higher risk/reward propositions. Now with these four miners in my stable, I am excited about the prospects for capital appreciation in the next five years. I know some readers will be critical that I have not gotten comfortable enough to add any pure exploration companies (non-producers), but I do have my eye on some. In the following discussion it may become clearer why I am shy about approaching those bold companies.


I think before making an investment, one should have a vision about where it could go and why. I have no crystal ball, but I do want to have logical expectations for an investment and a way to monitor its progress according to my vision. I also like to keep it simple enough so I can remember exactly why I made the investment.

Since my silver stock investments are in a ROTH IRA, my perspective focuses on how I expect silver to perform for the next five years. Since I am not trading these, I am not into micro-analysis, but I am more interested in the macro factors that will come into play during that time period. My expectation is that my investments in this portfolio will double in 5 years, or about a 15% average annual increase in value.

I think that the spot price of silver should increase 15% per year, and I am assuming that the miners' share prices will at least track that increase. Since the miners are actually leveraged, I think this is a conservative assumption.

There have been a number of studies analyzing the supply and demand for silver, comparing published production numbers against industrial and investment uses for silver. I consider this analysis admirably ambitious, but like my contractor neighbor describes construction estimates…it is a wild guess to the second decimal point. My logic tells me that the higher silver price has reopened dormant mines and paid for investments in increasing production on the supply side. The same increase in price has caused increased interest in physical silver as an investment in ETFs and others. I am not convinced that industrial demand alone will justify higher silver prices. The bigger influence will be the investment demand.

One of the supply factors that I do think will support the price in the near future is that silver miners will start keeping silver inventory instead of cash. Endeavor Silver (NYSE:EXK) is choosing to withhold from the market some silver with the intention of selling when the spot price is higher. Most silver miners have large capital expenditure programs so they keep large cash balances. Easily they could hold 10 - 20% of that in their own silver, and removing that from the market supply would insure better prices. EXK is a stock I like, but I can't buy them all. Of course, holding off sales of their production will falsely make the income statement look as if they are underperforming.

Silver is linked to gold at a ratio lately of about 50:1. If gold is bid up in price, silver usually follows. Gold has almost no industrial use…its price is driven by fear and greed. The fear factor is a powerful and under-appreciated influence on the price of precious metals. Politicians, news outlets and investment advisors have learned what preachers have known for centuries: terrorism sells. A buck in the collection basket is insurance against an eternity in hell. Out-of-favor politicians must convince voters that the current decision-makers will lead us to Armageddon. Some "news" organizations build the terror angle around every facet of our lives to keep people glued to their commercials. I see this trend growing, and as long as this "media terrorism" continues there will be increasing demand for gold and silver. Political ideological wrestling has become a popular spectator sport that can only help silver prices.

Some of the doom and gloom may come to pass, but we cannot really predict when or how. My personal belief is that things are neither as good nor as bad as competing sides depict. For my analysis, I am assuming that over the five-year period we will probably have one earth-shaking disaster that will temporarily cause demand to overwhelm sellers. The longer-term effect of this event will be a propensity to hoard metals, contributing to the support of a gently up-trending price for silver. I also think that inflation will account for at least a 3% annual price increase in precious metals.

We should also have a downside forecast to let us know what could happen as we evaluate our risks. I think that silver should trade above $20 per ounce during the five-year period and if the spot price drops below $25 we are in the caution zone. It is notable that when miners produce estimates for net cost of production, value of proven reserves, inventories and other financial metrics, these are based on an assumed price of silver and its by-product metals. In most of these reports that I have read lately, that number is $20 to $25 per silver ounce. If silver drops below that price for an extended period, these metrics will fall in domino fashion. It could be similar to the housing bubble, where an unexpected drop in home value caused a chain reaction in related investments. Silver could free-fall below $20 as margin calls come into play in the commodities markets. Some who thought home prices would never fall now think precious metal prices can never fall….never say "never."

In my portfolio, I am not yet including companies that have no production. I recognize that with ever-rising silver prices these "exploration" miners could be the biggest winners. However, it is good to keep in mind that the payoff for these explorers is likely to be a takeover by a producer. With high silver prices, the producers are investing in expanding milling operations and exploring their own vast land resources. A prospect has to be very good to attract any real buyer attention. If silver falls to the $20 level, the values they put on their stakes may have to be revised downward, which would probably cause panic selling in their stocks. Producers will not have the cash flow to fund their own capital improvements, much less acquisitions. With no production cash flow and no buyers, the stocks of these exploration-only miners do not just drop, they can virtually disappear. As attractive as some of those prospects seem, it is too unpredictable making a move on those that are virgins to production.

Although I intend to hold for the long term, I would have to do some serious analysis of the situation if prices fell below $25 per ounce. A spot price of $20 per ounce in silver would imply a gold price of about $1000 an ounce, which I think would be a strong technical support area. The $20 level was also the resistance from 2008 to 2010, and that tends to become the support once it is handily breached. Therefore, my five-year plan is based on silver spot prices that trend upward to $70 per ounce by 2017 with $25 an ounce being the reevaluation trigger. If my vision is conservative, that is even better.

As for my silver antique investments, as my wife says -- they are not really investments because I will never sell them ... never.

Disclosure: I am long HL, RVM, OTCPK:EXLLF, OTCPK:AUNFF.