Buying And Owning Silver Part 2: Specific Investments In Silver

by: Ben Kramer-Miller

This article continues Buying and Owning Silver Part 1: Arguments for Silver Ownership, in which I establish a bullish case for silver. In part 2 I present specific ways to buy silver. Each of these options will appeal to investors with varying appetites for risk.

Silver Itself

The option with the lowest risk would simply to buy silver itself. This in itself sounds simpler than it really is. There are various coins, bars, bullion vaults and ETFs available to investors. Each varies in terms of their relative availability to investors, their tax consequences, and their counter-party risks. Unfortunately none of these is risk free, and consequently diversification is the best option.

The easiest way to buy silver is probably to buy bullion coins (American Silver Eagles, Canadian Silver Maple Leaves … etc.) or bars/rounds (NWT Mint bars, Pan American Bars…etc). Investors who are looking for a lower cost option should consider junk silver coins. Junk silver coins are dimes, quarters, dollar coins and half dollars made before 1965. These coins contain 90% silver and the premium one pays over the spot price is substantially lower for junk silver than for bullion coins, bars, and rounds. Investors should be prepared to store physical assets in a safe place such as an at home safe. The primary risks here are theft and government confiscation, although unlike with gold, silver has never been confiscated by the U. S. government.

If one wants to hold silver bullion coins or bars in a bullion vault, they should be stored in a bullion vault in an account that allows its clients to take delivery of their silver. Absence of such an option should be viewed with suspicion.

For those who want the convenience of silver traded on American exchanges there are numerous options, although I personally prefer to hold my silver myself. The most common ETF by far is SLV, however I would recommend the Sprott Physical Silver Trust: PSLV. There are two reasons for this. First, PSLV has a tax advantage over SLV. The former shares are treated like any ordinary shares of stock, and are taxed at the normal capital gains rate, whereas SLV is taxed as a collectible, that is, at 28%. Second, there are many clauses in the SLV prospectus that suggest that SLV does not necessarily hold the silver they claim to. For a more in depth analysis of the problems with SLV see Jeff Nielson's article: Want to Own Silver? Forget About SLV.

2--Silver Miners

The shares of silver mining companies have performed horribly over the past several years despite the fact that silver prices have risen. Only two major silver miners to my knowledge have followed silver to new highs: Fresnillo (OTCPK:FNLPF) and First Majestic Silver (AG). (Silver Wheaton (SLW) is a royalty company, not a mining company.) The underperformance of silver miners relative to silver has created several opportunities.

Investors should understand that silver miners are not simply leveraged silver vehicles. More often than not silver is mined as a byproduct of other metals, and consequently even companies that try to focus only on projects that have mainly silver get a lot of revenue from other metals such as gold, zinc, copper, lead, nickel…etc. Prima facie this should dissuade silver bulls from investing in mining companies. However, these companies are so inexpensive that even if one were to value them only on their silver reserves and resources (assuming that the other metals were not there or that they were valued at zero), several of these companies are worth owning.

I will mention a couple of my favorites: one low risk miner that fits into a retirement portfolio, and one miner that is riskier with additional upside potential.

Pan American Silver

Pan American Silver (NASDAQ:PAAS) has a fully diluted market cap of $2.8 billion. It owns and operates silver mines predominantly in Latin America, although it has a few exploration properties in the United States. The company is not incredibly exciting compared to some of the other silver miners I follow, but it is among the least risky given that it owns eight producing mines. 71% of its 2012 revenues came from silver. Fortunately only about 10% of revenues came from base metals, while the rest came from gold.

While there is safety in its diversified portfolio, investors pay for this safety by sacrificing future growth. The company's pipeline of development and exploration projects is not that extensive, and consequently their future growth potential is not explosive. It produced approximately 25 million ounces of silver in 2012 and it only anticipates growing production to 30 million ounces or so by 2016.

However, Pan American Silver has extremely strong cash flow and $542 million in cash, so it is in a position to make acquisitions. Furthermore, while the company will not likely grow production rapidly they have 1.2 billion ounces of reserves and resources (valued at just over $2.30 per ounce) which means that they do not have to worry about running out of silver any time soon.

As silver prices increase PAAS should offer decent leverage to the price of silver. Furthermore this is a good stock to hold in a retirement account as their recent dividend boost gives the shares a nearly 3% yield. The company has also been buying back stock, which I endorse given the shares trade at just $17 after reaching a high of over $40 in 2007.

I should also note that investors in PAAS take on some political risk as three of its producing mines are in Peru, however this has yet to pose any significant problems.

Silver Standard Resources

Silver Standard Resources Inc. (NASDAQ:SSRI) is my favorite silver mining company as it offers incredible upside potential with minimal risk. I suggested PAAS as a less risky option because SSRI has yet to show investors the bulk of its potential cash flow.

The company is focusing on silver production and exploration in the Western Hemisphere, and it does not have significant exposure to high risk jurisdictions. Currently 80% or so of its reserves and resources are silver, so rising silver prices should drive the stock higher.

As is the case with most silver miners, SSRI shares have plummeted in price over the past several years. Before the financial crisis they traded more than four times higher than they do now, and that was when silver prices were lower and when the company had no production.

Currently the company has a fully diluted market capitalization of just $888 million (based on a share price of $10.57 as of 2/22/2013 and a total of 84 million fully diluted shares outstanding). Given the company's impeccable financial position and industry leading projects its shares are trading at bargain basement prices. If the company's cash is backed out then its estimated silver reserves and resources are valued at less than $0.40 per ounce.

The bulk of the value in Silver Standard Resources' stock lies in non-producing properties that are projected to provide enormous cash flow for many years to come. These properties are all the more valuable given that the company has the financial resources to extensively explore them and to see them into production. SSRI's financial resources include $353 million in cash as of 9/30/2012, or $4.20 per diluted share, and 18.9 million shares of Pretium Resources, Inc. (NYSE:PVG) that are valued at $155 million.

Presently the company only has one producing mine: the Pirquitas open pit mine in Argentina, which produced over 8 million ounces of silver in 2012. Most of the company's value, however, lies in its extensive pipeline of exploration and development projects. The most notable of these is the Pitarrilla project in Mexico, which has half a billion ounces in resources and will produce well over 10 million ounces per year starting hopefully in 2014. Production will continue for decades. This mine alone justifies the stock's current valuation.

Silver Standard Resources is ludicrously undervalued, and the market has been vicious to SSRI shares. When, in late 2011, Pirquitas reserve estimates declined slightly the stock fell by 20% in one day. More recently when they announced that Pitarrilla had resources 400% larger than they initially thought the stock fell again when simple back of the envelope math would suggest that the stock should have doubled. If the company is able to make just $1.00 of profit per ounce on just its Pirquitas and Pitarrilla properties then the company is trading at less than 5X future earnings. If silver prices go to $100 and the company's in-ground resources are valued at just $5.00 each the stock can go to $100.

Disclosure: I am long PSLV, PAAS, SSRI. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.