Why Invest In Silver Miners?

If I had money in silver mining shares I would be asking myself questions like, why am I in this space? That would lead me to question why any company I have invested in, or may consider investing in, is in this space. Certain realities of the silver mining business force the prudent investor to consider what is so great about being a primary supplier.

Supply beyond miners' control

"Silver distinguishes itself from many metals, including gold, by the fact that more than two-thirds of silver mine supply is a by-product of other metal mining, (in most cases lead, zinc, copper or gold)," says Polymetal International, one of the world's largest producers.

Imagine that. Companies dig for other things and they just happen upon hundreds of millions of ounces of silver that they pour onto the market, needed or not. These companies, considered secondary producers, find more silver than the people who do it for a living.

But lend silver mining companies an ear and they will proudly promote the fact that they are primary producers. They will also proudly announce goals to produce increasing amounts of silver. And they will celebrate it as a success when this happens.

Folks, borrow your ear back for a second. Silver production has been rising for a decade already. According to Thomson Reuters GFMS, silver supply exceeded over 1 billion ounces in 2012. There is a surplus and this has been the case for several years now.

Look at the numbers. Since the Silver Institute is considered an industry authority and it relies upon GFMS for data, let's do the same.

Last year, GFMS calculates that 787 million ounces of silver came from mines. Primary silver mine supply accounted for about 28 percent of that, or about 220 million ounces, and according to figures tossed around at the beginning of the year, the surplus was around 200 million ounces.

At this point, almost all of the silver from primary silver mines is extra. Yet, the silver miners are under the impression that growth for growth's sake should sound appealing to investors.

Silver miners' costs

Keep in mind that many of the secondary producers are not really spending any money to produce silver. It is basically a bonus for doing their real jobs, which is why the silver is considered a credit. Silver miners, on the other hand, are spending increasing amounts of money to explore for this metal and then spending more money to pull it out of the ground.

In 2012, the average cash cost for silver rose to $8.88, reflecting higher costs of labor, electricity and maintenance, the Silver Institute says.

Never mind that cash cost is generally only a portion of what miners really spend to be in business. Instead, just consider how a few of the top primary silver producers have done.

Fresnillo (OTCPK:FNLPF) proudly claims title of being the largest primary silver miner and owning the largest silver mine. The company claims to have "competitive cash cost performance." At $5.59 an ounce that may be fair, if the comparison is being made to other silver miners.

The Silver Institute considers Polymetal (OTCPK:POYYF) the second largest primary producer. Its Dukat hub contains the third largest silver deposit, the largest silver operation in Russia and is the company's flagship operation. Silver cash costs at Dukat were $12.10 last year.

Pan American Silver (PAAS) reported that its silver cash cost rose from $9.44 in 2011 to $12.03 in 2012. Coeur d' Alene (CDE) says its average silver cash cost was $8.30, which was below the industry average, but significantly higher than the $7.09 reported in 2011.

Part of primary silver miners' investment appeal is supposedly their ability to provide exposure to the metal.

Meanwhile, silver streaming company Silver Wheaton (SLW) considers itself a producer offering the same benefit. It doesn't have to dig a thing. The company just needs cash and a pen to sign contracts for other companies' silver. Its approach to the business resulted in a cash cost of $4.30 last year, less than half the industry average.

What about silver demand?

Before deciding whether investment in silver miners is compelling, here is another little bundle of considerations. Supply is expected to increase again this year, perhaps by as much as 5 percent. As you may have guessed much of this metal will come from companies whose primary business is something other than silver mining.

Although GFMS forecasted the possibility of industrial demand at a three year high in 2013, total fabrication demand, which includes demand from industries such as photography and jewelry, is not expected to consume the abundance of silver that will be on the market.

Whittling down the supply is a task therefore left upon silver investors. Last year investors consumed about 253 million ounces, representing only about a quarter of total demand. Many industry authorities will admit that expecting investors' appetite to expand enough to create a balanced market or market deficit any time soon is a lot to ask, which is a polite way to say it's not likely to happen.

In summary, primary silver miners specialize in supplying a market that is dominated by companies outside of the silver mining business. Silver prices have been in a downtrend and were already putting pressure on silver miners' margins before the steep declines seen this year.

But the array of silver mining professionals only needs two things from the investment community. They need investors to conclude that their services are valuable, their operations are competitive, and therefore their shares are worthy of purchase. In return, these companies will increase shareholder value by aiming to supply more silver to a market in surplus.

Then, the silver miners need investors to spend more cash to sop up increasing amounts of this highly volatile and oversupplied metal.

Disclosure: I am long SLW. 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.