Silver mine production is expected to come in at nearly 800m ounces in 2012, an all-time record and the seventh consecutive year of growth (per the U.S. Geological Survey). At 2012's average silver price, this total represents a value of nearly $25b. There's a lot of money to be made mining this shiny-white metal!
With a massive capital carrot supported by structural fundamentals that are still great, there ought to be a ton of mining companies targeting silver in their exploration endeavors. So in my latest silver-stock research project I took a close look at the companies on the ground floor of silver exploration, the juniors.
By its simplest definition, a silver junior is a non-producer that considers its primary business the exploration for and/or development of silver-centric projects. Regardless of market capitalization and asset base, a silver junior doesn't generate revenue.
While juniors don't directly contribute to mine supply, their role in the greater supply chain is invaluable. The successful ones are making discoveries and proving up deposits that will eventually feed the supply chain. They'll either develop their discoveries into mining operations on their own, or be acquired by the big boys.
These juniors that find success can also deliver legendary returns, which is what makes them so appealing to investors. But since mineral exploration is inherently a risky business, the odds of success are greatly stacked against these companies. Sadly, most juniors will fail. And this is why it is important for investors to be prudent in their selection process.
In my search for these junior-level companies I pulled from the universe of silver stocks that list in the US and Canada. And surprisingly I found there to be very few that actually qualified as silver juniors. By my count, there are just under 100 juniors that consider silver their primary metal of focus.
When I stepped back to consider why there were so few companies going after silver riches, I realized that these results shouldn't have surprised me considering the geological nature of this metal. Silver is actually quite unique in its geology from an economic point of view, as it usually occurs as a subservient mineral.
More often than not, silver occurs in polymetallic deposits that hold high concentrations of base metals and/or gold. And at the end of the day when the ore is processed and the metals are sold, these other metals end up delivering more revenue than silver. The silver content tends to be a byproduct of primary lead/zinc, copper, or gold mines.
There are of course exceptions, but it is quite uncommon to find a polymetallic deposit where silver would deliver the most revenue. And because of this, the vast majority of silver mine production comes to market as a byproduct.
To put this in perspective, it is estimated that over two-thirds of silver mined each year comes from non-primary silver mines! And a couple good examples of this are the operations of major copper producer KGHM Polska Miedz and major gold producer Goldcorp (NYSE:GG).
KGHM's three massive primary copper mines in Poland combine to produce byproduct silver in the neighborhood of 40m ounces. Each of the Lubin, Polkowice-Sieroszowice, and Rudna mines produce more silver by volume than most of the world's top-ten largest primary silver mines. Yet this silver is subservient in value to their copper output.
The same goes for Goldcorp's massive Penasquito mine in Mexico. Penasquito is a primary gold producer by revenue, but its huge silver byproduct (~23m ounces per year) ranks it as the world's third-largest silver mine. These four mines alone account for a staggering 8% or so of the world's mined silver supply. And the list goes on of mines that produce hefty silver streams that are only byproducts to other higher-revenue metals.
So as a result of silver's subservient geological nature, the odds don't favor mining companies discovering deposits that are silver-centric. And this somewhat explains why there are so few mining companies actually working primary silver deposits.
Another thing I discovered in my research is the lack of deliberateness of the companies that comprise this pool. Provocatively most silver juniors didn't actually start out with their sights set on being primary silver companies.
While the majority of junior exploration companies do start out with their sights set on a specific metal, they are ultimately at the mercy of what the rocks hold at depth. A company may stake its claim in a greenstone belt known for its gold deposits, in search of a gold deposit of its own. But when drilling underneath a gold anomaly at the surface, it may discover a thick deposit of high-grade copper. This company would thus transform from a gold junior into a copper junior.
Overall miners certainly don't mind finding a deposit comprised of minerals they weren't targeting. The fact that they found a deposit is usually a joyous occasion. And since their ultimate goal is the almighty dollar, they tend to be mineral agnostic if whatever they find can generate investor interest and ultimately a profit.
There are countless examples of juniors shifting metal focus based on the results of their exploration work. And on the silver front, more often than not those companies that do start out looking for silver are usually the ones switching to another metal. They find primary gold or base-metals deposits, and run with them.
Of the nearly 100 silver juniors, of which only half actually have "Silver" in their names, very few started out as silver companies. Most in fact started out as gold or base-metals companies that stumbled upon primary silver deposits. And of those companies that did start out as silver companies, many did so as a result of a spin-off or structured start-up. They already had their silver projects and didn't have to find them.
A good example is mega-junior Tahoe Resources (NYSE:TAHO). Tahoe's Escobal project in Guatemala holds one of the world's finest primary silver deposits. This project is currently under development, and when it achieves commercial production in 2014 it will be one of the world's largest and lowest-cost primary silver mines.
Tahoe is one of the rare juniors that started off as a silver company when it went public on the TSX in 2010 (it now has a listing on the NYSE as well), but it was a structured start-up courtesy of Goldcorp. A subsidiary of Goldcorp actually discovered Escobal while looking for gold. And it is only thanks to the fact that Goldcorp desired to stay gold-centric that it established Tahoe Resources, thus allowing silver-stock investors to take part in this beauty.
Perhaps the most surprising thing I discovered about silver juniors is their size. Now I didn't expect these companies to be huge. With an ounce of silver generally worth about one-fiftieth that of gold, the value of a primary silver deposit is typically worth a lot less than a primary gold deposit (most silver deposits don't hold 50x the resources by volume of an average gold deposit).
Because of this it is of course logical that on balance silver juniors are going to have smaller market capitalizations than gold juniors. But after running the numbers, "junior" is an understatement in describing these stocks. If I exclude Tahoe Resources, a huge top-side outlier (~$2.5b market cap), the average market cap of the junior silver stocks is only about $29m.
Taking it a step farther, if I exclude just the four largest by market cap (Tahoe, MAG Silver, Orko Silver, and Bear Creek Mining) the average drops to about $17m. These stocks are tiny! Check out the pie chart below to get a good visual read of just how small the silver juniors truly are.
The market caps of the nearly 100 silver juniors were updated through last week, and this breakdown is simply mind-blowing. At the top are an elite group of $100m+ companies. These juniors own large deposits in relatively geopolitically-safe regions. And they collectively hold 1.7b ounces of silver resources. But as you can see, this group is the smallest with only a 6.3% share of the total population.
Next are those silver juniors in the $50m to $100m range, and again this group towards the top is sparsely populated. Interestingly it is well understood that stocks with market caps between $50m and $300m are labeled as micro-caps. The fact that most of the largest silver juniors are micros puts their collectively small size into context.
At under $50m you get into the realm of the nano-caps, which is where the majority of the silver juniors reside. Amazingly 86% of all silver juniors have markets caps of less than $50m! And as you can see, only a small fraction reside in the top half of this range.
Incredibly the largest group of silver juniors sport market caps under $5m. We're talking penny-stock realm here! While most of these companies may be sniffing a potential silver deposit, they don't yet have a compliant resource base. And not surprisingly, most have very limited working capital and thus meager work programs. These juniors are the riskiest of risky!
And speaking of risky, one of the major takeaways for me is that this sector is not for the risk-averse. Investors need to be keenly aware of what they are getting into if they decide to put their capital to work in this sector. While the reward side of the risk/reward trade can reap fortunes if you pick the right stock, the risks are extreme.
The biggest risk of course is a company failing to find and/or develop an economically-feasible silver deposit, which is the most common outcome for most juniors. But there are also non-company-specific risks that come with nano-caps.
One big high-level risk is where these stocks trade. Interestingly only about 15% of silver juniors have primary listings in the US, with most of these being on the OTC Bulletin Board. Sadly an overbearing regulatory environment (primarily Sarbanes-Oxley) turns most start-ups away from listing in the US. And this is a big reason why the majority of silver juniors take their shots at tapping public venture capital on the TSX Venture Exchange. Though not ideal, thankfully US investors can still own most TSX-V stocks via the Pink Sheets.
But whether TSX-V, OTC BB, or PNK, all of these exchanges/platforms come wrought with volatility and liquidity issues. Many of these stocks simply lack exposure, and thus capital volume. And as a result it doesn't take much action to move them violently in either direction. And unfortunately the downside action is amplified in a tough environment like we're in today where junior resource stocks are highly out of favor.
The nice thing about juniors though is their fortunes can change in the blink of an eye. All it takes is some upside momentum in the price of silver and renewed interest in resource stocks for investors to once again glom onto juniors. And when this happens, the breakdown of this pie chart can look radically different.
If you can stomach the inherent risks of trading on the frontier junior exchanges/platforms and accept the company-specific risks that come with the micro- and nano-caps, then junior silver stocks may be just for you. As daunting a picture as I have painted, there is enormous upside potential in this sector. Even though a lot of these nearly 100 stocks are junk, there are some quality companies working on quality projects that could pan out nicely. And if you pick the right ones at the right time, there are some legendary gains to be won.
The bottom line is silver's secular-bull-driven demand has led to a huge increase in silver-mining output. And the mining companies have been rolling in the dough selling their silver at near-record-high prices. This silver renaissance has not only turned on investors to the producer companies, but the juniors that have a huge role in developing the next generation of mines.
But as a result of silver's subservient geological nature, investors are finding a sparsely populated junior market. With primary silver deposits few and far between, the population obviously isn't as robust as one would hope. And adding to the precariousness of silver juniors are depressed market conditions and generally smaller deposit values, which makes most of them nano-cap in size. Thankfully even amongst this trifling group is an elite bunch that ought to thrive with their underlying metal.
December 28, 2012
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