Way back last Friday, July 19, in my Friday Trick or Trend post on my subscription JubakAM.com site, I argued for adding silver to a portfolio because 1) it is a good hedge for portfolios in the second half of 2019, and because 2) silver, after lagging gold for the first half of 2019 , looks to be playing catch up now. On Thursday, July 18, silver futures on the Comex had used a fifth straight day of gains to record their highest finish since June 29, 2018.
The reasons I cited in that post included a continued expansion of the money supply by central banks that is increasing fears of inflation (someday) and the devaluation of financial assets; a cut in production targets from Fesnillo (FNLPF), the world’s largest silver miner; and a steady climb in the gold to silver ratio to historic extremes that make silver look seriously underpriced versus gold. The gold/silver ratio, which measures how many ounces of silver it takes to equal the price of a single ounce of gold, came close to the 100/1 mark–meaning it would take 100 ounces of silver to equal the price of one ounce of gold. That ratio is down to around 88 ounces of silver to one ounce of gold as of Friday, July 19. The average gold to silver ratio for the last 20 years is 60/1.
I did also note that silver isn’t as good a hedge against financial market uncertainty as gold is because while only about 10% of gold consumption goes to industrial uses, 60% of silver consumption goes to industrial uses. That means that an economic slowdown that would send gold prices strongly higher as investors and traders hedge financial uncertainty with the metal doesn’t have as strong an effect on silver because industrial consumption of the metal would be falling with slowing economic activity.
Still, I said, the huge gap in valuation between gold and silver does make up for quite a bit of that handicap at the moment. Precious metal traders speculate that a move in gold from the current $1426 an ounce to $1500 an ounce (a 5.23% gain) could send silver prices up to $20 from the recent $16.20 an ounce. That would be a gain of 23.4%.
In that post I promised that I would add a silver vehicle to my Jubak Picks and Volatility Portfolios.
Here’s that pick: First Majestic Silver (AG). There are other ways to play silver. I already own one, Wheaton Precious Metals (WPM) in my Volatility Portfolio where it’s up 21.78% since my June 15, 2018 purchase. You could buy silver through an ETF like the iShares Silver Trust (SLV), up 5.79% year to date as of July 24. Miners such as Pan American Silver (PAAS), ahead 12.74% in 2019 to date, are leveraged to the price of silver and give you more upside and downside. Among miners First Majestic is among the most leveraged. The shares are up 74.19% for 2019 as of July 24.
With that kind of performance, there’s obviously more going on with First Majestic than just the rising price of silver. The company owns and operates six producing silver mines in Mexico: San Dimas (silver/gold) Santa Elena (silver/gold), La Encantada (silver), La Parrilla (silver), Del Toro (silver), and San Martin (silver.) Production was up in the second quarter, the company announced on July 17. (First Majestic reports second quarter earnings on August 7.) In the quarter the company produced 3.2 million ounces of silver, 33,500 ounces of gold, 2.5 million pounds of lead, and 1.4 million pounds of zinc for a total of 6.4 million silver equivalent ounces. Total production in the first half of 12.7 million silver equivalent ounces was near the midpoint of the company’s guidance for the full year of 24.7 to 27.5 million silver equivalent ounces.
It’s when you drill down another level to the production of individual mines that an investor starts to see where than 74% gain–and future big gains–come from. Of the company’s two big mines, the Santa Elena mine saw total silver production climb 4% quarter over quarter and the San Dimas mine saw production climb 15% quarter over year on higher than expected ore grades.
Pay close attention to the San Dimas mine. First Majestic only acquired that mine in May 2018 from troubled Primero Mining for $320 million in an all stock deal. That deal gave First Majestic control of a transformative asset. Not only is San Dimas one of the world’s largest silver mines (with annual production capacity of 5.8 million to 6.4 million ounces of silver), it is also one of the lowest cost. For fiscal 2019 the all-in sustaining cost at San Dimas is projected by First Majestic at $7.58 to $9.27 an ounce of silver. (For reference silver for September delivery closed at $16.42 on the Comex on July 25.) That’s the lowest all-in cost at any of the company’s mines. Santa Elena is the next lowest with a forecast cost of $8.99 to $10.66 an ounce. All of the company’s other mines show double digit all-in sustaining costs ranging from $12.39 to $23.87 a ounce.
In its first quarter earnings report First Majestic announced that all-in sustaining costs were down 19% from the first quarter of 2018. That was for the most part due to San Dimas. And as production at that mine continues to increase, and as production at some of the company’s higher cost mines declines, the all-in sustaining cost at the company as a whole will continue to fall.
Which means that when it comes to leverage on the price of silver, First Majestic wins as the price of silver goes up and wins again because its cost of production is falling even as production volumes increase.
This doesn’t mean that First Majestic is a problem-free stock. If it were it would trade at way more than the $9.67 close on July 25 (after a drop of 5.75% today.)
Primero Mining sold out to First Majestic at such a bargain price because Primero faced falling production at San Dimas because it couldn’t reach a lasting agreement with Mexico’s national union of mining workers. That labor turmoil came as the mining sector in Mexico was looking at new legislation revising Mexico’s mining code that would give greater power to local indigenous communities and that includes provisions for the revocation of permits for mines that cause negative social and environmental impacts. First Majestic did the deal on the belief that its history in the Mexican silver industry has given it a strong relationship with the San Dimas union and with regulators that will enable it to work out the problems that Primero faced.
The danger to investors is that First Majestic could be wrong.
But as part of its deal to acquire San Dimas from Primero First Majestic got an important financial lifeline. Some of the shares paid out in the acquisition went not to Primero but to Wheaton Precious Metals. Wheaton doesn’t operate mines itself but instead strikes deals to purchase metal production from miners at a discounted price. Wheaton gets that discount because its commitment to purchase part of a mine’s production at a set price provides the mine operator with virtually guaranteed cash flow. Under the terms of the acquisition Wheaton, which now owns about 11% of First Majestic, is entitled to buy 25% of the gold equivalent ounces produced from San Dimas at $600 an ounce with a 1% annual inflation adjustment or at the spot price of gold–whichever is lower. First Majestic estimates that the terms of its deal with Wheaton comes at about 60% better terms than that company’s deal with Primero. And, First Majestic projects, that the cash flows from Wheaton will fund plans to expand San Dimas to full capacity.
As of July 26, I’m adding shares of First Majestic Silver to my Volatility Portfolio on JubakAM.com and JugglingWithKnives.com. And I’m adding the stock to my Jubak Picks Portfolio on all three of my sites. Target price for First Majestic is $12.40.