TradePlacer.com Blog - paas tag

Finding a Floor for Silver and Silver Miners

Thu, 17 May 2012 15:37:00 GMT

Since silver reached our target of $50 last year it has been in a treacherous downhill descent. The depth of the decline in precious metals is approaching 2008 levels, and many mining stocks are at 2009 price levels. While it has been painful for bullion investors, it's been even more disastrous for silver miners and their investors. Now we must revisit our analysis to determine if silver and miners are near their trading floor.

We've seen a lot of bearish reports on silver including a comparison to the Nasdaq bubble crash, which overlays a projection of silver to continue falling to the $6-$8 range. Is it possible for silver to reach or hold at those levels?

Using earnings data for PAAS, SSRI, EXK, and AG from the first quarter of 2012, we divided earnings by actual silver produced, giving credit for gold and other base metals, in order to determine the actual break even cost of production. Gold sales averaged $1700 and silver averaged $33 for the first quarter. Despite this SSRI wasn't profitable. EXK had the lowest breakeven point of $14.68 per ounce of silver, followed by AG at $18.33 and PAAS at $23.87. The average breakeven production cost was exactly $24 per ounce. Even excluding SSRI, the average was $21.50. Over the past 11 years, silver has risen by nearly 10 fold; however production costs have almost risen just as much. Silver's price is approaching its long term cost of production level, and given the depletion of silver stockpiles of the last 3 decades, we don't anticipate silver's price holding below that level for long - if at all. If you're somehow able to buy silver for less than $21.50 to $24 an ounce we'd argue that miners are literally paying you to buy it. Given that over the long run miners need a healthy profit margin as an incentive and buffer against their depleting resources, we'd argue that $26 to $30 is the long term nominal floor for silver.

Interestingly, when we began accumulating silver positions at the onset of the bull market in 2001; our target price was $30. A lot has changed in the last decade. At that time silver was in the $3 range and its production costs were in the $3 to $5 range. We anticipate that this nominal $30 range will be the floor not only for this bull market, but also for the aftermath of the expected silver bubble in coming years. Just as $3 was the floor after the hunt brother debacle, $30 will be the floor of silver's next secular bear market.

We're unable to generate a realistic scenario where the cost of production significantly declines from current levels. Wage costs aren't expected to recede, and materials and energy costs will remain near these levels as their own production costs have increased. Furthermore, we're confident that governments won't stop regulating, and taxing mine output. As such, we believe that unleveraged, allocated silver below $30 has very little risk, and its upside potential remains.

Another significant change since the bull market began is the health and profitability of silver miners. When the bull market began silver miners were breaking even at best, and for many years these companies had to resort to dilution in order to raise capital for development and ongoing operations.

Now, the leading primary silver producers have significant cash reserves, mature developed properties generating sizeable earnings, and many are giving back to their shareholders via dividends and buybacks. Over the last year the prices of miners have declined, however their earnings and financial stability has increased substantially - which has led to a shocking compression in PE ratios. Typically, silver miners have traded at premiums in relation to base metal producers however they are now at a discount. The expected forward PE ratio for 2013 from analysts is 7.2 for PAAS, 12.1 for SSRI, 6 for AG and 6.9 for EXK, giving an average PE ratio of 8. This has setup a scenario where these companies could increase by multiples if silver tops its high of $50 and PE ratios expands to match the S&P.

Given the limited downside potential, and our inflationary expectations that we don't believe our priced into the market, we believe that silver and silver miners are very close to an important floor with substantial upside.

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PAAS Acquisition of MFN is Highly Dilutive

Fri, 27 Jan 2012 20:54:00 GMT

As long term shareholders of Pan American Silver, who've held it for more than a decade, we were surprised to hear that its management has decided to purchase Mine Finders – whose PE ratio is roughly twice that of PAAS's. We've taken a closer look at the proposed financials, and the deal does not add up.

On August 26th, 2011, PAAS shares were low enough that the company initiated a stock repurchase program for up to five percent of the stock. At the time it was stated that "in the opinion of its board of directors, the market price of its common shares, from time to time, may not fully reflect the underlying value of its mining operations, properties and future growth prospects." The price of PAAS closed that day at $31.72. It's rather dubious that a stock price which was considered cheap at $31.72 is now considered well priced to use as buying collateral at $23.

Generally, acquisitions are accretive when a company with a large cash balance uses it to purchase a profitable business in cash, or when a fair to highly priced company trading near the highs of its PE range uses its stock as collateral to purchase a business with a lower price and higher growth rate. In the case of PAAS buying MFN, neither of these conditions apply. PAAS has proposed to make a stock purchase using its shares with a PE in the 7-8 range of MFN whose PE is in the 15-16 range. Furthermore PAAS earnings are projected to grow faster than MFN.

	PAAS	MFN	Combined
total shares MM	107.3	96.3	160.265
price	$23.18	$14.40	$23.18
mkt cap	$2,487.21	$1,386.72	$3,714.94
2011 e/sh	$2.3	$0.86
2012 e/sh	$2.85	$0.95
2011 pe	10	16.7	11.27
2012 pe	8.1	15.1	9.35
2011 total e, MM	$246.79	$82.818	$329.608
2012 total e, MM	$305.805	$91.485	$397.29

Based on the data above, we estimate that due to the proposed acquisition of MFN, PAAS shareholders will suffer an immediate loss of $1.11 per share for the cash payout, and an additional 15 percent dilution in earnings. We estimate that instead of trading at $23.18 today, PAAS would be trading at $27.77 implying a total dilutive loss of 20 percent. It is worth noting that PAAS's massive Navidad project in Argentina is not currently priced into either the earnings projections or price of its stock. As a result, Navidad is an effective call option which could potentially double the production from roughly 22 to 44 million ounces of silver per year. Since this isn't priced into the stock, the dilution of current shares could prove to be even more folly pending approval of Navidad by the Argentinean government.

At the end of 2011, Bill Fleckenstein resigned from the board. While we don't know the reason for sure, we now know that this directly preceded PAAS's dilutive bid of MFN. Perhaps Mr. Fleckenstein opposed the dilutive action.

It's difficult to buy and hold a stock which is underpriced by the market. It's even more difficult to learn that management of the company attempts to justify the low price by diluting the company's value. We expect PAAS to underperform its peers going forward as it consolidates the dilutive loss.

The largest winners of this deal will be the management teams of PAAS and MFN. The largest losers will be PAAS shareholders. One year ago, MFN stock was trading in the $11 range and PAAS was above $40. Had they purchased MFN then, it would have been far less dilutive. Now, PAAS shareholders are paying almost twice the price for the same acquisition. We plan on voting against the acquisition, and would support an effort to replace current board management.

Did You Miss Out on Gold and Silver?

Tue, 09 Nov 2010 17:53:00 GMT

With gold up over 25 percent and silver up more than 64 percent year to date many investors are wondering if they missed out on the bull market in precious metals. Even if you already had a substantial allocation towards precious metals it's easy to kick yourself from not buying more. Silver has tripled since its 2008 lows and some stocks such as SLW have risen 10 fold in a short two years.

While smart money and early investors have enjoyed large gains over the decade long bull market in precious metals, the big money and mania money is yet to be made. The bull market is now in the institutional phase, also known as phase two, where hedge funds, banks and pension funds are bidding up prices of metals and miners. As the bull market has matured, investment strategies should be modified to accommodate the phase two bull market, with a pending phase three mania.

Phase two and Phase three bull markets are driven by increasingly larger volumes of incoming capital flows. This can be seen in the rising trend of open interest as well as stronger bids on corrections. Price movements upwards will get larger and corrections will become shallower in duration as can be seen in the October precious metals correction. This presents challenges to both new and veteran investors.

Investors already in the market will have a tendency to want to take gains, but should resist the temptation to sell everything. As Jesse Livermore once said, "throughout all my years of investing I've found that the big money was never made in the buying or the selling. The big money was made in the waiting." The fundamentals are still in favor of much higher gold and silver prices and until that changes the long term trend will remain upwards. Real interest rates are in double-digit negative territory, and money supply growth is still in double-digit positive territory.

Despite the real possibly of waking up tomorrow to find that silver has doubled or gold is up $200, investors new to precious metals would be prudent to avoid buying in a lump sum. Both gold and silver are technically overbought and could succumb to a sharp correction. Thus the best strategy kept by professionals is to accumulate using small orders over a period of time and keep on buying where cash flow permits. If prices do correct, then increase the size of the planned purchase by pyramiding orders based on price.

Investors should also consider diversifying the type of precious metals investments that they hold. While the physical metal has outperformed gold stock indexes in recent years, this is expected to change. The financial meltdown of 2008 left many companies unprofitable, and without the credit to continue business. PAAS, SSRI, AUY and others are still well below their 2008 highs despite gold prices of $1400 and silver prices of $28. Price premiums were shifted from explorers and junior producers to large, well capitalized, producing miners. Now that credit is more available, and metals prices are much higher, capital has just begun to flow into the smaller juniors and explorers as investors realize that they hold the future supply.

While the easy money in gold and silver has been made the largest gains are still ahead. Long term investors should sit tight and continue to accumulate, and those who consider gold and silver insurance should not even consider selling as the global decline in fiat currencies is just beginning.

Do Industrialized Economies Support Growth?

Fri, 24 Sep 2010 15:20:00 GMT

The book "For Good and Evil: The Impact of Taxes on the Course of Civilization" by Charles Adams is a must read for those interested in learning how taxation has both created and destroyed civilizations. Over the course of history, governments have tried every tax strategy and tax rate imaginable from flat income taxes to taxes based on how many windows a building has. Students of history will find a clear pattern. Low and fair tax rates have fueled the creation of massive expansive empires, and repressive unfair tax rates have destroyed countries to the point at which they are no longer recognizable.

During the Pyramid age, Egyptian peasants paid 20 percent of their crops to the Pharaoh. Historically, medieval serfs and farmers revolted when tax rates exceeded 30 percent. European empires such as France and the Netherlands collected tax rates between 15 and 20 percent during the 1600's and prospered. However when those rates increased, it led to French Revolution in the late 1700's. The Roman Empire began as a free trade state, in which revenue was collected from 1 to 3 percent in property or sales taxes. However, in the last years of its decline, tax rates and inflation were so repressive that many peasants welcomed barbarians.

Although capital is often taxed at capital gains rates, global economic activity is largely defined by income derived from labor. In this spirit, it can be argued that capital will tend to flow into countries with low income tax rates and enough perceived economic and political freedom to conduct business transactions in the pursuit of happiness.

One reason why economies are able to grow is because workers are able to specialize in a particular skill and trade that skill for other services or products. This concept, known as division of labor, enables increased productivity because producers can focus on what will create the most economic value. For example suppose apples and oranges cost the same amount, but farmers are specialized in growing one or the other and can produce twice as much product in their field. The apple farmer can produce two apples and trade one with the orange farmer who produced two oranges so both would end up with more value than they could individually produce. However, if tax rates exceed 30 percent then this division of labor breaks down because the apple farmer wouldn't produce enough apples to pay the tax and trade for an orange. If tax rates exceed 50 percent, then the farmers would have to be 300 percent more productive in their specialization to make it worthwhile.

It is not a coincidence that the three largest economies have effective tax rates higher than 50 percent (including social security and other income taxes), zero economic growth, near zero interest rates, and are past the point of no return in insolvency.

Country	GDP	Currency	% of Currency Exchanged Market	Unfunded Liabilities as Percent of GDP
EU	$16.4 Trillion	Euro	42.45%	434%
US	$14.2 Trillion	Dollar	19.55%	854%
Japan	$5 Trillion	Yen	9.5%	227%
Total	$35.6 Trillion		71.5%	574%

The three largest economies in the world are in structural decline and represent 61 percent of the global economy, measured by GDP estimated at $58 trillion. Their currencies also account for 71.5 percent of the global foreign exchange market. The Swiss Franc, and British pound account for an additional 9.65 percent of the market which leaves only 20% of the remaining foreign currency market from a long list of countries.

Currency "investors" and traders are really just gamblers unless they are only seeking to hedge another business transaction. There is no fundamental basis for 80 percent of the market, and no reason why Jim Sinclair or others will be right that the US Dollar index will fall to 50 or below because all major currencies are priced against each other. However, compared to any tangible asset a severe decline in currencies is inevitable. If hyperinflation does occur, it will likely be in all major fiat currencies and be witnessed in all countries except those with a completely closed economy.

With virtually every major industrialized nation insolvent, using repressive taxation and unsound fiat currencies the implication is clear. No matter how bullish the prospects are for emerging economies – they are not large enough to sustain positive global economic growth nor do they have an alternative currency that could be used to replace foreign exchange at current levels. The reality of peak oil and other resources will cap emerging economy growth as well.

Because these global imbalances are structural, capital will continue to flee industrialized economies in favor of higher returns and lower taxes. The result will be overnight boom towns, and planned cities, but it's arguable whether much of this money will be misallocated. Precious metals could also undergo a historic revaluing as holders of majors currencies seek alternatives. It is unlikely that capital, or people anywhere in the world will be left unaffected by the ongoing and inevitable devaluing of all major currencies.

A Japanese Styled Economy is the Chosen Path

Fri, 03 Sep 2010 20:17:00 GMT

Large global imbalances both between and within nations have been well documented over the last decade and have continued to become more misaligned. While most commentators have argued why a Japanese style stagflationary reversion to the mean is unlikely, it is both the most wanted and mostly likely outcome of current imbalances. It is most wanted by policy makers and most likely for the reason that it's being targeted.

The Japanese economic model over the last 20 years is the best alternative for the Federal Reserve and other government policy makers because the alternatives are too great and terrible to imagine. If the government discontinued its intervention, the credit expansion created during the last 30 years would be completely reversed resulting in massive defaults to the point at which banking as a whole would discontinue. This is the natural force of the market. On the other hand, if the economy stalls and the government intervenes with too much force too quickly, then confidence in currencies would collapse and global hyperinflation would ensue. Either of these scenarios would risk a breakdown in society and likely change in government regime.

The Goldie-locks path would be to intervene just enough such that the dollar slowly depreciates, and financial firms slowly rebuild their balance sheets over decades. In this scenario society as a whole may slowly change, but change would be less drastic. The wealthy and powerful would benefit the most from this outcome as they would maintain their control. Meanwhile, the middle class would slowly disintegrate as pressures from all sides erode any remaining wealth and income. Make no mistake, the only deflation the Japanese have suffered is in asset prices not monetary supply. Costs will inflate including commodities, energy, transportation, and of course taxes. At the same time, income will stagnate at best or more likely fall. Interest income will remain below inflation and traditional investment performance will remain subpar. Businesses will operate with lower margins and lower returns. There will be near 0 economic growth, with near 0 interest rates, and near 0 employment growth.

Just as in Japan, the population will age and require more care. At the same time the number of children born will continue to fall, and immigration will decline as foreigners look elsewhere for opportunities. The result will be a declining population, with lower quality of services provided to them at a higher cost.

Investment Strategies for the Japanese Style Reversion to the Mean

Just as there has been over the last decade and last few weeks (depending on your perspective), there will be plenty of bull and bear markets with rallies and slides. Some traders may be able to time these correctly, but most won’t. On a grander perspective, equities will oscillate with no trend and no significant returns for long term investors. Even if bond investors aren’t slaughtered by higher rates, the best they will achieve is 2 percent return from government bonds. While commodities will rise, producers will also experience similar increases in production costs led by energy and construction. The result will be much higher commodity prices with little or no benefit to the producers. Stocks will be pressured lower by a decrease in PE ratios, stagnate dividends, and an aversion to risk. All asset classes will experience selling pressure from a change in demographics as workers retire and begin selling whatever assets they have to live off of.

Investors may seek to capitalize on the dollar carry trade by borrowing dollars and investing in other assets with higher expected returns. However, overuse of leverage could become detrimental as it did in 2008 even with undervalued assets.

Emerging markets would likely become a core component for successful investors as both the equities and bonds will likely outperform US or European based investments. Commodities will most likely continue to perform well, although their producers may not. Resource companies will have to dig and drill farther and farther into the ground to obtain less and less. Physical commodities will retain their value, but many can't be purchased and stored in large amounts. While it is feasible to buy physical gold and silver, buying soft commodities such as wheat and sugar are not practical investments for most people so it will be difficult to capture their gains. Commodity ETF's and futures will contango and slippage so they won’t track spot prices accurately. This can already be seen by comparing DBA to its underlying commodities and UNG to natural gas. Farmland itself will likely appreciate, however so will fertilizer and gas, so owning and operating a farm would not likely be as lucrative as investors expect. Precious metals will continue to outperform in this environment, because there simply isn’t any competing asset class. With interest rates near 0, there is no opportunity cost to carry gold or silver. Risks of large takedowns and possible impunitive taxes or capital controls will remain, however.

Investors may have to plan for a Japanese style reversion of imbalances that stretch into the next decade, as it is the chosen path by policy makers. Overall, profits will be harder to make and harder to keep, but they will still be available.

Some Mining Investors are Already Witnessing Hyperinflation

Wed, 28 Jul 2010 20:37:00 GMT

Some Mining Investors are Already Witnessing Hyperinflation Over the last decade, investors seeking protection from inflation have been accumulating gold and silver mining shares. Gold and silver have appreciated by more than 300 percent from their lows, so it would be logical to assume that mining shares have performed even better given their inherent leverage in earnings potential. Ironically, some of these investments have already suffered from their own hyperinflation in the form of share dilution. Just as governments have mismanaged their budgets and printed too much money; some mining companies have done the same to the detriment of their shareholders.

Coeur d' Alene (CDE), an American silver miner, is one such company. It has diluted its shares so much that on May 27, 2009 it had a reverse 10 for 1 stock split. This article will use post split adjusted figures. Governments often do the same thing with their failed fiat currencies. In the wake of Germany's Weimar Republic hyperinflation, a new Rentenmark was created that was equal to 1,000,000,000,000 of the old German Marks. While not as bad, CDE's shares outstanding have risen from 2.4 million in 1999 to over 80 million in 2009 - a factor of more than 33.

The majority of miners do issue shares in order to raise capital that is invested in projects with double digit returns; however this hasn't proven to be the case for CDE. $1000 invested in CDE in 1999 would now be worth only $440, while an investment in silver would have grown to $3300, and PAAS would have grown to $4220. Clearly not all precious metals investments are the same, and not all mining companies track the price of gold or silver over the long run.

Despite the all time highs seen in gold and a large increase in the price of silver, CDE was unprofitable in 2009 and the share price continued its long term trend downwards. Management's compensation was able to hit a new high though.

	2005	2006	2007	2008	2009
Executive Compensation	2,325,837	3,254,007	5,677,971	5,064,010	5,997,589
Dennis Wheeler, CEO of CDE	1,459,901	1,897,946	2,560,960	2,245,362	2,527,319

It is possible to be right about a major bull market, but still lose money if the wrong investments are chosen. Investors should be careful to only invest in mining companies that restrain themselves from over-dilution. Furthermore, if mining companies such as CDE lose half their value in a 10 year bull market due to share dilution, there is a significant risk that they won't survive a bear market in precious metals.

Silver May Go Lower, But it won't Stay There

Mon, 12 Jul 2010 21:39:00 GMT

One way to value something is by its replacement cost. Appraisers and insurers often use the cost to replace an investment as a baseline of value. In analyzing the silver market, one way to value silver is by measuring the real cost of producing an ounce of silver. This value does not include any premium from investment demand or industrial demand, but it provides a pricing floor because companies don't stay in business for long by losing money.

With the price of silver near its highs this decade and far from its bottom of $3, it would be easy to assume that miners are highly profitable. Considering first quarter earnings from the top four pure silver miners (PAAS,CDE,HL,SVM, Excluding SLW because it doesn't mine, and SSRI because its arguably an explorer), just how much are they earning from these high silver prices?

Company	Earnings	Silver Produced	Breakeven Silver Price
PAAS	$19.1 million	5.5 million ounces	$3.47 below spot
CDE	-$8 million	1.3 million ounces	$6.15 above spot
HL	$18.4 million	2.5 million ounces	$7.36 below spot
SVM	$9.8 million	1.08 million ounces	$9.07 below spot
Total	$39.3 million	10.38 million ounces	$4.33 below spot

The average realized sales price of the silver sold was around $16.90. Averaging the earnings and production from all four companies, the breakeven spot price of silver was $12.57. However, it should also be noted that the majority of these earnings did not actually come from silver production, but the byproduct sales of base metals. Silvercorp (SVM) recorded a negative silver cash cost of $4.61 per ounce, and Helca (HL) recorded a negative silver cash cost of $3.03 per ounce. Without sales of other metals, many of the worlds silver mines would be still unprofitable at these prices.

Miners often provide financial figures that sound too good to be true. For example, Pan American Silver's cash cost per ounce of silver net of byproduct credits was only $4.35. While this sounds fantastic, it doesn't include many other fixed and variable business costs such as infrastructure, maintenance and exploration that is vital to replace consumed resources over time.

While these mining companies have excellent potential and leverage to the silver price, their financial statements also provide a window into just how profitable they will be at lower silver prices. A 30 percent decline would render the industry unprofitable, and if prices fell further mining production would be delayed or canceled. In addition, if energy and water prices spike, or if wages rise, a similar outcome could occur. Despite rising %500 percent in the last 10 years, the price of silver is scraping its own floor.