Silver Sector Shrinking

It has been a while since we had this nagging feeling that we’re witnessing something profound taking place before our eyes and the market doesn’t seem to grasp it yet. We are not talking about the smorgasbord of events effecting markets all over the globe that is receiving ample coverage elsewhere in the media. As readers might know, our particular interest is in the silver space, and that is where we see an elephant in the room that hasn’t made headlines yet.

No doubt most readers are aware of the recent developments in countries like Argentina, Bolivia, Peru and others, with respect to what can be broadly classified as “resource nationalism”. Our general views on the subject were detailed a few years ago, here [5]. As discussed by this writer and others, such developments are not new and certainly not limited to silver or even the mining sector. However, in our opinion, it is in the silver space that these events should have the most profound effect.

Why? Because the silver sector is so small and the above mentioned countries collectively make up a big of chunk of it. According to CPM Group’s 2012 Silver Yearbook, the aforementioned countries are projected to produce some 170 Moz silver this year versus the anticipated total global silver production of 788 Moz. While at first glance that only makes up 21.6% of total annual mine supply, which in itself is significant, we submit that it represents an even greater percentage of “investible” silver production. 

Let’s take a closer look…

Of the total 788 Moz of annual (projected 2012) world silver production, the part that is accessible without much hassle to you and I, the unsophisticated investor through public markets is largely limited to Mexico, USA, Canada, Australia and Europe. For the purposes of this missive, the rest of world offers few-to-no easy ways to invest in silver. Why not much to look at here? The larger contributors to silver production in the rest of the world are China, Russia, Kazakhstan, Chile, Turkey, Morocco, Indonesia and India.

- The bulk of Chinese production is dominated by large base metal producers and/or smelters/refiners. Silvercorp is an exception and is a Canadian company, so we bundle it into North America;

- Russia has several companies listed in New York and London as well as RTS – most of them primarily gold and/or base metal miners;

- Kazakhstan has few larger publicly traded companies (Kazakhmys in London) – none of which make primary silver plays;

- Same for India, Indonesia and Turkey. Morocco may produce a silver play in the near future if efforts of May Gold and Silver (TSX-V: MYA) are successful;

- Chile has no primary silver mines with the exception of Kinross’ La Coipa, which once again, makes a poor silver play – the remainder of silver comes from primary copper and gold mines buried in large companies such as Codelco.

The only destination of significance in Europe in terms of contribution to silver production accessible via public markets, is Poland (KGHM is a large silver producer but primarily a copper mine). The rest of European production is scarcely accessible as a bet on silver because the mines that produce silver are either not primary silver mines, or are private, or otherwise not easily investable. The other European silver play that we know of, is Global Minerals (TSX-V: CTG) – a Canadian junior advancing a past-producing silver project in Slovakia – not yet in production, though moving in that direction. There are a few other juniors scattered around Europe with some silver exposure that are not primary silver plays. That about sums it up, given that the whole of Europe is projected to kick-in 56.5 Moz in 2012 – of which, Poland stands for 40.4 Moz followed by Sweden at 9.1 Moz (Boliden, a conglomerate, not a silver company).

Australia has a handful of smaller silver mines (under 3 Moz annual production) to choose from, since the biggies do not make good silver plays (BHP and Xstrata).

Sounds ominous, doesn’t it? You know, there is a reason silver is a p-r-e-c-i-o-u-s metal. That is why Silver Wheaton has a business – it provides a way to unlock the value of silver buried within larger polymetallic mines, which by itself is insignificant to the actual miner, but can be substantial when separated. Silver Wheaton’s $12B market cap is proof of that.

So what is wrong with Argentina, Peru and Bolivia, and why is it a big deal [6]? Here we would like to refer the reader once more to the article we penned on the subject in 2009 [5] where we defined nationalization as “not only outright expropriation of private property but all other forms of "creeping" or indirect nationalization which ultimately leads to increased control of natural resources by governments at the expense of current stakeholders in a non-free market way. These may include any flavor or combination of increased taxation, excessive/retroactive taxation, breach of contracts, delay or revocation of permits and licenses required to exercise legal owner's rights, support or tolerance of other groups/interests' illegal activities to the detriment of property owners, and so on”. It looks as if Argentina, Bolivia and to a lesser extent, Peru, are trying to hit it on all points, based on the actions of central and (in the case of Argentina, some) provincial governments. 

Bolivia, of course, was the latest in the news with nationalization of the flagship Malku Khota silver-indium project of South American Silver (TSX: SAC). So much so, that it led to the ultimate resignation of Greg Johnson as its President & CEO – who was largely responsible for putting that company on the map in the first place. The stock is back where it was when Johnson took over as President, back in March, 2010.

Peru has had its share of “misfortunes” in this regard with Bear Creek (TSX-V: BCM) still trying to recover from its fall from grace in public markets – through no fault of its own that we can find. All the rhetoric to the contrary notwithstanding, things seem to be far from “business as usual”. The good news is that Peru (and Chile) has a rather elaborate domestic mining industry with sizeable publicly trading companies contributing a great deal to its economy, which is not the case in Argentina or Bolivia. The assumption here is that the government will be hard-pressed to make a move on foreign investors without at the same time squeezing influential domestic companies.

Argentina has been making waves for some time, which seems to have culminated with its government taking control of 51% of Spanish oil major Repsol’s oil interests in the country. Here’s a direct quote from a news release dated July 2, 2012 by Geoff Burns, President & CEO of Pan American Silver [7] commenting on the legislation proposed by the government of Chubut province of Argentina:

"This is an incredibly unfortunate development for the mining industry in the province of Chubut and in Argentina. Having made significant investments over the last two and a half years in work to prepare the world-class Navidad silver project for development, it is extremely disappointing that the government of Chubut would introduce this legislation without meaningful consultation with the mining industry. Since acquiring Navidad, we established a policy of open and honest communication with all levels of government as to our progress and plans and were surprised that we were not consulted on the economic effects that the proposed legislation would have on Navidad's development. I am convinced that it was the provincial government's intent with the new draft legislation, to define a path for the development of Navidad, not to render the project uneconomic. However, if the draft law is passed as submitted there can be no other choice currently than to stop investing further in the project". 

We encourage you to read that entire news release to learn what else they propose to do. Mind you, Navidad was supposed to be this blockbuster mine that would take Pan American to a whole new level (more on that in part II). If memory serves, they paid some $660 MM to buy it. Despite the recent acquisition of Extorre by Yamana Gold, which incidentally went for a much lower price than one figures it would in a more mining friendly jurisdiction, Argentina appears to be determined to exhaust all other options before doing the right thing. After all, it’s barely been 20 years since they opened up the resource sector to foreign investment [8].

We would be remiss not to mention Guatemala, as it is home to the other blockbuster silver project being advanced by Tahoe Resources (TSX: THO). If you examine its stock chart and check the news from the company, Tahoe appears to have lost about $1 Billion in market capitalization on the account of talk related to nationalization of Guatemalan resources by that government. They back-tracked on that, saying they want a bigger stake “only in new projects” [9] – but the market was spooked and seems to be slow to warm up.

Where to look going forward

Why not look where the “pros” are going? While we were mulling these matters over in the last few months, the event that “drove it home” for us was the unsuccessful bid by Hecla for US Silver. Incidentally, Hecla is our “favorite co to criticize” in the sector. Why? Because coming into this cycle (say 10 years ago), Hecla was the ‘IT’ company in the silver space. They had it all – the 100 year history, the NYSE listing, the name recognition, the size relative to peers, the following (by resource investors and funds), the technical expertise and reputation of a top underground mine operator. And they have successfully squandered that early leader advantage. We are aware of several “due diligence” undertakings by Hecla that ultimately resulted in them shying away from pulling the trigger on an acquisition. The best thing they did in the last 10 years was to acquire the balance of Greens Creek that they didn’t already own. It is about the only thing of note they did in that period. That, and the settlement with the EPA – which didn’t come cheap. That same Hecla, who’s execs all but swore on a stack of bibles to never “cross onto the wrong side of the highway” (referring to highway I-90 which cuts through the Silver Valley separating operations of Hecla from the other big three mines – The Sunshine, Bunker Hill and Galena/Coeur) made a bid for US Silver – which now owns the assets previously owned by Coeur D’Alene Mines in the Silver Valley.

Question becomes, where else they had to go? There aren’t many more places they can go! That brings us full circle to where we started from. As we write this, the news came out on August 21, 2012 that Hecla made a “strategic investment” in Dolly Varden Silver Corp [10]. And it only re-affirms the point we are trying to make: if you want to be a player in the silver space, right now you’re virtually limited to Mexico, USA and Canada. Hecla’s actions suggest that they “get it”. In part II of this piece we will examine who else gets it.

In summary, we don’t suggest that countries presently stepping up resource nationalism are a complete write-off, or the situation could not change in the future. Companies neck-deep with operations in such places will try to make the best of it and rightfully so – they owe it to their shareholders. Even when projects are nationalized, they usually continue to operate – though history suggests that government-run industries eventually work themselves into the ground (no pun intended). At that point, they start to look to private business to right the ship and the cycle starts over. In the meantime, as Jim Dines puts it, the overall trend is “southward” – towards more government control – and capital will flow wherever it is treated best. Jindal Steel exit from a $2.1 Billion iron or project in Bolivia [11] is a manifestation of that.

August 23, 2012

Sean Rakhimov

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Information contained herein is obtained from sources believed to be reliable, but its accuracy cannot be guaranteed. It is not intended to constitute individual investment advice and is not designed to meet your personal financial situation. The opinions expressed herein are those of the author and are subject to change without notice. The information herein may become outdated and there is no obligation to update any such information. The author, entities in which he has an interest, family and associates may from time to time have positions in the securities or commodities discussed. No part of this publication can be reproduced without the written consent of the author. © Copyright 2012 by Sean Rakhimov.