By Scott Wright
It’s hard to believe that silver was trading at only $4 just 11 years ago. And amazingly it was only 7 years ago that silver had hit $10 for the first time in nearly two decades. Now at over $30 and rising, silver is flexing its muscles as one of the best-performing assets of the last decade.
There’s no arguing that silver’s secular bull has been spectacular. Since its 2001 low, silver had soared a staggering 1094% to its 2011 high. And based on its structural fundamentals, silver’s bull still likely has plenty of room to run in the years to come.
Investors who’ve been accumulating this precious metal over the years (like our newsletter subscribers who first started buying with us when we officially recommended it as a long-term investment back in 2001) have obviously fared quite nicely. But there’s another silver vehicle that in some cases has fared even better. Silver stocks, leveraged plays on the underlying metal, have had quite the bull market of their own.
Though there is no silver-stock index that has a long-enough history to give us a direct comparable to silver over the course of this bull, the next-best comparable is the performance of gold stocks given their tight correlations. And the venerable HUI gold-stock index is probably the most conservative metric (the HUI is comprised of the world’s largest gold stocks, along with a couple of large silver stocks).
Considering their risks, mining stocks should exhibit positive leverage to the metals. And with a bull-to-date gain of 1664% to its 2011 high, the HUI has indeed easily outperformed its underlying metal (+640%). And I suspect a primary silver-stock index would have gains just as good, if not better, over this time.
Thankfully there’s a product that has come to market recently that does offer investors some semblance of sector-level performance for silver stocks, the Global X Silver Miners ETF (SIL). Global X Funds has been a huge innovator in the ETF realm in recent years, especially when it comes to commodities stocks. Its unique approach gives investors easy access to small commodities sectors and subsectors. And the first-of-its-kind Silver Miners ETF is a godsend to the tiny silver-stock sector.
SIL was conceived in April 2010, and like all ETFs its goal is to closely mirror the performance of an underlying index. This index is the Solactive Global Silver Miners Index, and it is designed to generally reflect the performance of the silver-mining industry. SIL is ultimately comprised of stocks that are actively engaged in some aspect of this industry whether it be mining, refining, or exploration.
I see two major benefits to this ETF, and the first is the overall benefit offered to investors. As with most ETFs, SIL is easy to buy, easy to sell, and it even has a relatively liquid options market. SIL’s basket of silver stocks also greatly reduces individual-company risk. And it even offers geographical diversification, which is a big deal in the mining industry.
SIL also opens up the opportunity for institutional investment. Since most individual silver stocks rank too small and/or illiquid for institutional guidelines, most institutions couldn’t or wouldn’t touch them. With the advent of SIL, many can and hopefully will as this ETF grows in popularity (SIL’s total assets are currently about $366m).
Many folks, especially ETF haters, may look past these obvious investor benefits. But they shouldn’t! Since silver stocks are small by market capitalization, thin in population, tend to be illiquid, and are known to be hyper-volatile, they can be very intimidating to potential investors who aren’t attuned to the industry. I guarantee you that a big chunk of the capital pouring into this ETF wouldn’t have found its way to silver stocks otherwise if it didn’t exist.
The second major benefit of this ETF piggybacks off the first. And that is capital shunting directly into the underlying component mining companies. This may not seem like a big deal, but considering the size of these stocks, any buying is good buying. This increases exposure, liquidity, and ultimately the stock prices in a strong silver environment.
Speaking of strong silver environment, this is exactly what investors rely upon in order for silver stocks to move to the upside. And as most folks who are interested in this sector are likely aware, silver is in the midst of a strong new upleg. Since its late-June low, silver is up an impressive 32% to its high just last week.
This new silver upleg gives us an excellent chance to test the resolve of the SIL ETF. And with a 48% gain since its own low in July not only has SIL kept up with silver, it has indeed provided the positive leverage that is essential to keeping investors interested in these types of stocks.
Returns like this over only about two months are certainly attractive. And this will no doubt draw increased attention to silver stocks. And for many of the first-timers into this realm, the SIL ETF will be their first destination for capital.
These returns of course piqued my own interest, which prompted me to do a little dissecting. It’s always prudent to get more intimate with an ETF than just its name, to find out if it truly is the best proxy for a given sector. Even a high-level peek can speak volumes.
In the table above you’ll find a summary of SIL’s holdings, ranked by percentage of assets in descending order. In blue are the stock symbols, followed by the market capitalizations in US dollars, and then the stocks’ flagship project location(s).
In total SIL is comprised of 32 component stocks, which is actually a significant portion of the world’s population of silver stocks. By our count, there are less than 125 primary silver stocks (explorers, developers, and producers) with listings on the US and Canadian exchanges. And it is well known that these exchanges are host to the vast majority of resource stocks.
To put this listing concentration in context, of the 32 SIL holdings all but 5 have primary listings in the US and/or Canada. While there are a handful of silver companies that list their stocks exclusively in London, Mexico, Australia, or elsewhere, it is a minority. I’d say that SIL’s 85% weighting towards US and Canada stocks is a fair representation of the global concentration of silver stocks.
Even if we are conservative and say there are 150 primary silver stocks in all the world, this is still an incredibly small number. You’d think there’d be more companies scouring the planet for this precious metal, especially considering its fortunes over the last decade or so! There are however logical reasons for this phenomenon, the most prevalent being silver’s geological nature.
Interestingly as measured by revenue, silver is usually a byproduct of polymetallic deposits that hold strong concentrations of either base metals (typically lead and zinc) or gold. For this reason less than one third of total global mined silver production comes from primary silver mines. And because of this, mining companies that explore for and successfully develop primary silver deposits are not as common.
Another attribute that comes with primary silver stocks is their generally small size. The simple average market capitalization of the 32 SIL components is only $2.6b. And if I exclude its big four, the average goes way down to $873m. This is definitely small-cap territory to say the least. And there are a few main reasons for their pint-sized statures.
The first reason is simply the lower relative value of primary silver deposits and/or operations. In general a large silver deposit contains resources in the neighborhood of 40m ounces, with a very large mining operation producing 4m ounces per year. Compared to gold (at the current 1-to-52 ratio), a large silver deposit is equivalent in value to a moderately-sized gold deposit (769k ounces). And a very large silver-mining operation is equivalent in value to a small gold-mining operation (77k ounces).
Another reason for the generally small size of silver stocks as a group is the lack of producers. There is naturally a big drop-off in market cap from producer to explorer since there is no guarantee that a deposit will ever be developed into a profitable mine. Amazingly there are less than 30 publically-listed primary silver producers in the world. And SIL holds nearly all of them, with three-quarters of its components actively mining the shiny-white metal.
Lastly we can attribute silver stocks’ small size to the fact that many of them are woefully undervalued. There are a myriad of fundamental and technical reasons supporting this assertion. But in general this sector is still greatly lacking in the exposure it deserves considering the performance to date and future promise of its underlying asset.
As for SIL’s percentage of assets, the weightings clearly heavily favor the larger-market-cap companies. Nowhere in its prospectus can I find a reference to a strict adherence to the conventional weighted-average market-capitalization formula that most indices employ, but I assume its custodians run some kind of a hybrid formula along those lines judging by the weightings.
As you can see, SIL’s largest three holdings combine for 36%+ of its total weighting. Silver Wheaton (SLW) is SIL’s largest holding, and it of course lists on both the NYSE and TSX. Known as a streaming company, SLW is somewhat of a hybrid between a royalty company and a producer. I’ve long held the stance that its brilliant business model makes it the perfect silver stock. SLW is thus the perfect company to anchor this fund!
SIL’s next two largest holdings are Mexican-based companies that actually don’t carry big-board listings in the US or Canada. And they have quite an interesting interrelationship. Fresnillo PLC (FRES, listed in London) ranks as the world’s largest primary silver producer, with the lion’s share of its volume coming from its massive namesake mine (30m+ ounces per annum) in Zacatecas.
Industrias Peñoles (PE&OLES, listed in Mexico) is more of a conglomerate company that sports a broadly diversified portfolio of operations. Peñoles has its hands in a wide variety of metals mining, and also operates a robust downstream business (smelting, refining, marketing, etc…). In fact, the only reason Peñoles is considered a silver company is because of its 77% ownership of Fresnillo (Peñoles spun off Fresnillo in 2008).
As you go down the list, the next 13 stocks combine to account for 55% of SIL’s weighting. And this brings the total weighting of the top half of its holdings to 91%. It is quite clear that this ETF adheres to some sort of market-cap-weighted structure.
Of these 13 stocks there’s a good mix of mid-tier and major producers, along with a high-quality junior. On the producer front Pan American Silver (PAAS), Coeur d’Alene Mines (CDE), and Hochschild Mining (HOC, listed in London) are among the rare 10m+ ounce primary silver producers. And then we see First Majestic Silver (AG), Hecla Mining (HL), Silver Standard (SSRI), Silvercorp (SVM), and Endeavour Silver (EXK) as primary silver miners producing in the neighborhood of 5m to 9m ounces annually.
In this group we also find Polymetal International (POLY, listed in London) and McEwen Mining (MUX). And interestingly these companies tout themselves as primary gold producers. POLY does own the third-largest primary silver mine in the world (the Dukat mine in Russia), but it is just one spoke on a wheel that is mainly filled with gold mines. And while MUX’s current operation in Argentina slightly favors silver over gold measured by revenue, it is in the process of developing a gold-centric portfolio.
Lastly in this group of 13 is the lone junior, Tahoe Resources (TAHO). Looking at its market cap, you wouldn’t think this company was a junior. And it only is in the sense that it hasn’t yet produced any silver. But it will soon be a major producer once its massive under-development high-grade mine in Guatemala achieves commercial production in early 2014.
As for SIL’s remaining 16 stocks, they cumulatively account for only about 9% of its total assets. These smaller stocks have an average market cap of just under $200m, which ranks in the micro-cap category by definition. And of this group 10 are smaller producers and 6 are explorers.
Overall after a quick run-through of its holdings, I’d say that the SIL Silver Miners ETF is a fantastic vehicle for gaining exposure to silver stocks. And I would highly recommend it to investors who are either just getting to know this sector and/or have no interest in owning individual stocks.
But for investors who do have a bit higher risk tolerance and are willing to learn, individual stock picking is where the real gains are at. If a large basket of stocks heavily weighted to the biggies is capable of positively leveraging silver’s performance, imagine what a smaller skillfully-selected portfolio of stocks can do!
The bottom line is investors who’ve been buying the companies that explore for, develop, and mine primary silver deposits have been greatly rewarded over the course of silver’s secular bull. And thanks to the recent addition of the SIL Silver Miners ETF, this sector is able to reach investors on an entirely new level.
After taking a closer look at SIL, a case can be made that this ETF represents an excellent proxy for this high-risk high-reward sector. And as a new wave of investors find their way to silver stocks, SIL will be waiting with open arms. But by their nature ETFs have their flaws. And for investors who seek better leverage than what ETFs have to offer, nothing beats a skillfully-selected hand-picked portfolio of elite silver stocks.
September 28, 2012
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