By Sean Rakhimov and David Morgan
The Morgan Report
No matter how you look at it, by now most anyone with any sense of the market is likely established in the belief that commodities are in a secular bull market and we are now entering the second phase. This is the phase in which institutions enter the market and the Ibbotson study should convince many fund and money managers that the precious metals are vital to proper portfolio management.
Up until now fund families like Legg Mason and Vanguard have been content with one or two "Gold" or "Natural Resource" Funds in the total mix, which were grossly outnumbered and outsized in quantity, capital, and TV time by their numerous other funds - the Large Caps, the Core Funds, the Diversified Funds, the Growth Funds, the Aggressive Funds, and so on. The commodities sector, aside from oil, simply could not accommodate more institutions because there weren't enough quality companies that would clear the minimum investment requirements of most mutual funds. To that end I would venture to guess that about half the companies listed on Amex in the last two years came from the natural resource sector.
Funds are starting to come into the sector. Gabelli Gold Fund was started recently, and Mr. Gabelli is known as one smart investor. In fact, this fund was written up in the January Barron's. Additionally Endeavour mining Capital (TSX EDV) is trading at about a 40 percent discount to net asset value; we wrote about this fund in our January issue and think it is a very safe way for investors to speculate in the junior sector with less risk than individual stocks.
Jim Puplava has just created a Gold Index that makes an emphasis on quality juniors including silver juniors. With that in mind, we decided to look at some of the emerging silver producers that may qualify to be added to shopping lists of institutions entering the sector or otherwise materially impact their own standing by becoming a producer.
Apex Silver (NYSE SIL) to be the first company we look at because it's clearly the largest company with the largest mine coming on stream. Igor Leventhanl of investor Relations assured us that all work is proceeding as planned and, if anything, is slightly ahead of schedule. "There are a lot of things taking place on the ground, like the infrastructure project road construction we just finished," said Igor, implying that this work has to be done, even though it does not draw much excitement from investors.
As you'll recall, Apex is developing its 100-percent owned San Cristobal project in Bolivia. It's a silver/zinc/lead property with vast resources. The plan is to produce 22.3 million ounces of silver a year (plus a whole lot of zinc and lead), scheduled to begin in the second half of 2007. While it is two years away, Apex is expected to become the world's largest primary silver producer and add substantial supply to the market. It will also be among the cheapest silver producers with cash cost projected at around US$1.31. In addition Apex has an extensive portfolio of silver properties for which it does not get any credit at this time.
The main drawback with Apex is the fact that it is in Bolivia. A democracy can never survive the attack of a benefit-seeking populace once they realize the amount of control they can wield over the political system. Peasants in Bolivia have become inflamed by the prospect of taking control of oil and gas revenue and have taken to the streets, paralyzing the country, under the direction of trained Marxists. The Associated Press reported, "The crisis in this nation of 8.5 million people pits Indian and labor groups from the poorer western highlands, including La Paz and its poor satellite city of El Alto, against ruling elites from Santa Cruz in the east and the oil-rich gas fields to the south that are pursuing greater autonomy." Bolivia's democracy may not survive. Bolivia has seen their democratically elected leaders resign instead of confront the violence of peasant-driven strikes and riots.
The question becomes will San Cristobal become a producing mine in spite of the political problems? Yes, it should, and the stock is certainly undervalued at the present time, but we are too cautious to recommend a buy on it at this time.
Genco Resources (TSX-V GGC) is perhaps one of the least known companies on the list, yet it is probably one of the more deserving of your attention. We personally critiqued Genco for what we believe is "insufficient marketing and promotion," which stands in contrast to a lot of its peers. The management asserted that it has been a company policy to "under-promise and over-deliver." Still, the company is taking steps to address the situation and among other things launching a Web site next month (August 2005).
So what should you know about Genco? For starters, Genco is a silver producer (with some gold credits) and is profitable at that! In the first half of 2005 the company earned about 5 cents/share net of all expenses. That is a rare feat among not only silver but also even a vast number of gold companies.
Yet the good news is just beginning to flow and there is a lot more coming. To date, Genco has been processing some 140 tpd (tons per day) of ore and is expecting to increase that to 220 tpd by the end of this year, a 63 percent growth. It gets better: in 2006 the company expects to go through 340 tpd and thus ramp up production to 2,000,000 ounces of silver equivalent from 460,000 ounces in 2004. In the first half of 2005 the company already produced as much silver as it did in the entire last year.
The bulk of this growth is attributed to higher grades of both gold and silver at its new San Rafael vein. The management is rather optimistic about the prospects of this vein and has reason to believe there are more parallel ore-shoots like it nearby. To confirm this prognosis, Genco retained another drill rig that is already on the property and should start poking holes any day now. That is in addition to ongoing drilling at its main La Guitarra mine. The company's plan is to maintain at least two years' worth of reserves at the prevailing production rate at the time. That said, Genco's master plan is to eventually upgrade the mill capacity to 1,000 tons per day if in fact enough ore is found to support such production scale.
The beauty of it is that all this growth is being financed from operating cash flow. The company is making money today and putting it back in the ground to fund the expansion. Genco has about C$2 million in the bank and has no plans for additional market financing at this time. The insiders own about half of outstanding shares and there are no cheap warrant or options hanging over the stock. In fact the management is very wary of stock dilution. For instance, a number of projects the company looked at for acquisitions have been turned down because they did not offer as much value as there already is in the stock and therefore would mean dilution to existing shareholders. At the present time, the company is considering five more prospects.
Endeavour Silver (TSX-V EDR) has been among the most aggressive silver juniors. EDR owns 51 percent of the Santa Cruz Mine in Mexico and is the operator. It has an option to acquire the remaining 49 percent for US$4 million by 2008. The company is projecting silver production to triple to 1.3 million ounces in 2005. EDR is also embarking on an aggressive exploration program to expand silver resources from 10 million ounces to 20 million ounces by the end of 2005.
EDR is active in acquiring silver assets in the area and recently bought nine properties from Penoles. Interestingly, in addition to 3 percent NSR, the deal provides that ore mined from these properties is to be sent to Penoles for smelting. Some of these properties have historic silver production and could have significant potential. EDR is planning still more acquisitions in the near future.
First Majestic (TSX-V FR) is another junior silver producer that has been very active in Mexico. Even though it's a relatively young company, they control a producing mine in Mexico and have excellent prospects to build on their initial success. The company is likely to fall short of its target production of one million ounces of silver for 2005. First Majestic cancelled proposed financing of $C15 million earlier this year due to falling stock price amid a broad sell-off in silver stocks, despite holding up remarkably well compared to its peers.
Still, FR has been busy restoring access to lower areas of the mine, which needed to be done so mining could be possible. The company now expects to produce 0.5 million ounces of silver this year and up to 2 million ounces in 2006. A twenty 5,000-meter drilling campaign is underway to upgrade the quality of those resources. At the same time, the company is expanding the mill capacity at the La Parrilla Mine to 400 tons per day. The company believes that its planned drill program at its Chalchihuites group of properties (host to four former producing mines and only 40 miles away from La Parrilla), will yield sufficient results to eventually expand the mill capacity to 1,000 tons per day.
In addition, the company is looking at other prospects with a view to acquiring new properties. Expect the company to do another financing before the year-end. The size of it is likely to be determined by the stock price at the time and could be anywhere from C$5-$15 million.
Macmin Silver (ASX MMN) is the only primary silver company in Australia. It has 55 million ounces of silver equivalent (some gold credits) in resources and a significant gold kicker through its ownership of 30 percent stake in New Guinea Gold, which in turn is planning to be producing 40,000 ounces of gold starting in 2006. The company is well on its way to becoming a silver producer from its Twin Hills Project in Texas, Queensland. Mine construction is underway and should be entering final stages. Production is scheduled to commence late in 2005 at an annual rate of 2.5 million ounces of silver (equivalent). It can be increased to full mine capacity of 3.5 million oz/year if needed.
Processing of thirty-ton silver ore sample is underway for trail silver powder production for marketing purposes. Macmin will employ open pit heap leach processing but unlike other silver producers may be able to market its silver powder directly to end-users. This is possible due to its metal recovery process called "electrowinning." Tests are being conducted to assess the suitability of Macmin's product for various end-user applications, ranging from electronics to medical and construction fields. If successful, this may result in higher realized sale price per ounce of silver and add to the bottom line. Of course, the company can always go the traditional route and sell its silver to refiners.
Sterling Mining (Pink Sheets SRLM) is now producing silver from its Baroness Tailings Project. The company originally forecasted 30,000 ounces/month of silver based on conservative grades of 2.4 oz per ton (compared to historical data of 3.0 opt). In the last update from Silver Strategies we provided for these and other factors by further reducing the 360,000-ounce annual production forecast to 200,000. now that the first set of VATS has been successfully completed, the company intends to proceed with its plan to build the second facility. Since production just commenced in Q2 2005, at this time Sterling is abstaining from further projections due to insufficient data about ongoing operation of the facility. However, later in the year, once a record of production is established as well as schedule of construction of the second facility is determined, production forecast from Baroness is likely to be revised upward.
Sterling conducted initial tests with material from its San Acacio project and came back with some interesting results. After processing "fines' from the San Acacio dumps and backfill, it has confirmed metallurgical tests that this material is amenable to the leaching process used at Baroness. The company appears to be excited about these findings and believes that there is a real potential to significantly expand production rate in 2006. Sterling already obtained approval from the authorities for a 667-ton-per-day third facility at the Baroness, intended specifically to process San Acacio material. According to Sterling, rehabilitation is underway to allow access to lower underground workings. Prior drilling of over 600 meters resulted in an inferred resource of 14.2 million ounces of silver. The Spanish mined 32 million ounces from the San Acacio over hundreds of years, with a cutoff grade of 30 ounces of silver per ton, so the company is very optimistic about processing material from San Acacio in the near future.
At the Sunshine, the company completed its Phase II Mine Plan, with the final Phase III Mine Plan to be completed in November 2005. Key rehabilitation efforts are ongoing, with particular emphasis being placed on the Silver Summit tunnel and hoist. This hoist is necessary for a secondary escape way, i.e., so that the project is not dependent solely on the Jewell shaft (which is currently in operation). In addition to ongoing maintenance and rehabilitation work, the company has contracted an ex-Sunshine geologist to do computer modeling and work on planning the exploration program.
Note: Fund managers cannot purchase this company at this time due to the fact it remains on the pink sheets; once it is a fully reporting company, some fund managers can purchase.
ECU Silver Mining Inc. (TSX-V ECU) is a Canadian company engaged in production of base and precious metals. The principle asset the company owns is a 4.6 square kilometer property hosting seven mines in the Velardena District. Two of these mines are currently in production. The Santa Juana and the San Mateo are epithermal systems bearing gold, silver, lead, and zinc. The producing mines are well served by good infrastructure including rail lines and roads and are also connected with reasonably priced power.
The Santa Juana hosts a narrow vein underground system, however at the recently opened 18th level, a carbonate replacement potential has been discovered. If this is part of a larger deposit then the potential for expansion is greatly enhanced. More work is required to determine any additional resources.
According to Mike Kachinovksy writing in Resource World Vol. 3 Issue 6, ECU only requires production of 170 tons per day to break even on all operating and administrative costs. We could not reach the company for verification of their average value per ton. We tried their Web site and it was down; we later discovered that trading in the shares of the company was halted at ECU's request, pending an announcement on July 22, 2005.
According to the Resource World article, the values of ore is in the range of $140 per ton. This is our number and quite a valuable ore grade. We are going to use it for illustration purposes, only! The mill capacity is estimated to be 250 tpd. This means the company has a net 80 tons per day profit. This is equivalent to approximately $11,000 per day net of all expenses.
Thus, the bottom line of the company could be 200 days of mining times $11,000 per day, for an estimated net profit of $2.2 million a year. With 152 million shares issued (192,745,250) fully diluted, we have a profit per share of one and a half cents per share. The gold shares are trading at a multiple of 27 times earnings. This would put the shares fairly valued at 0.39 cents, or 0.31 on a fully diluted basis.
But, silver stocks are trading at a much higher premium than gold stocks, somewhere in the range of 50 times earnings.
If we look at Silver Wheaton that just reported earnings of 0.03 cents per share last quarter (.12 per year), we find .12 x 27 = $3.24, but if we compare Silver Wheaton to the peers of Pan American, CDE, and HL, then the company could be valued at .12 x 50 = $6.00 per share. Interestingly, a major brokerage gave coverage to silver mining equities and had to buy on Silver Wheaton with a price target of $6.00.
We concur that this company now listed on the American Exchange should be in the Model Portfolio and can be purchased at current levels. Silver Wheaton (AMEX SLW) is not a producer as such, but generates revenue from producing mines. Our initial look at the company showed it to be overvalued, but now that we have the facts, it is undervalued and represents a good buying opportunity now.
Editor's Note: The Morgan Report is posted on Jim Puplava's Financial Sense web site at www.financialsense.com. David Morgan is editor of the Silver-Investor.com newsletter, 21307 Buckeye Lake Ln., Colbert, WA 99005, 1 year, 12 issues, $149. E-mail version, $99. Morgan, a private economist and precious metals analyst for over 20 years, reviews current trends, long-term fundamentals, and specific information required for any investor, especially the serious silver or precious metal investor.
