An investor who
decides silver deserves a place in the portfolio usually reaches for the miners
first. That is understandable: a mining company files accounts, reports
reserves and produces the cash flow statements that fundamental analysis is
built around. The metal itself offers none of that. But the two exposures are
not interchangeable, and treating a silver equity as a proxy for silver is one
of the more common category errors in the sector.
A miner’s revenue line
does start with the silver
price, so the correlation is real. What sits between that revenue line and
the share price is an operating business: a cost base, a reserve grade, a
permitting timetable, a jurisdiction, a management team and a capital
structure. Each of those can move the equity independently of the metal, and
several of them tend to move at the worst possible moment.
Most silver is not
mined by silver miners
The first thing that
complicates a silver equity screen is that the pure-play universe is small.
Silver is predominantly a by-product metal, recovered alongside lead, zinc,
copper and gold rather than pursued on its own. The Silver Institute’s supply and demand datashows lead and zinc operations as the dominant single source of
mined silver. The consequence matters for anyone modelling supply: a large
share of annual production is set by decisions taken about entirely different
metals. When the silver price rises, that by-product output does not respond
the way a textbook supply curve suggests, because the mine was never built for
silver in the first place.
Operating leverage
cuts in both directions
A producer’s costs are
largely fixed in the short run, so margins swing harder than the metal does.
Move the silver price up by a tenth against an unchanged cost base and the
earnings effect is a multiple of that. The same arithmetic runs in reverse, and
a producer whose all-in sustaining costs sit close to the prevailing price can
move from comfortable to loss-making on a modest correction. Leverage is the
product being sold here, whether or not it is described that way.
The risks that have
nothing to do with silver
Production is
concentrated in a handful of countries, with Mexico, China, Peru, Bolivia and
Chile at the top of the table, which brings royalty regimes, permitting
decisions and tax policy into the investment case. Add the ordinary hazards of
the business, grade declining as a deposit is worked through, a mill running
below nameplate, a development project absorbing more capital than budgeted,
and the risk register grows well beyond the commodity. Equity beta compounds
it: miners are shares, so they can be sold off in a broad market drawdown even
in a week when the metal holds its level. Dilution belongs on the list too,
since the sector funds itself through equity issuance more readily than most.
Royalties and
streams narrow the gap
Between the two sits a
third structure that equity investors tend to discover once the operating risk
becomes clear. A royalty or streaming company puts capital into a mine up front
and receives in return either a percentage of the revenue that mine generates
or the right to buy a fixed share of its output at a price agreed in advance.
Because that purchase price is contractual, the cost side of the income
statement barely moves when wages, diesel or reagents do. Margins widen with
the metal price in much the way a producer’s do, but without the cost inflation
that has repeatedly eaten into producer margins during the strongest part of a
cycle, which is precisely when the leverage was supposed to pay. The portfolios
are usually spread across many operations as well, so a single mill failure or
permitting delay does not carry the whole investment case.
The structure does not
escape the problem this article started with, though. A royalty holder owns a
security rather than metal, and still depends on somebody else running the mine
competently: if the operator suspends production, the stream delivers nothing
that year, and the holder has no operational say in the matter. Counterparty
quality therefore matters as much as the geology. Valuations reflect the
attraction, so the sector rarely screens cheaply on conventional multiples, and
the discount rate applied to cash flows that run decades into the future does
most of the work in any model built around them. It is a genuinely different
risk profile from a producer, and a useful one, but it is still an equity, with
equity beta, an issuer and a share count. It narrows the distance between the
miner and the metal without closing it.
What the metal
gives you, and what it does not
Holding silver bullionstrips all of that away. There is no management to assess, no
reserve statement to interrogate, no share count to watch. There is also no
cash flow, no dividend and no possibility of a company compounding value on the
investor’s behalf. The return is the price change and nothing else. Under
allocated vault storage the holder is recorded as owner of specific bars, which
removes the issuer from the equation but introduces charges the miner does not
have: annual storage, and in the European Union a VAT treatment that differs
from investment gold, since silver is not covered by the same exemption.
Volatility is its own consideration. The World Gold Council puts silver at
roughly twice the volatility of gold on daily annualised data, which argues for
a smaller position than an equivalent gold allocation.
Two different bets
Set side by side, the
choice is clearer than the shared exposure suggests. A silver equity is a
leveraged bet that a specific management team will execute at a given metal
price, in a given jurisdiction, without diluting shareholders along the way.
Bullion is an unleveraged bet on the metal, with the operating risk removed and
the carrying costs made explicit. An investor can hold both, and many do, but
sizing a bullion position as though it behaves like a miner, or the reverse, is
where the category error usually turns into a loss.
Disclaimer: This article is for
general information only. It does not constitute investment, tax or legal
advice, nor a recommendation to buy, sell or hold any asset, and it does not
take account of any individual’s objectives or financial situation. Precious
metals prices fluctuate and the value of an investment can fall as well as
rise, so investors may get back less than they put in. Past performance is not
a reliable indicator of future results. The figures quoted come from the
sources linked in the text and reflect the position at the time of writing.
Readers should do their own research and, where appropriate, consult a
qualified financial adviser before making any investment decision.
This article was written by IL Contributors at investinglive.com.