Following a relatively solid week for silver stocks, today was a complete and somewhat unexpected about-face that can be squarely blamed on rumors and guessing. Earlier today, it was announced that Federal Reserve Governor Lael Brainard, a noted supporter of hiking interest rates, is scheduled to deliver a speech this coming Monday, Sept. 12. It's somewhat uncommon for Fed governors to deliver speeches so close to a meeting of the Federal Open Market Committee, which is scheduled to take place between Sept. 20 and Sept. 21. The expectation is that Brainard will again call for the Fed to raise interest rates.
For the time being, interest-rate-hike talks rule the roost for the silver industry. The reason this is the case is because of opportunity cost. Opportunity cost is the idea of giving up a guaranteed return in one asset for a chance to earn a better return with another asset.
At the moment, interest-bearing assets like bank CDs, money market accounts, and savings accounts, are all yielding well below the national rate of inflation. This would mean that, even with nominal gains being made, investors would be losing real money -- i.e., purchasing power -- by purchasing these assets. This makes buying precious metal like gold and silver, which have no yield, seem more attractive. The opportunity cost of giving up on interest-bearing assets is relatively low.
However, if the Fed flips the script and begins raising its federal funds target, the expected reaction in interest-bearing assets is for yields to move higher. The higher those yields move, the more attractive they could become to investors, which could put pressure on physical gold and silver prices because the opportunity cost of forgoing the guaranteed yield of a bond or bank CD would be on the rise.
What sort of havoc did "Fed-speak" unleash on the silver industry today? Have a closer look at some of these intraday moves:
- Coeur Mining (NYSE:CDE): Down as much as 11%.
- Endeavour Silver (NYSE:EXK): Down as much as 12%.
- Silver Standard Resources (NASDAQ:SSRI): Down as much as 11%.
- Hecla Mining (NYSE:HL): Down as much as 10%.
- Fortuna Silver Mines (NYSE:FSM): Down as much as 12%.
Three reasons this dip is a buying opportunity
However, I would encourage investors not to be panicked by today's move, or any increased volatility in silver stocks, for three key reasons.
To begin with, we have to take into context exactly what sort of "opportunity cost" we're talking about. The Fed has enacted just one interest-rate hike since Dec. 2008; otherwise, it's left lending rates at or near a record low.
Even if the Fed were to raise interest rates a handful of times, the yields on most interest-bearing assets could still be less than the U.S. inflation rate, making it not worthwhile for investors to invest much, if at all, in those assets. Silver and other precious metals should still be a very viable investment option on the basis of opportunity cost, even if the Fed decides to hike rates in September.
Secondly, there are fundamental reasons to like silver beyond just the aforementioned opportunity cost trade-off. According to the Silver Institute, silver is expected to see steady demand growth in jewelry fabrication and industrial demand, but it's surprisingly strongest growth opportunity is as a conductor in solar panels.
GTM Research released a report in March calling for a 119% increase in the U.S. solar market in 2016, which implies that silver demand should remain relatively strong. Supply and demand still matter when it comes to the underlying precious metals that miners produce, so strong demand could help put a floor under spot silver's per-ounce price.
Finally, we're witnessing demonstrable improvements in the underlying fundamentals of silver miners. In fact, some look to be trading in value territory.
As we examined recently, some of the biggest gains among silver miners have come from closed or expected acquisitions. Hecla Mining is acquiring Mines Management in an all-stock deal that'll give Hecla access to the Montanore Mine. Montanore is expected to have an initial capacity of about 12,500 tons per day, and is capable of producing more than 6 million ounces of silver and 50 million pounds of copper, annually.
Silver Standard Resources has also taken advantage of M&A to boost its results. In June, it completed its acquisition of Claude Resources, bringing the Seabee mine and Santoy Gap under its control. Claude's expansion into the Santoy Gap came ahead of schedule and allowed the gold miner to push its annual output from about 50,000 ounces of gold to approximately 70,000 ounces. Claude immediately brings extra income and cash flow to Silver Standard Resources, and it helps further balance the company's output.
Simple production expansion has been critical for Coeur Mining, which, during the second quarter, met the minimum ounce obligation forged from its royalty agreement with Franco-Nevada on its Palmarejo mine. Now that it has repaid its $100-million term loan, Palmarejo is expected to deliver substantially higher cash flow in the years to come. All-in silver sustaining costs for Coeur Mining also fell 8% on a quarter-over-quarter basis.
Endeavour Silver, on the other hand, is focused on doing more with less. Even though its silver production dipped 14% during the second quarter, it managed to flip a $1 million net loss in Q2 2015 into a $1.7 million net profit in its most-recent quarter. Reduced capital expenditures helped push its all-in sustaining costs down to $10.53 per silver ounce, a 38% drop from the prior-year quarter. It didn't hurt that gold production increased 17%, either.
Fortuna Silver Mines has taken a similar path. With its San Jose Mine now commercially operational and ramping up, Fortuna has turned its attention to cutting its capital expenditures at existing mines, and funneling its attention to the Lindero Gold Project, which could be a commercially viable mine by the second-half of 2018. Thanks to its mining of by-products (gold, lead, and zinc), Fortuna's all-in sustaining cash costs are already below $10 per silver ounce.
Long story short, the investment thesis in this industry hasn't changed because of a few Fed rumors, and it won't change even if the Fed enacts a rate hike in September. We're seeing real demand growth and significantly improved fundamentals from the silver industry, and it could very well be worth your while to dig into one or more of these aforementioned names.
Sean Williams owns shares of Silver Standard Resources, but has no material interest in any other companies mentioned in this article. You can follow him on CAPS under the screen name TMFUltraLong, and check him out on Twitter, where he goes by the handle @TMFUltraLong.
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