Saturday, July 30, 2011

Guest post: THE COMPLETE COST OF MINING SILVER

By SRSrocco:

The inspiration to write this post was to clarify some issues with the costs of mining silver. I believe many of the investing public has mistaken what is termed as the “CASH COST” as the real cost of mining silver. According to the Silver Institute in 2010, the cash cost from primary mine production was $5.27 an ounce. The Silver Institute gets their info from the World Silver Surveys produced by GFMS. I have had an email exchange over the past several months with one of their metal analysts on various topics. I recently asked permission to reproduce their Cash Cost graph for this post, and was told I could do so for $1,500.

Instead of forking out 1,500 clams for a graph that I believe is highly overrated, I decided to reproduce my own simpler version for this post. Let me point out, the 2010 silver cash cost posted on the Silver Institute comes from a percentage of primary silver producers. If global primary silver production was only 30%, the $5.27 an ounce cash cost was only a small part of the overall global cash cost picture. To understand what represents “CASH COSTS”, here is a good definition:

CASH COST: The costs of onsite production including by-product credits as well as transport, refining, onsite administration costs and royalties.

What isn’t included in the cash costs are depreciation, depletion, amortization, general and administration, exploration, interest expense, and taxes. This is not a complete list, but you get the idea. Furthermore, cash costs of silver represent measurements that are not in accordance with GAAP (General Accepted Accounting Principles) that management uses to evaluate the performance of mining operations. Why is that last sentence important? Even if you have a very low cash cost, it doesn’t guarantee profitability.

Let me give you an example. In 2008, Hecla had a silver cash cost of $4.20 oz. Even though the average price of silver in 2008 was $14.99 oz, Hecla had a Net Income loss of $66.5 million. We can see that the cash cost in reference to the profitability of a company is completely worthless. That is why I have come up with my own formula on what are the COMPLETE MINING COSTS for silver.

Investors need to realize that all costs should be factored into calculating what a company actually pays for bringing an ounce of silver to market. In each ounce of silver that a mine produces and sells to market a portion must go towards exploration, general administration staff, interest expense, depreciation and etc….we also can’t forget the costs in mine remediation when the operation is finished. To me, it doesn’t matter what a mine’s cash costs are if they can’t make a profit. The industry has highly publicized the cash costs of mining companies which in my opinion has misled the investing public.


This is my version of a cash cost graph. I have been focusing on U.S silver companies, but wanted to throw in Fresnillo as a comparison. Fresnillo located in Mexico, is the largest primary silver mine in the world with 38.5 million ounces of silver produced in 2010. Hecla has mines in Idaho and Alaska. US Silver’s Galena mine is located in Idaho and Revett Mineral’s Troy mine is located in Montana. I did not include Coeur d’ Alene, even though it is the largest U.S. based primary silver mine in the country. Most of Coeur’s silver production comes from Mexico, Bolivia and Argentina. I wanted to stick with the largest domestically producing primary silver mines in my report.

As you can see from the graph above there is a range from Hecla’s negative cash cost of -$1.46 oz to Revett Mineral’s cash cost of $14.38 oz. Basically, Hecla is mining silver for free when you factor in all their by-product credits from gold, lead and zinc. Now that you know the cash costs of these companies, let’s look at my formula for calculating the COMPLETE COST OF MINING SILVER.

CALCULATING MY COMPLETE COST PER OUNCE

To get a more complete cost of mining silver, I took the net income at end of the year from each mining company and divided it by their total sales. This turns out to be a percent. That percentage figure is subtracted from 100% and then multiplied by the average price of silver in 2010…which was $20.16 oz. Again, this is a formula I came up with does not factor in the sales of silver vs. silver production as well as other items including differentiation of by-product credits between different mining firms. I believe that most by-product metal sales from the majority of mining companies’ are sold at market value or similar in price to their competition. As you can see there are so many variables, but at least my method gives the investor a better idea of how much it really costs a mining company to profitably produce silver. Here is an example below:


As I mentioned above, I did not use what is termed as “Income applicable to common shareholders”, which in Hecla’s case was $35.3 million in 2010 ($13.6 million in dividends). Some mining companies have dividends and some do not. To make it simple and easy across the board, I used the Net Income from each mining company. I plugged in the formula above for each mining company and came up with the COMPLETE COST GRAPH below:


Here we can see there is quite a difference between the mining companies’ cash cost per ounce and what the complete cost per ounce after everything is paid (except shareholder dividends). Even though Hecla had such a low cash cost in 2010 (due to a great deal of by-product credits of gold-lead-zinc), its complete cost per ounce was $17.84 using my formula. When someone asks me how much it cost for Hecla to produce an ounce of silver in 2010….it’s closer to $17.84 than it is to -$1.46. If the average price of silver had fallen below $17.84 an ounce in 2010 and each mining companies’ production costs remained the same, Hecla, Revett Minerals and US Silver would all have shown losses instead of profits. Fresnillo had a much larger margin due to its huge volume of high grade silver production that it could have absorbed much lower silver prices.

There seems to be a correlation between production volume and cost. The more volume, the lower the complete cost. If many of the silver bears had their way and the price of silver remained below an average of $15 an ounce in 2010, mining companies can’t stay in business giving away silver at a loss. This is the same situation in the oil business. Tar Sands at a production expense of $80+ a barrel cost a great deal more to produce than Saudi oil at $20 a barrel (in 2007 dollars). If the price of oil falls below $80 and stays there for quite some time, Canadian Tar Sands would be one of the first operations to cease production. Price destruction = Supply destruction. Below are the silver production figures for the 4 mines used in my graphs:

2010 SILVER PRODUCTION FIGURES

Fresnillo = 35.8 million oz
Hecla = 10.5 million oz
US Silver = 2.3 million oz
Revett Minerals = 1.0 million oz

Three of the four primary silver mines listed above are located in the U.S. which accounted for 36% of total domestic silver production in 2010. Again, if the average price of silver remained below $17.50 an ounce in 2010, three U.S. silver miners would more than likely have suffered losses rather than profits.

I hope this gives the investor a better idea of complete costs of mining silver. For all of you who think that it costs more to mine silver in the U.S. than it does in Mexico and South America….I give you Coeur ‘d Alene. In 2010, the majority of Coeur’s silver production came from Mexico, Argentina and Bolivia. In 2010, Coeur ‘d Alene had a net income of -$91.3 million. That’s right a negative 91.3 million clams.

DISCLAIMER & FINAL THOUGHTS

Any of you who think you can take my complete cost figures and try to tell others that so and so mining companies’ cash costs are bogus, need to read my disclaimer. My formula above is a common sense approach to finding out what a “next to best complete cost” to mine an ounce of silver for each mining company. It is not a precise science. There are a lot of variables that are not included. What it is…is a guideline to show a complete cost picture rather than what the industry touts as CASH COSTS….which to me are totally meaningless.

That being said…..I plan on doing a 2011 Q1 update to show that even though complete costs are rising, profits are rising even faster. For example, using my formula Hecla had an increase of a complete cost per ounce of $21.59 for silver in Q1 2011 compared to $17.84 in 2010. With the average price of silver in Q1 being $31.66, Hecla has more than a $10 net profit per ounce….or a whopping 31.8% net return after all costs compared to only 11.5% in all of 2010.

One of the reasons why I write these posts is due to what I refer to as ANAL-ISTS rubbish. This is what I term as ANALYSTS gone bad. There are several of these on my list. I will come out in this post and say that Ned Schmidt has been one of my favorites on this list. Ned put together a chart on what he thought was a FAIR VALUE for silver. I might reproduce his chart in a future post when I feel like presenting “THE OTHER SIDE OF THE STORY”. Ned Schmidt gave a fair value of silver in JAN-FEB 2011 of $15.42 an ounce. He also stated that it was OVERVALUED at $20.04.

I believe I proved that if silver was anywhere near $15 an ounce, several mining companies would have suffered big losses. I sometimes wonder the motivation of so called gold and silver analysts who offer such splendid advice and forecasts.

Lastly…I mostly enjoy writing these posts to help educate others. I believe a better informed investor makes better decisions. Because these posts take a great deal of time to put together, I would really enjoy seeing your comments…either pro or con. I imagine a great deal of the readers may never leave a comment…but I would just like to know if this work has had some benefit to the reader.

28 comments:

  1. So my original question was a good one and has now been answered. I remember that certain persons ridiculed my question when I asked if anyone knows the cost of producing an ounce of Silver.

    This is a very good detailed analysis and puts the "price" of Silver in perspective.
    Now I wonder what the "cost" of producing an ounce of Gold is? We would then be able to judge how far Silver could rise in price relative to its production cost.

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  2. thank you so much for taking the time and expertise to share the above post; being a writer myself it's always nice to be appreciated :)

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  3. Great post! Articles dwelling into the fundamentals are the best (only?) way in keeping perspective on lt investments. What are the average costs of mining Gold, how what is the minig vs price_per_ounce ratio comparision between gold and silver?

    Alot of silver bears like to claim that silver only costs 5$ an ounce to mine so it should never be selling for 50$ an ounce. If such logic were valid then crude prices should be selling for less than half the current price just because it only costs 20$ to extract it from Middle East and Russia, and totally ignore the the proven reserves, production capacity and supply vs demand scenarios.

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  6. Hecla lost it's ass of derivatives so not a good base case but the point is valid and well presented. GW SGS

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  7. Jasper...hecla lost $20.76 million on its derviatives according to their 10-k. If we did add this to their true earnings of 35 million. we would get about $56 million. Don't forget...I took their NET INCOME and not their INCOME THAT CORRESPONDS TO SHAREHOLDERS. Hecla paid their shareholders $13.6 million in 2010. That is a cost that I did not include...but be that as it may if we take that $20.76 million derivative loss and add it we get the $56 million.

    $56 million / $418 million = 13.4%
    100%-13.4% = 86.6%
    86.6% X $20.16 = $18.24 COMPLETE CASH COST

    So their big derivative HIT did not change the bottom line all that much did it Japer? Furthermore, if Hecla's Management staff is going to be that reckless in betting on Derivaties, then by all means it should affect their price of silver profitability.

    If a native tribe sues a mining company and wins $25 million....hell it comes out of PROFITS doesn't it?? Whatever the losses goes against the cost to produce silver

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  8. I must say, I enjoy life too much for this fundamental news. The people that follow it put money down, no? They are showing their positions, no? It shows up in the bars/candles,no? All you fundamentalists read all these reports...your boys will show it in the charts that I will trade from.
    Keep looking at the "fund"-u-mentals. I read them & let the bars take them in stride.

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  9. http://etfdailynews.com/2011/07/25/investors-the-1-billion-armageddon-trade-placed-against-the-united-states/

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  10. I feel like say thank you even before reading it (i first give a global look to the post & read the final)
    Grazie anche dall'Italia!

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  11. when silver is in high enough dealer demand and it is an investment asset desired by all Chinese, Europeans and americans, every day, then it can rise to the multiple above mining cost that oil has, because the mines are as rare and no environmentalists are going to let you open a galena/lead mine in their backyard. so oil can go to 120 per barrel spot with 20/barrel mining cost, then silver will go to $120 an ounce also! In terms of populace demand every day in every city China is halfway there, Europeans are one tenth of the way, and Americans are just beginning to awaken. THERE IS NO BULLION DEALER at all in my city of 1 million people. NONE AT ALL. Anyone want to go into business with me, I have the customers, but I just need 60 days working capital...

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  12. @SRSrocco, Thanks a lot for this. Puts a lot into perspective and could eliminate a lot of debate. Maybe you could forward this to Robo Trader.

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  13. honest info is ALWAYS appreciated...it is rare to come by...which means you do not have an agenda...other then to help others..again a rarity

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  14. Ledbedder...you bring up a valid point worth discussing. Traders can and will trade a price up as well as down. Management of mining companies are bound by their shareholders to go by the fundamentals of producing profits.

    Furthermore, the notion that fundamental bets are priced in the trading candlesticks is a nice one in a free market...which we don't have.

    Lastly, those fundamental bets in Enron and Bear Stearns became totally worthless within a very short period of time when their stock plummeted to basically zero. The whole market has been mispriced like Enron.

    I do not put a whole lot of faith in any of it except physical.

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  15. Thank you, SGS, for posting this article.

    SRSrocco--First and foremost, thank you for your efforts in helping to keep us better informed. I am not a trader but I am invested in mining stocks and it is very helpful to have an understanding how the production cost work. I never realized how much more was behind the "Cash cost" until now. Thank you for, what appears to be, an unbiased analysis of these companies. Looking forward to your bit of truth.

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  16. @SRS: If you looked at the charts of the above mentioned companies, they were telling that all was not right. I looked at them after the fact (I'm not a stock guy), but they kept breaking technicals over & over again. I will admit, I wouldn't have traded them down as far as they went, but if I did catch their breakdown, I would have been buying alot of puts. As far as having the actual stuff in hand, I agree completely.

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  17. This is great info SRSrocco. Thanks for your time.

    From this I would say the likelihood of a hit below or near $20 oz is low. Although TPTB are obviously fuckwits anyway, so there's no telling. It would be a helluva buying opp.

    Just shows even further how good value silver still is at $40. Anything between $20 and $40 is effectively a steal.

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  18. I was calling out your whiny tone, georgesilver. That's what, not the question, you dweebster.

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  19. How do you know that the "whiny tone" isn't just a figment of your own imagination? After all, this is written word and there's no voice inflection to determine what george's tone was. Not picking a fight...just sayin'...

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  20. Folks...I appreciate the comments. Trying to get to the bottom of a vague system of pricing silver has been a long term goal of mine. It took some time to figure out what would be a more appropriate system.

    Ledbedder....what you stated about the precious metal stocks does seem correct at first glance. The so called "CONTINUED BREAKDOWN" of the mining stock technicals may have occured due to factors beyond their control. How?

    Gata -Gold Anti Trust Action Committee proved that back in late 1990's and early 2000 the US GOVT put forth laws and regulations to siphon money into Derivatives rather than physical assets. The past 11 years has been DEATH on the producers of the country due to this reason.

    Precious Metal Mining Companies are producing "REAL FRICKEN MONEY" fer pete sakes. They are the Banks of the world. They are the ones that are creating money...not the stupid FED or memember banks. They are creating debt and an increasing unstable financial system.

    The only BEEF I have with the majority of CEO'S of mining companies is how they treat their mines. They produce their mines like they were BASE METAL MINES instead of PRECIOUS METAL MINES. As Jim Sinciar states, a proper CEO would mine their low grade ore when the price of the metal goes higher, and their high grade ore when the price drops.

    Today, these CEO's are trying to extract the metals at the lowest cost and as quick as possible. This is the way of mining copper, not silver or gold.

    Furthermore...the price of the metals has been kept artifically low as well as the price of mining stocks. So much money has been siphoned into the biggest PONZI SCHEME in history that when it finally IMPLODES, it will destroy the system itself.

    We can't blame the mining stocks performance that take place in such a manipulated market. Its funny that David Morgan has finally come around and admitted that the SLV may be manipulated. Good Grief.

    I plan on doing a follow up GUEST POST on this subject soon as there are many more facets that need to be discussed.

    Again...the comments, questions and replies are appreciated.

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  21. @paidingold

    You are not even worth ignoring.

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  22. Add in the cost of purchasing silver-bearing land? no matter how high the price of silver goes I won't be able to dig up any silver on my property, because there isn't any here. The cost of digging up silver can only go up, as the easy-to-get silver has already been found. As companies go deeper and run out of silver the price to mine will keep going up, and as demand rises the people will be bidding up the actual price of silver. Silver Eagle rolls were going for $400 a year ago, now they are pushing $900+.

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  23. WORD IS FINALLY GETTING OUT

    One of the important reasons for writing this post was to put a PHAT HOLE in what other analysts call SILVER FAIR VALUE at $15.60 an ounce. What is so Ironic is the fact that Ned Schmidt who I specifically wrote about at the end of my post just did an update on his FAIR VALUE of silver which is still a STRONG SELL.

    He did this in his new article "GOLD WORSHIP & DONUTS". Ned states that according to him, Donuts are a better value than gold...LOL

    I submitted it to Nadeem over at Market Oracle, but thought he would never link my post here on his website due to the negative nature on Ned Schmidt. Well guess what?? He just posted the article on Market Oracle.

    First here is NED SCHMIDT...you have to take a look at this CLOWNs article:

    GOLD WORSHIP and DONUTS
    http://www.marketoracle.co.uk/Article29580.html

    THE COMPLETE COSTS OF MINING SILVER
    http://www.marketoracle.co.uk/Article29591.html

    SGS was kind enough to allow this post to get as much coverage before new posts were put in. I am glad that many investors as possible will understand that silver's FAIR VALUE is no where near $15

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  24. take cover, the machetes are out from starting gate, wow! down 16 in gold and 75 in silver in minutes.

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  25. Good let them sell it, I will be silently accumulating a small army of Jan 2012 calls.

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  26. @SRSrocco - congrats! You have been published!

    Great write-up!

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  27. @SRSrocco

    Thank you for taking the effort to put forward a straightforward and honest look at an oft debated question.

    It makes one wonder why the mainstream does not do this, which of course leads us to question their motivation and their role as purveyors of information.

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