Riding The Silver Bullet
September 22, 2011 by Brien Lundin
Silver investments are becoming increasingly attractive in an uncertain economy. With good timing and the right strategy, you could reap huge profits on the expected gains in silver.
As an investment tool, silver enjoys unique advantages. In its dual role as both an industrial commodity and a monetary asset, silver’s impressive industrial qualities make it more than just another shiny metal. Its malleability, ductility and sensitivity to light ensure its value in a variety of industrial, medical, decorative and monetary applications.
Silver is used to make ball bearings for jet engines and electrical switches of all types, and it is used as a soldering material. Many plastic-manufacturing processes require silver as a catalyst, and it forms an essential component of corrosion-resistant batteries and solar panels. In the medical field, silver serves as both an ingredient in diagnostic imaging procedures and as an antibacterial agent.
Profitable Supply Gap
The consistent gap between silver mine production and silver demand represents an essential fact that continues to drive the bullish silver market. This gap, which began about a decade ago, arises because most silver is mined and extracted as a byproduct of zinc, lead and gold operations. The fact that the amount of silver needed for industrial processes consistently outstrips the amount that is mined means old silver scrap and net government sales are continually necessary to close the gap between supply and demand.
Fortuitously for future silver investors, the supply of silver scrap, while plentiful, is finite. Since silver is annually drawn from government sales and scrap to fulfill the demand for the popular metal, the available scrap supply keeps diminishing. Consequently, the gap between what mines can produce and the fabrication demand for silver has recently kept silver prices at the high end of historical levels.
A look at the recent history of silver prices shows that they have moved up in concert with gold, but silver’s wide range of practical uses offers an upside sensitive to both a strong economy and the inflationary pressures from economic growth and loose monetary policies.
The economic recovery of the past two years, centered in continuing strong growth in China, has pushed silver prices up significantly. In silver’s favor is its relative low profile in the overall cost of most of the industrial processes that involve this metal. Silver’s unique properties make it an indispensable ingredient in many of these applications, so there’s no adequate substitute. Therefore, manufacturers are resigned to paying the asking price for silver.
Playing The Silver Market
The best way to play silver is to employ a three-tiered approach that combines the leverage-generating power of options and equities with the safety of physical silver. This “Silver Bullet Strategy” incorporates the best features of the options, the physical and the equities market for silver.
In using options, you can invest in Comex (Commodity Exchange) silver options to gain big leverage with limited risk. This entails buying a long-dated silver call option and simultaneously selling a similarly dated call option at a strike price at least $4 per ounce higher. This strategy is the equivalent of owning a “mini hedge fund” in silver. It allows you to profit from an advance in silver prices but limits your losses in a retreating market.
In playing silver, you should also have a position in physical silver. This is best accomplished by purchasing United States 90 percent silver coins, known as “bag silver.” These bags are typically traded in increments of $1,000 in face value and come in denominations of either 10,000 dimes, 4,000 quarters or 2,000 half dollars. In these purchases you receive silver coinage (90 percent silver, minted before 1965) with a circulation value of $1,000. Each bag contains 715 ounces of pure silver.
Building A Silver Stock Portfolio
Building a portfolio of companies that explore for or produce silver can deliver substantial leverage on rising silver prices. The most promising silver recommendations in the junior mining space include:
Great Panther Silver (GPL: Amex; GPR.TO; $3.31) is a fast-growing company that owns two operating mines in Mexico: the Topia and Guanajuato mines. The properties are 100 percent owned and have no lingering royalty concerns.
In 2010, Great Panther generated $5 million in net income at a low cash cost of $6.50 to $7.50 per ounce of silver. With 71 percent of revenues coming from silver production (and the balance coming from gold, lead and zinc), Great Panther definitely qualifies as a primary silver producer.
As a growth-focused company, Great Panther has turned in four straight years of production growth, a period of time that included the huge economic downturn of 2008 and 2009.
The company’s latest avenue for growth is the San Ignacio Mine, an offshoot of its Guanajuato operations. The company is looking to increase production at both its Topia and Guanajuato mines to 3.8 million silver-equivalent ounces by 2012. Its low operating expenses, combined with sky-high silver prices, should produce substantial profits.
The company’s three-year, $57 million capital expenditure program will be entirely financed by cash flow from Topia and Guanajuato. It’s a strong buy at or near current levels.
South American Silver (SAC.TO; SOHAF.PK; C$1.94) lays claim to one of the world’s largest undeveloped silver-indium deposits.
Its flagship Malku Khota deposit in Bolivia boasts 230 million ounces of measured and indicated silver and another 140 million ounces of inferred silver, for a combined silver hoard of 370 million ounces.
A recently updated Preliminary Economic Assessment on Malku Khota projects the deposit there can deliver a pre-tax net present value (NPV) at a 5 percent discount rate of $704 million and an internal rate of return (IRR) of 37.7 percent. These are eye-popping numbers — which is even more impressive when you consider that they use very conservative, base case metals prices of $18 per ounce of silver and $500 per kilogram of indium. But if you take into account recent silver prices of $35 per ounce for silver, those numbers balloon to a pre-tax NPV (at 5 percent) of $2.571 billion.
Since the company currently trades at a market capitalization of around C$234.6 million, South American Silver offers huge upside potential. Even getting valued at the “base case” NPV projection would deliver almost a triple on its current share price.
Perceived political risk in Bolivia has held back the company’s share price. But that perceived risk has created an unprecedented buying opportunity. Silver deposits this large in a dynamic silver market make this company significantly underpriced. Eventually, the market will realize that Bolivia cannot afford to turn away foreign investment. And as the perceived political risk dissipates, early investors in this large silver project should reap lucrative returns.
The savvy investor recognizes that silver offers the promise of huge profits. For 17 consecutive years, silver demand has outstripped supply: The cumulative supply deficit in silver tops 1.75 billion ounces. In fact, silver almost always outperforms gold in bull markets. So if you’re looking for a relatively inexpensive way to take advantage of today’s shaky economic times, an investment in silver offers a relatively cheap investment that can pay big returns.
All that glitters isn’t gold! In fact some of the most profitable opportunities for precious metals investors can be found in silver. In my complete Silver Bullet Strategy Report, I’ll reveal why I think “poor man’s gold” is the best investment in today’s turbulent and uncertain markets… plus give you six rock-solid reasons to start investing in silver today… as well as reveal three simple silver strategies that have the potential to make you a killing! Claim my FREE Silver Bullet Strategy Report and I’ll send you my periodic Golden Opportunities e-newsletter where I share some of the best market intelligence, tips and red-hot opportunities that cross my desk.
— Brien Lundin • Editor, Gold Newsletter