Saturday, October 31, 2015

A Long-Term Look At A Few Precious Metals Miners

In my last article published at Seeking Alpha I have presented two companies (Fresnillo and Randgold), which are worth investing in the long-term. I have also presented two miners not worth investing.

Below you will find a supplement to this article. These charts show the relative strength of each miner's shares against the sector average (expressed in GDX - an ETH holding big miners shares):

How to read these charts? Let me explain using Randgold as an example.

On May 27, 2008 GDX was trading at $44.7 per share. Today (October 30, 2015) these shares are trading at $14.96 so between May 27, 2008 and October 30, 2015 they went down by 66.5%.

As for Randgold:
On May 27, 2008 Randgold (GOLD) was trading at $41.59 per share. Today (October 30, 2015) these shares are trading at $66.87 so between May 27, 2008 and October 30, 2015 they went up by 60.8% (yes, despite the ongoing bear market in gold, which started in 2011, Randgold has been quite a good investment).

Next, $100 invested in GDX in May 2008 today is worth only $33.5, while $100 invested in Randgold is worth $160.8 today. So the value of investment in Randgold is higher from the investment in GDX by a factor of 4.8.

This is what the second chart shows. Since May 2008 Randgold has been appreciating against GDX and today its value is higher than value of GDX by a factor of around 4.8.

The behavior of Fresnillo is similar to Randgold,

On the other hand, AngloGold Ashanti and Barrick Gold have been losers against GDX (and in nominal figures as well).

Sunday, October 25, 2015

Alphabet (former Google) or Intel - An Alternative Look At Investing

Alphabet (former Google) is an excellent business. Year to year, quarter to quarter, the company improves its financial results. Please, look at the chart below:

Of course, due to the fact that now the scale of the Alphabet's business is much bigger than it used to be a few years ago, its revenue, operating profit and cash flow from operations are not growing as much as a few years ago - please, look at another chart:

 In my opinion, one of the best metrics to measure how the investment in any company is performing is the so-called free cash flow. Simply put, free cash flow is a difference between cash flow from operations and investment made by a company. My formula goes as follows:

Free Cash Flow = Cash Flow From Operations - Purchases of Property And Equipment - Acquisitions

I have calculated combined free cash flow for Alphabet and Intel, starting from 2009. For many years there was practically no inflation therefore adding up all free cash flows generated each year  is not a big error (although it is a little bit unorthodox way of an investment's performance measurement).

Then I compared the combined free cash flow to the value of investment in 2008, calculated as the market capitalization at the end of 2008. Therefore the ratio defined as:

Combined free cash flow / Market cap

shows how much cash an investor would get for its initial investment after nearly 7 years of holding the shares of Intel or Alphabet.

Please, look at the chart below:

This chart shows that an investor putting his/her money in Intel would get 86% of its investment back. As for Alphabet, this ratio would be much lower - just 25%. Let me show it, using figures.

At the end of 2008 the Intel's market capitalization was $58.6 billion. Then, between 2009 and 3Q 2015 the company generated free cash flow of $50.6 billion - hence the ratio of 0.86.

In the case of Alphabet , these figures were: $216.4 billion, $54.3 billion and 0.25, respectively.


Both businesses, Intel and Alphabet, are excellent ones. However, from an investor's point of view, Intel looks much better than Alphabet. Simply put, at the end of 2008 Intel was relatively much cheaper than Alphabet.

What is more, the Intel's shareholders were rewarded with a 204% gain, while the Alphabet's shareholders booked a gain of "just" 103%.

Friday, October 16, 2015

Crash Alert - U.S. Equities And Skew Index

Last year I presented one of the less known indicators - Skew Index. To remind my readers:

Skew Index is a risk measure  (quite different from the popular VIX index) daily-published by the CBOE. Without details (for those interested the details are here) this index measures the risk of a very rare market event, e.g. stock market crash or another black swan event.

Yesterday Skew Index hit its record high. Please, look at the chart below:

Well, such a high indication does not mean that we will see an instant outcome. However, Skew Index "says" - "Be extremely careful with US equities now"

Thursday, October 15, 2015

IMPACT Silver - Cheap Stocks But Fundamentals Are Not Impressive

IMPACT Silver Corp. (OTC: ISVLF) is a small silver producer, operating four mines across the two districts located in South-Central Mexico. In 2006 the company started producing silver and this year it expects to produce 1 million ounces of silver. Unfortunately, though in the short-term the production growth is quite impressive, IMPACT is a high-cost producer. In this article I would like to present a short description of the company and to prove my thesis on high production costs.

Business description

IMPACT is organized into two the so-called production centers: Guadalupe Production Center and Capire Production Center. Of these centers, silver and other metals are extracted only at Guadalupe - the Capire Production Center, consisting of a 200-ton-per day pilot processing facility and the Capire Mine, has been suspended until market conditions improve.
Guadalupe Production Center
Guadalupe, acquired by IMPACT in 2006, consists of a 500-ton-per day processing facility fed by three underground mines:
-    Cuchara-Oscar – it started its operations in 2013. Now, the mine is a principal producing operationdelivering a silver-zinc-lead feed.
-          San Ramon – this mine was opened in 2008. In 2014 the company discovered new high grade silver zones at San Ramon, located below the current production zone.
-          Mirasol – it is the newest mine in the company’s mineral portfolio (it started its operations in the third quarter of 2014). Currently the mine is ramping up its production.

The company’s strategy

IMPACT, well aware of the current gloomy situation in the precious metals market, tries to focus itself on extracting metals from high grade zones, where costs of production should be lower. The last discovery at San Ramon plus opening the new, high grade Mirasol mine contribute to the company’s strategy – please, look at the chart below:

As the chart shows, the average silver grades have gone up significantly since 2013, with the highest increase taking place between 2014 and 1H 2015 (an increase of 16.4%, from 159 gram per ton to 185 gram per ton).
What is more, since 2012 the IMPACT’s silver production has been also going up. The chart below supports this thesis:

However, looking at the company’s silver production in the long term, it is easily spotted that between 2008 and 2014 the annual output was rather stagnant, within a range of 636 thousand (2008) and 834 thousand ounces (2011). This year IMPACT expects to produce around 1 million ounces of silver – if the company succeeds, it would be the highest output in its history, indeed.
1 million ounces of silver is quite a large amount of this metal, at least for the small company as IMPACT. However, there is one technical constraint. In 1H 2015 the company was processing 460 tons of ore per day, which was close to the full mill capacity (500 tons per day). To produce larger amounts of silver, IMPACT will have to increase its capacity or implement other solutions, for example a mill located at Capire (this mill has a capacity of 200 ton per day). I am not sure whether the Capire mill is suitable for Guadalupe because the Capire mine, in contrast to Guadalupe, is an open pit mine, where the processing method may be different. Anyway, if IMPACT wants to increase its output it will surely have to introduce some changes to its business model. If such is a case, an additional investment could be needed (for example, constructing a new mill or increasing the capacity of the existing facility).

Production costs

Now, the most important thing. Despite higher output and higher ore grade, the company is still unprofitable. What is more, IMPACT has a different cost reporting philosophy than its peers. A vast majority of mining companies report their cash costs on a per-ounce basis. IMPACT does not report its cash costs at all. The only metric the company provides is the direct costs per ton of ore produced. Therefore it is possible to calculate the accounting costs of production on a per-ton of ore basis. However, it is not possible to find in what way these costs refer to the prices of silver. As a result, it is impossible to find at what silver prices the company’s business is profitable. Additionally, the company’s final product is a concentrate (zinc - silver and silver – lead). IMPACT, reporting the amount of ore sold, reports an artificial thing – the company is selling concentrate, not ore. Let me dig a little bit deeper into this matter. In two sections below I am using the company’s metric to present the costs of production and then I am trying to estimate, using my own methodology, at what silver prices the company could be profitable.

Note: if somebody does not feel good about basic math, please, go directly to the final section of this article (Summary).

The company’s metric

Through reporting the direct costs per ton of ore sold, no matter how artificial this measure is, IMPACT provides the most important figure – the amount of ore sold. Therefore it is possible to find out whether the company is making money on its ore or it does not. For example, in 1H 2015 IMPACT sold 85,392 tons of ore, which, having in mind that the company’s half year revenue was $6,647 thousand, means that the company got $77.84 per ton of ore sold. Then, to produce these 85,392 tons of ore, the company incurred the accounting costs of $8,107 thousand (accounting costs are defined as operating costs less impairment expenses), which is attributable to $94.94 per ton of ore sold. The difference between revenue and costs per ton is $17.1. This figure should be read as: “In 1H 2015 IMPACT was losing $17.1 on each ton of ore sold”. The chart below shows revenue and costs per ton of ore sold since 2011. It is easily seen that since 2013 the accounting costs have been higher than revenue – IMPACT has been losing money since then.

The picture above is telling quite much about the company’s economics but it does not provide any clue at what price of silver the company could be profitable. To answer that question I will use my own methodology.

My metric

Each quarter the company reports the amounts of silver, zinc, lead and gold sold in its concentrates. Therefore it is possible to calculate the amount of the so-called silver equivalents sold.
First of all, it is the standard in the precious metals sector that refiners pay the miners for metals extracted from concentrate using market prices of these metals. Therefore I think it will be correct if I calculate silver equivalent ounces using the average prices at which silver, lead, zinc and gold were traded in each analyzed period. Let me calculate this figure using 1H 2015 data.
In 1H 2015 IMPACT sold 450,370 ounces of silver, 225 tons of lead, 136 tons of zinc and 288 ounces of gold. The average prices of these metals were $16.57 per ounce of silver, $1,873 per ton of lead, $2,134 per ton of zinc and $1,206 per ounce of gold. After multiplying the amount of each metal sold by its price I am able to find that in 1H 2015 the company’s revenue obtained for each metal was as follows:

  • Silver: $7,463 thousand
  • Lead: $421 thousand
  • Zinc: $290 thousand
  • Gold: $347 thousand

To find the number of silver equivalents ounces sold in 1H 2015 I have to divide the revenue obtained for each metal (except silver) by the average price of silver in that period. After doing this math and summing up all silver equivalent ounces attributable to each metal (plus silver ounces sold) I find that in 1H 2015 the company sold 514,284 ounces of silver equivalent. Having that figure I may calculate production costs on a per-ounce basis.

As I mentioned in the section above, in 1H 2015 the company incurred accounting costs of production of $8,107 thousand, which means $15.76 per ounce of silver equivalent.
However, there is a catch because this figure does not take into account the refining charges paid by IMPACT to refiners for treating its concentrate. Simply put, any mining company producing concentrates, instead of dorĂ©, has to deliver its concentrate to the specialized companies (refiners). Refiners, carrying out the complex chemical processing, are able to convert a concentrate into the highest quality precious metals bars. This process costs money, which is paid by the mining company according to the industry standards. Basically, the refiner is paid for the previously agreed amounts of metal contained in the concentrate plus some additional fees paid for excessive impurities. The vast majority of mining companies report these charges but IMPACT, unfortunately, is an exception to this rule. The company confirms that its revenue is reported as net revenue (refer to “Significant accounting policies” in each annual report):

“Refining charges are netted against revenue for sales of metal concentrates.”

However it does not go into specifics about these charges. Fortunately, there is a way to cope with that lack of information. According to its financial statements, in 1H 2015 IMPACT had revenue of $6,647 thousand, which is attributable to $12.92 per ounce of silver equivalent (revenue divided by the number of silver equivalent ounces sold). Since in 1H 2015 the average price of silver was $16.57 per ounce of silver, the difference between this price and the price got by the company ($12.92) is the theoretical refining charge ($3.65 per ounce of silver equivalent). Therefore the overall cost of production is $19.41 per ounce of silver equivalent (accounting cost of $15.76 plus the refining charge of 3.65 per ounce of silver equivalent). The chart below evidences gross production costs against silver prices, since 2009:


As the chart shows, IMPACT is a high cost producer. For example, in 1H 2015 its production costs were $19.41 per ounce of silver equivalent, much above the average price of silver in that period. What is more, despite heavy investment expenditures, the company has made nearly no progress in its business Let me show it using a few figures.

Since 2009, when the last bull market in the precious metals had started, IMPACT generated $19.5 million from its operations. This cash flow was delivered mainly between 2009 and 2011, then, when silver prices started to fall, cash flow from operations followed them.
Next thing, since 2009 the company had invested in its business $48.1 million, which was $28.6 million more than the company obtained from its mining operations. Most of this negative gap had been covered through new share offerings ($25.5 million obtained mostly in 2010 and 2011).
Summarizing, since 2009 the company has invested a lot of money in its business. Most of this investment program was financed by the company’s shareholders. However, the result of this heavy investment and shareholder’s effort is miserable. IMPACT is still producing silver at very high cost and, what is more, in the long term the company’s output is not impressive at all. For example, in 2014 the company produced 725.7 thousand ounces of silver, much less than in 2009 (823.6 thousand ounces). Although IMPACT has strong balance (nearly no debt), its business is going to stay depressed, even at higher silver prices.

Last but not least – the company’s reporting is, in my opinion, under the industry standards. To find the most vital figures, as, for example, production costs, one have to dig very deeply, I think too deeply.

Friday, October 9, 2015

Precious Metals Sector Looks Better But Something Is Still Missing

Most recently precious metals shares have gone quite substantially. For example, GDX (the ETF comprising the big miners shares) increased its price by 28.8% in comparison to its bottom established in September 2015. Many other miners and juniors followed GDX.
However, the whole picture is still not bright - please, look at the chart below:

As the chart shows, big miners are still stronger than juniors, which is definitely not a bullish pattern. During the typical bull market in gold, juniors should be stronger than big miners.

On the other hand, this could be a trap. Since 2012 the entire precious market sector has been out of fashion. At this stage probably more money goes to less risky investment - and in the case of PM market, big miners are less risky. So who knows...

Another chart:

Most recently the PM shares hit another record low against the broad market (represented by S&P 500). From a contrarian point of view, it could be a buying opportunity once again.