Is Silver Worth A Play During The Commodity Rout?

The impressive commodities bull market of the 2000s has been followed by an equally remarkable crash. Commodities across the board have hit hard as the USD has rallied versus other currencies while the rapid increase in Chinese raw material demand has softened. For the time being it appears this trend will continue. Fortunately, the supply of many commodities – excluding natural gas and oil – is slowing or declining. Although the supply dynamic is positive and the Euro has already fallen dramatically, there could be more downside ahead, especially in the short term. It would not be surprising, for example, to see the Euro dip below parity with the USD or to see Chinese growth slow further before this cycle ends.

Assuming the end of the commodities downturn is not far away, this is a good time to scout out opportunities in this sector. One commodity which does not get significant attention – at least versus its big brother – is silver. While gold has dropped roughly 45 percent from its peak in 2011, silver has plummeted approximately 70 percent. Historically the latter has been much more volatile than the former and the current cycle has been no exception. Given this historic volatility, there is an excellent probability that when this cycle ends, the prospects for silver will be better than those of gold. Worth noting is that silver has a potential positive tailwind due to the high projected growth rates in industrial markets such as solar energy, water purification, medical devices, and nanotech.

Last summer Phil participated in a Yukon Territory mining tour. One mine he visited was Alexco’s (AXR – TSX) idled Keno Hill silver project. This enterprise has been on our radar for a few years due to its balance sheet strength, location in a mining-friendly jurisdiction, and environmental reclamation business. The Keno Hill region has been mined sporadically for over a century and unlike many operators in the Yukon, AXR has the necessary infrastructure in place with their mill, roads, and power to fire up operations quickly when the market turns. In addition to this, the indicated resource is over 55 million ounces, three mines are fully permitted with another underway, and the estimated all-in sustaining cost is a reasonable $15.00. Albeit, that is higher than current lowly price of silver.

As an added bonus, Alexco’s environmental reclamation business has continued to produce revenue since the mining operation was idled in 2013, and provides the corporation with another sales stream, which offers it a significant advantage over other miners during these tough times. Going forward, the goal is to grow this throughout North America. The money in the kitty and the fact that the corporation has no debt will help.

However, there are caveats associated with a small company like this. Investors must beware the risk of dilution or draconian debt financing. In December, management closed a $4 million flow-through equity financing agreement and a $960,000 non-brokered equity financing agreement, which increased the share count by 5.78 million shares to a fully diluted share count of about 84 million shares. Overall the terms of this transaction are decent but further dealings of this nature cannot be ruled out, especially if the commodity downdraft continues or if mine restart costs are higher than the initial estimates of roughly $10 million.

While we like Alexco and think that when the market turns this could be a $5.00 + stock again (which is where it traded in 2012), the average daily trading volumes are nominal at about 50,000 shares a day. That combined with a stock price of around $0.50 makes buying a substantial number of shares difficult. Still Alexco may make a good investment for an individual investor who is not constrained by a low trading volume and who has both a strong stomach along with the patience necessary to stick with a small cap company in the resource sector during a bear market.

If Alexco is too small to catch your fancy, there are bigger silver companies out there that we have our eye on. These companies include Endeavour Silver, First Majestic Silver, Pan American Silver, and Standard Silver Resources. In our estimation, these companies should also do well when the fortunes for silver turn. Part of the assumption, though, is that the slump will not last too many more years, and if it does, many enterprises in this sector will succumb. However, all of these have a reasonable chance of survival, proven operational track records and well-defined resources. A couple other options for people intrigued by this arena are silver ETFs and/or purchasing the underlying commodity, but in all likelihood equities should do better than commodities when the market turns.

Normally in this space, Benj writes about companies that he already owns. That is not the case here and it will be interesting to see if some of these stocks make it into the Contra portfolio. Meanwhile, for those looking for a pretty much guaranteed return on investment, a trip to the Yukon during the sunny season is spectacular.

 Phil McKellar joined the Contra team on a part-time basis in 2011 and has been investing since the early 2000s. He has been with Contra full time since 2014, before which he was a financial advisor for Freedom 55 Financial and an analyst at New Energy Finance in the United Kingdom.

More recently, he was an analyst at Sustainalytics, where he assessed the environmental, social and governance dimensions for forestry, mining, steel, and utility companies.

Benj Gallander, MBA, Co-editor of "Contra the Heard", Toronto, ON (416) 354-2458, gall@pathcom.com, www.contratheheard.com