SILVER COSTS: Much Higher Than Most Realize

There still seems to be huge misunderstanding by many investors as to what it really costs to mine silver.  I still come across individuals and analysts who believe the price of silver is overvalued because it is so cheap to mine the metal.  Part of the reason for this FALLACY, especially from bearish silver analysts, is due to the reporting of CASH COSTS.
It doesn’t matter which mining company report you look at, just about all of them list what their cash cost is to produce their main metal.  Furthermore, the Silver Institute lists the primary silver miner’s cash cost per ounce from the Annual World Silver Survey on its website for all to see.

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From The SRSRoccoReport:

According to the Silver Institute:

Primary silver mine supply grew by 1 percent to account for 28 percent of global silver mine output. Mexico was the world’s largest silver producing country in 2012, followed by China, Peru, Australia and Russia. Primary silver mine cash costs rose to $8.88 an ounce, reflecting higher prices for labor, electricity, and maintenance charges.

So, it seems as if the primary miners produced silver at $8.88 cash cost an ounce in 2012.  This was up over 2011.  Here are the cash cost figures for the past 3 years (World Silver Survey’s, Silver Institute & Kitco):

2010 = $5.47   (avg. spot price = $20.19)

2011 = $8.11  (avg. spot price = $35.12

2012 = $8.88  (avg. spot price = $31.15)

With low cash costs such as these, the silver miners should be raking in the dough and stating huge profits.  However, a percentage of these primary silver miners are actually stating net income loses even at realized prices of $28-30 an ounce.

When the World Silver Survey calculates the primary silver miner’s cash cost, they only use a sample portion.  Let’s just say, this sample size is less than two-thirds of the silver produced from the primary miners.  Even though the folks (GFMS, Reuters) who publish the World Silver Survey do a good job calculating the cash cost for the primary silver mining industry, we will find out how useless it can be in determining the profitability of a mining company.

Excellon Resources Very Low Cash Cost & Net Income Loss??

I selected Excellon Resources as they are a perfect example to show how a company can state a very low silver cash cost while reporting a net income loss.  Now, I am not singling out Excellon or putting out negative information about the company, rather  Excellon is actually a pretty good company that has the highest grade silver mine in Mexico.

Let’s take a look at Excellon Resource’s Q1 2013 report on their cash cost:

According to Excellon, they produced silver at a cash cost of $6.96 an ounce in Q1 2013, up from $5.67 in the same period in 2012.  As you can see they took their cost of sales ($5,963,000) and then added back Depletion, depreciation, amortization, inventory changes and by-product credits.  Thus, they had a cash operating cost of only $2,173,000 which was divided by silver ounces produced (312,167 oz) to get their $6.96 cash cost.

With this sort of low cash cost structure, Excellon should be making excellent profits.  However, if we look at their Financial Statement for Q1 2013 we have the following:

Even, with such a low cash cost of $6.96 an ounce, Excellon stated a $601,000 net income loss for Q1, 2013 compared to a $5.6 million net gain in previous period.  If we went by Excellon’s change in cash cost year over year, this would be the result:

CASH COST Change:  $6.96 – $5.67 = +$1.29 oz

Something seems fishy.  How could Excellon’s cash cost increase only $1.29, but their net income decline more than $6 million year over year?

First… we will notice, that revenues on the top of the table declined more than $3 million.  That alone wipes off $3 million from their bottom line.

Second…. their Cost of Sales increased from $4.8 million to $5.9 million, year over year.  So, that knocks off another $1+ million of net income.

Third… if we look at their exploration cost (in blue), we will see that it increased nearly $2.8 million compared to the same quarter last year.  That erases at least another $2.5 million from their bottom line.

Without those three factors, Excellon would have shown a positive $6.5 million net income gain instead of a loss.  As you can see, Excellon’s cash cost of $6.96 does not provide the investor a clue to the profitability of the company.

The Cash Cost Disclaimer

Anytime a company reports their cash cost in their financial reports they include the following explanation (I label it as a cash cost disclaimer) of their cash cost.  This one is from Excellon’s Q1 2013 MD & A Report:

Cash operating cost, net of by-product credits, is provided as additional information as is non-IFRS measure that does not have a standardized meaning.  This measure should not be considered in isolation or as a substitute for measures of performance prepared in accordance with generally accepted accounting principles and is not necessarily indicative of operating expenses as determined under generally accepted accounting principles.

IFRS stands for International Financial Reporting Standards and GAAP is the generally accepting accounting principles.  Basically, cash costs are not indicative of operating expenses and are not in accordance with either the IFRS & GAAP.

What Caused Excellon to Lose Revenues & Profits?

So now that we know Cash Costs are bogus in determining the profitability of a company, let’s look at what happened to Excellon’s balance sheet.

If you look at the table below there are TWO BIG Culprits that destroyed Excellon’s profitability compared to the same quarter a year ago.

The first big problem was the decline in silver grade year over year.    At the top of the table you can see that the average ore grade in Q1 2013 was 591 g/t (grams/tonne) compared to 949 g/t, Q1 2012.  Not only did Excellon suffer a 38% decline in grade, the also processed an addition 1,250 tonnes of ore.  Here we can see that Excellon had higher costs to produce 125,000 less ounces of silver.

The next big hit came from their $6.30 decline in the price of silver they received shown at the bottom of the table.  I highlighted the green areas to show the zinc and lead by-product data.  We can see that zinc and lead were not part of the problem in profitability as the price of lead was the same while zinc fell half of what silver did.

Furthermore, both lead and zinc had higher production and sales.  The practice of  mining companies subtracting their by-product credits from their silver mining costs to show a LOW CASH COST obfuscates the TRUE BOTTOM LINE PICTURE.

What was Excellon’s Estimated Silver Break-Even Price

There are several ways to get to a pretty good estimated break-even price for a silver miner.   You have to use either Net Income or Adjusted income and divide it by the Silver ounce sold during the quarter.  Then you add or subtract that figure to their Realized Price that quarter.

-$601,000 / 302,466 = -$1.99

$27.60 + $1.99 = $29.59 Net Income Break-Even

So, we can see that Excellon needed $29.59 an ounce silver to break even that quarter.   This is a very simple and easy way to get an estimated break-even, however there are other more detailed methods which will be discussed in future posts.

Total costs to mine silver are much higher than the industry is putting out in their financial statements.  With the current low price of silver below $22, the majority of primary silver producers are losing a great deal of money.   According to my calculations of my top 12 silver miners only ONE is making a little money.

Even though the mining stocks have declined substantially over the past few years, once the broader stock markets collapse, money will be forced to move into hold physical assets to protect their wealth.  The mining stocks may turn out to be some of the best assets to own in the next several years.

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Comments

  1. They make their money by shorting. Doesn’t matter what these figures say, if they do the maths correctly (which they do) and they control one side of the arbitrage, then they can make money out of the short. Take a look at the COMEX OI report. We all rant on and on about these shorts being Bullion banks, no one ever takes the time to realize that the main players in shorting the COMEX are the mines. Its all a massive tax Dodge.

  2. Whats wrong with this picture? :)

  3. I’ve said it before, it is disgusting the mining sector generally is on its way to being gutted, but if it helps the market break, then bring it on. No need to keep the world on life support for the benefit of a criminal .1%.

  4. “The mining stocks may turn out to be some of the best assets to own in the next several years.”
     
    Yes, they might.  We have, however, been hearing this for years now and all these shares have done in general is get cheaper and cheaper.  Lots of investors have lost LOTS of money in these shares so far.  At some point, I fully expect them to rocket upwards in a 5-10x share price surge… maybe even more than that.  The question is, can the share buyers hang on until that happens?  Maybe.  If they buy some shares and toss them in a drawer, who knows what they might be worth in 5-10 years?  My guess is either zero or a LOT.
     

    • Mines may see increase in security costs. It will take an army to defend a gold mine when the story really breaks. Why mess with drug wars if you can just rob/take over a mine?
      Then there are oil prices. USA controls those and they have just opened up the biggest oil field since the start of oil drilling. Guess what the plan is after the Middle East has been taken offline?
      Costs for mines will rise. There are no costs to cut back on. Only exploration, and that will bite you in the behind quite quickly via bad ore grades, etc. And that also cuts into stock value. 
      I am not so sure stocks will do exceedingly well this time. A short squeeze might occur in some outstanding ones, which I suspect will be harder than ever to pick. 
      What does the stock price of a mine do when the mob or the army takes over?

    • Never fear, XCS.  I am sure that various governments will step in and, uh, partner with the miners to provide all of the security that is needed… for a fee, of course, say, half of the mine production.
       
      “Guess what the plan is after the Middle East has been taken offline?”
       
      I’ve long thought that THE plan was to buy all of the oil in the middle east, use it and store some of it, and then when it runs dry, destroy the dollar to effectively steal their oil.  THEN we can get serious about exploiting North American oil, coal, and gas… and at MUCH higher prices, in gold, silver, or other useful commodities.
       
      “I am not so sure stocks will do exceedingly well this time.”
       
      Agreed.  We have all heard the catch phrase, “this time is different”.  Well, as an investor of long experience, I can say that the current market IS different… vastly different than at any other time during my adult life.  Expecting it to work in the same way as it has in the past is not rational.  It will be different this time because it must.  There are simply too many things occurring that either never happened before or that are now happening to a MUCH greater degree than ever before.  The real question is, “How will these differences manifest themselves?”.  I wish that I knew!  Because I do not, I really like the idea of hedging my bets whenever possible.

  5. @Ed_B
    Weren’t the best oil well just put ablaze in the first gulf war?
    Now that USA doesn’t need to import oil anymore, sitting on such a sweet well up north, what better than to take out cometing supply, Goldfinger vs 007 style? Purchasing so much oil may be cumbersome with a dying currency. Look at Iran, they are accepting gold for oil. Some producers may look at that and think it may not be the worst way to be paid.
    I think now that they have the northern field online, the US is ready to set the gulf ablaze once more. Just take the whole region offline, and let prices float up “naturally”.

    • Yes, they were… by Saddam’s retreating troops.  This was a “screw you guys” message as well as a handy smokescreen to provide some withdrawal cover.
       
      As to setting the ME ablaze, no problem.  Just step back and let it happen.  Because it will.
       
      All this crap over oil occurs because it is cheap.  There are VAST amounts of methane hydrates on the sea-floor in many parts of the world. These are stable at high pressures and low temps but if they are warmed a little or the pressure is reduced, they will decompose into methane and water.  This was the slush that plugged the pipe that BP tried to use to capture and pump the oil leaking from their Deepwater Horizon drilling platform in 2010.  This is a HUGE potential source of nat gas energy that will become very important in the future as the cheap and easy to get gas supplies are exhausted.  Only the US and the Brits have the kind of technology that can develop this… at the moment, anyway.  I am sure that Japan, Russia, and maybe a couple of other high-tech nations could develop it in a few years, if they wanted to do it. 
       
      Yes, gold as payment for oil works well, because… GOLD IS MONEY!  Not only that but that same gold can then be used to purchase wheat and the other things that most ME oil producing countries need.
       

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