“$12.5 Billion in Abandoned Silver”

by Travis Johnson, Stock Gumshoe | December 1, 2008 12:08 pm

I’ve seen this particular ad a few times in the last week or so, and I know that there are many folks out there in Gumshoe Land with a yen for silver[1], so I thought it deserved a few minutes of consideration.

The ad is for a special report from the Oxford Club[2] — sounds like it’s a book, more or less, about some hard asset investment ideas they have. It’s entitled Five Ways to Profit from the Base and Precious Metals Supercycle, and they’ll sell it to you for $49. I don’t have any idea whether or not it’s any good, but I can tell you that we’ll spend a few minutes looking for that “$12.5 billion in abandoned silver” that they claim as their key investment idea.

The ad is structured as one of those secret missives, with a copy of an email from a top researcher that lays out the investment case for this particular stock. All hooey, one must imagine, but it probably still works pretty well — it gives the illusion of being an insider, and sometimes investors like that just as much as they like making money. Whenever you see emails like this that purport to share a secret message from a top researcher, just remember that there are probably hundreds of thousands of people just like you getting exactly that same email.

The ad makes the argument for silver in general, too — it’s not just a tease for this company, but for the idea of investing in silver. They use several of the arguments that are probably familiar to many Gumshoe readers …

• The gold[3]/silver ratio is abnormally high now (that’s the number of ounces of silver it would take to buy an ounce of gold, historically it averages about 31, though it varies widely, and today it’s at about 82).
• Silver, unlike gold, is consumed in significant quantity by industrial uses — largely photography, which is declining, but also electronics, medical tools, and many other applications. Industrial uses have apparently grown more than photographic use has shrunk in the last decade or so.
• New uses for silver are being discovered — silver fights rot and bacteria, and nanoparticles of silver or thin coatings or electroplating are increasingly used in medicine, lumber, food storage, and other areas.

Both silver and gold have been quite volatile when measured in decades, and both receive lots of attention as “safe” asset investments during times of uncertainty, though gold is at the forefront of that trend — which is probably why that gold/silver ratio number has climbed dramatically in the last year.

So what’s the stock that the Oxford Club folks think we should look at now for silver?

We get a few clues. Here’s the intro:

“One of the top researchers at The Oxford Club[4] has just unearthed an extraordinary find: $12.5 billion in silver that has literally been abandoned for the past 15 years. Given silver’s value as “real money,” this could be a wealth-saving discovery for investors seeking real safety from the worldwide financial meltdown. And that’s just for starters…

“This is not another “strike it rich” mining story. The clever group who discovered this stockpile – called the “Silversmiths” – kept it hidden from the public for a long time and for a special reason. A reason that compounds the silver’s market value and the return to investors. No bullion, no coins[5], no delivery, no stacking or storing involved.”

And while the actual clues are few, there are a few more details hidden in the exciting sales language:

“Fifteen years ago, a group of investors bought one of the largest reserves of silver in the world – nearly a billion ounces – spread across seven countries and six continents.

“They spent millions on the acquisitions. But it seemed strange at the time because silver was almost worthless. And once this group had made the purchase, they promptly did nothing with the silver.

“They didn’t mine the silver; they didn’t sell the silver; and they didn’t make any profits from it. In effect, the group decided to “abandon” the silver for the next 15 years and not make a single dollar from selling silver.

“But this unorthodox arrangement allowed the company to build up over $12.5 billion in hidden reserves and fall “off the radar” of virtually every minerals analyst. So naturally, their share price plummeted, which was fine by them. “

There are a few other little clues, too:

“Still, the “Silversmiths” did nothing. In fact, for 15 years, the “Silversmiths” reported practically nothing but small losses – the cost of upkeep on dormant mining deposits and salaries for a few secretaries at headquarters. (They reported a profit twice. Once when they sold off a mine, and in 1994 when they had some remnants from their old business model.)”

and …

“when silver crossed the $15 mark earlier this year, the “Silversmiths” quietly sprang into action.

“At one of their properties in Argentina[6], the camp for construction and mine workers has just been completed. Connections to a natural gas[7] terminal 36 kilometers away are being put into place. And starting in the first quarter of 2009, the mine should start producing pure profits for the next 14 years.

“Of course, this is just one property. Four other properties are in the advanced drilling stages and well-positioned to take advantage of current silver prices.”

So what is this company?

Well, this is one of those cases where I might be 99% sure, but I can’t guarantee that I’m right — there is one clue that doesn’t quite fit. At one point in the ad they say that this company had acquired potential mines in seven countries across six continents over the past 15 years (that would be all of them except Antarctica), but the company I have in mind for this currently is active in seven countries across just three continents.

So I think the company they’re teasing here is …

Silver Standard (SSRI)

It does match the clues in most ways — it did become a major silver investor in 1993, back when silver was much cheaper ($3 an ounce or so, and you could buy potential reserves in the ground for a penny or two an ounce). Their plan was to buy up reserves and hold them until silver got as valuable as they expected it to, and for the most part they’ve been vindicated (as long as silver stops falling, as it’s doing today). The company has actually been around for much longer than that, at least back 50 years or so, but did reorganize to focus entirely on silver in 1993.

They did sit on most of those properties for a long time, though they weren’t totally inactive otherwise — they’ve made occasional profits by selling off shares of mines, and they’ve been exploring and acquiring all along even as they didn’t actually produce much.

And currently, their first property for development is indeed on the eastern edge of the Atacama desert in western Argentina … it is indeed commissioning this quarter and, one hopes, starting production early next year. It is also 36 km from an existing natural gas pipeline, so that might also match that clue. This mine, called Pirquitas, is expected to produce for 14.5 years and to deliver 10.9 million ounces of silver a year, on average (along with a bunch of zinc[8] and tin).

And they do have four other projects in advanced stages of development, up to and including exploratory drilling: San Luis in Peru[9]; Pitarilla in Mexico[10]; Diablillos, also in Argentina; and Snowfield in British Columbia, Canada[11]. The other continent that gets us to the total of three is Australia[12], where nothing is as far along as those North and South American projects.

I’m no expert in mining, so I can’t tell you what their mines look like or how their reserves stack up in terms of their cost of production or any other metric like that, but I can tell you that they claim to own the largest reserves of silver of any publicly traded silver-focused company in the world (there aren’t a huge number of those — some of the others are Pan American, Silver Wheaton, Hecla and Couer d’Alene). Silver Standard claims just over 1.5 billion ounces of potential silver, but the lion’s share of that is classified as measured, indicated, or inferred resources — the actual proven and probable reserves are significantly smaller than Silver Wheaton or several others.

So is this the stock for you? It has been a favorite of many “silver bugs” for many years, and has often been characterized as an “option” on silver, since the stock was considered really to be just a way to leverage[13] your silver investment by buying cheap silver that was still safely buried in the ground. That’s starting to change now that they’re getting close to producing at their first major mine, which is probably both good and bad news — with the deflation[14] buzz hitting silver prices at the moment, the shares of Silver Standard are down more than 10% as I type this on Monday morning, and, as with all actual producing miners, their prices can now fluctuate with performance and execution in their mining operations, and with subsequent changes in reserve assessments, as well as with the movement of silver prices.

It’s an interesting company, well followed by the investment press as a significant silver player, with probably the most compelling comparison being Silver Wheaton (even though SLW operates as a royalty owner on other peoples’ mines, it is similarly leveraged across a wide array of mines that may produce silver). In the end, though whether you want simply to owns silver or to investigate a junior miner that is highly leveraged to silver, what matters most is the future direction of silver prices — if they fall well below these prices, there will come a point when Silver Standard’s projects aren’t economically feasible, if they climb SSRI should have great results.

SSRI right now has a market cap of a bit under $600 million, and though they’re not yet profitable the analysts do see profit for them next year — the projected forward PE ratio is 11, but that’s based on just two analyst estimates, and I doubt they know exactly where silver prices will be a year from now, either. The shares had a great year in 2007 as silver prices climbed and their mine development and permitting moved forward, and traded mostly at or near $30 a share for the better part of 2008, too, but the autumn collapse hit them at least as hard as others — you could have bought shares for about $6 if you were watching a few weeks back, and you can buy them today at about $9 if you’re interested.

The big argument for both silver and gold remains the same, at least as most investment touts present it: As a consequence of the massive creation of new money by the Federal Reserve as we attempt to flood the broken credit system with cash, the US dollar is going to fall, and inflation is going to rise dramatically, which will drive the prices of precious metals higher.

Eventually. Unfortunately, this prediction of the future is often described as a “no brainer” — the teasers and touts and pundits all say (OK, almost all) that it’s inevitable that inflation will climb dramatically, and that the US dollar will collapse in the coming years. I’m not going to tell you that they’re wrong, and I find the argument compelling, too … but there’s no such thing as “inevitable” when it comes to the global economy. The U.S. is suffering through either disinflation or deflation right now, and the U.S. dollar is clobbering most of its competitors in recent months — I agree that if the economy recovers inflation will likely come back at some point, but I don’t think it’s guaranteed to work out that way.

So it’s a very logical argument, and it may well be prescient — certainly it seems to make sense that flooding a system with money will lead to inflation, but remember that there are several components to the money supply and to inflation. I’m not an economist, so this is a partial and simplistic explanation, but the existence of money as created by the government is only one driver of inflation — what is at least as important is the velocity of money (the frequency with which it changes hands), and the expansion of money through new debt issuance. Since the economy is slowing down and people are fearful, they’re saving instead of spending to some degree … that slows down the velocity of money; and since banks aren’t willing to lend, they’re not inflating the money supply by leveraging their dollar of reserves into ten dollars of new loans. At least, not yet.

Will all that money that’s being created start to actually move in the real economy, and start to flood the system with liquidity? We better hope so, but if they overdo it and it turns into hyperinflation then the case for all resource plays might be strong indeed.

And besides, silver is shiny. Who doesn’t like shiny?

full disclosure: I do not own any shares of gold or silver mining companies, including those noted above, but I do own some coins of each metal.

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