Can the Primary Miners Survive $18 Silver?

Thanks to the wonderfully functioning rational markets that we have today, at current silver prices virtually all of the primary miners are now below net income break-even. I say this with a great deal of sarcasm because in fact there is nothing rational about the markets today.

It becomes increasingly frustrating to watch the television and read on the internet, some of the worst analysis from what is a supposedly, an intelligent species. When I was growing up, I actually thought the people in government, news anchors and financial commentators actually knew what they were talking about.

However, there is little in the way of truth being broadcasted over the airwaves today. In all actuality, the Main Stream Media has actually convinced the public (presently) that GOLD IS GARBAGE… AND GARBAGE IS GOLD. By garbage, I am referring to most paper assets.

We can witness this by the Grand Charade currently taking place in the paper gold and silver markets as the charlatans, gadflies and nitwits proudly proclaim that the ‘Great Gold Bull Market” is in fact… OVER. Even though they may have bamboozled some of the weaker hands as well as the majority of the clueless public… the fundamental bull market in the precious metals has only just begun.

Unfortunately, the majority of the world has no idea of the real power of owning gold and silver due to the breakdown and failure of the analyst community. Here are a few of my thoughts on the role of a proper analyst.

First and foremost, the world is awash in lousy analysis. It doesn’t matter from which sector or what industry, the ratings-analyst community is like a dead fish, rotting from the head down. There is plenty of evidence of this, but due to the short-term attention span of the investing public, the sins and errors of the Wall Street analyst community for the most part, are largely forgotten.

Second, for analysts to provide accurate forecasts, they need to base their work on root fundamentals. Today, very few analysts create forecasts this way. The overwhelming majority are providing reports derived from a sea of conflicting and superficial data. That being said, I really don’t blame them as they are producing forecasts respective of the very world and markets in which they live. As they say.. Garbage in, Garbage Out.

Lastly, the most important fundamental is unknown by most analysts. I do not claim to be a gold or silver bug. Even though I may be passionate when I write posts and articles defending the precious metals, I try to base my work on fundamental logic rather than emotion. While some of the more proficient precious metal analysts write excellent articles about certain fundamentals, I believe there is one that has been completely overlooked — and this is by far the most important fundamental.

Before, I get into explaining this key fundamental, let’s explore how the extremely low (manipulated) paper price of silver has impacted the miners.

How $18 Dollar Silver Impacts the Primary Miners

I don’t believe there is one precious metal analyst who thought silver would fall from $32 in the beginning of the year to the $18 level today. Sure, there are always a few eccentrics who proudly proclaim they saw this coming for years, but while they may have got the call right, they did so for the wrong reasons.

To be able to understand how $18 silver affects the miners, we have to figure out what break-even is for the individual company and the industry as a whole. My first attempt at calculating break-even was presented in my article The Complete Cost of Mining Silver. The article was a bit simple and rudimentary, however it tried to show how certain metrics like cash costs can be completely meaningless in determining the profitability of a company.

To be able to expand on my net income break-even analysis and to see if it would pass the smell test by the accounting profession, I contacted one of the more prestigious schools of accounting in the nation and asked for assistance. After a few email exchanges with some of the professors at the college, my email address was forwarded to one of their colleagues who was at one time a CFO of a gold mining company.

Within a few days, I received my first email from this individual and for the next several weeks we corresponded on different aspects of mining accounting. To make a long story short, there were some important agreements of my methods by this professional as well as some objections.

However, when I first sent my Excel spreadsheets showing my work on net income break-even on a few of the silver miners, the response I received from this ex-gold mining CFO was, “Your approach makes perfect sense, which is probably why it has never been embraced by the precious metal industry.”

You can’t believe my elation once I opened the email and read that sentence. Again, it turns out that we differed on certain aspects of mining account that will be addressed in future articles.

If we look at the table below we will see the top 12 primary silver mining companies Q1 2013 financials and break-even (minus Fresnillo and Hochchild as they state the financials every half year):

As we can see these top 12 primary miners received nearly $805 million in total revenue from selling 20.3 million ounces of silver as well as by-product metals. If we look at the sales that came from the by-product metals, it turns out to be $255 million or a surprising 32% of the groups total revenue.

One of the issues I have with the present method of accounting in the mining industry is what is called as “by-product accounting.” For instance, cash costs are figured by taking all of the company’s by-product metal and subtracting it from the overall cost. So, if a company has 45% of by product metal revenue (credits) and they deduct this amount from the overall costs to show a “Very Low Cash Cost”, they can do so while at the same time stating a net income loss for the period. This is the insanity of cash cost accounting.

To get the net income break-even for the entire group, we take the total net income and divide it by the silver sold:

NET INCOME $90.7 mil / SILVER SOLD 20,366,789 oz = $4.45 net income per oz

If we take the $4.45 net income per oz figure and subtract if from the average realized price of silver the group received that quarter we get the following:

REALIZED PRICE $29.85 – NET INCOME PER OZ $4.45 = $25.40 break-even

If we look above the Net Income break-even area to the ADJ-Silver Income per oz, you will notice that is lower at $3.40. I obtained this lower figure by certain calculations such as deducting an estimated percentage by-product income to get a more representative pure silver break-even figure. I will explain this more in detail at the SRSrocco Report.

Regardless, we can at least see for the top 12 primary silver miners to state net income profits, they will need to average approximately $25.40 an ounce silver for the group. Now, this doesn’t mean all the miners are making money at $25.40, some companies actually reported net income losses during Q1 2013 as their break-even price was $30+ an ounce.

Part of the reason why I developed my ADJ-Silver income per ounce (ADJ = adjusted) was due to the relative volatility inherent in the net income approach. For example, if a mining company sells a property or has an impairment charge during the quarter, it can greatly impact net income. Thus, the company could have a much higher or lower silver breakeven, due to circumstances that don’t pertain to the actual day to day business of mining.

Now that we understand the formula for calculating net income break-even, at $18 the primary silver miners as a group are losing approximately $7+ an ounce of net income. We must remember, even though the current price of silver is in the $18 level, the average for the second quarter is presently $23.15.

If we were to make a rough estimate based on $18 silver at 20 million oz worth of silver sales assuming costs remained the same, the 12 top primary silver miners would be losing approximately $140+ million of net income… and that figure could be even greater. Normally, as realized prices fall, net income declines in a greater percentage.

However, if the paper price of silver remains this low or falls lower for an extended period, we could see a net income break-even price below the LOWEST COST PRIMARY SILVER PRODUCERS ON THE PLANET.

Of course these miners could cut back on everything, such as exploration, development, maintenance as well as shutting down high cost mines, laying off employees, withholding dividends and etc. But this is not the path these miners should take if the world finally woke up to the horrors of debt financialization by its fiat monetary masters

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