There still seems to be huge misunderstanding by many investors as to
what it really cost 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. 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):
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.
