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Investors Not Quite Ready to Embrace 'Ugly Sister' Silver

By: The Gold Report and Chris Thompson

-- Posted 21 November, 2011 | | Discuss This Article - Comments:

Volatility in the markets overall, and particularly in the silver price, continues to deter investors, even the major producers, from stepping in on silver juniors. Chris Thompson, equity research analyst with Haywood Securities, talks to The Gold Report about what's next for silver.

The Gold Report: Chris, you recently called silver "the most volatile of all the precious metals." Why do you believe that?

Chris Thompson: Silver is often called gold's ugly sister because historically it presents itself as a very volatile metal, price-wise. Silver demand is typically determined by two main influences. First, silver as a store of value, much like gold. Second, silver is valued as an industrial metal. Right now, there's a lot of concern about demand for silver as an industrial metal, about the lack of demand for silver for industrial fabrication. The interplay between these two demand uses contribute to its price volatility.

TGR: And you expect that volatility to continue for a while yet?

CT: I think so. We've seen a lot of volatility in gold. Earlier this year, many argued that gold could easily move up to $2,000/ounce (oz), over the long term. When gold ran up rapidly a couple of months ago, it did more damage than good to the precious metal sector because it caused a lot of people to wonder whether those high prices were sustainable. It discouraged them from playing the precious metal game in anticipation of a correction of sky-high gold prices.

The same is true for silver. Earlier this year silver approached $50/oz, and then fell back severely. My sense is the move forward will be volatile for a lot of metals, copper included.

TGR: You suggest the near-term price for silver will be around $38/oz. But, your long-term price drops to $20/oz. Is the lack of industrial demand behind that or are you just taking a very conservative approach?

CT: We are taking a conservative approach. We are looking for a weakening in the silver price into the medium to longer term. Anyone who suggested a long-term silver price of $20/oz a couple of years ago would have been called very, very aggressive. Now, a lot of commentators are predicting $20/oz in the long term. My sense is that $38/oz is a healthy price for silver in the near term, as is $20/oz as a long-term price. These prices will, in time, contribute to new mine production, which will contribute to new mined supply. Increased supply will depress the price of the metal.

Also, we have to recognize that 80% of the mined silver supply comes as a byproduct credit. In that sense silver production is linked to the economics of gold, lead and zinc. All things being equal, we are looking at good prices for gold and reasonable prices for base metals, all supportive of additional silver mined supply and a lower silver price in the long term.

TGR: For most of 2011, share prices of most major precious metals producers lagged the price appreciation of gold and silver. Lately that gap has started to close. Will this trend continue?

CT: I believe so, yes. I think the lag relates to the volatility of gold and silver prices, and arguably copper as well. That price uncertainty has caused a lot of companies to stay on the sidelines, to wait and see whether metals prices in the broader context are sustainable before engaging in merger and acquisition (M&A) activity. Now, I think there is a growing appetite for M&A in the precious metals space, being driven by the need to sustain production growth.

TGR: So, in effect, investors need precious metals prices to stabilize before they will invest in the companies that produce them?

CT: I think so, yes. This is the case for many individual investors, particularly those looking at takeout candidates. For certain producers, equity prices have caught up to metal prices.

A couple of the companies we have under coverage in the silver space, companies that have cash flow, are trading at relatively high multiples to cash flow for next year. That suggests that there is a lot of appetite for cash-flowing companies focused on silver, especially companies that have demonstrated their ability to grow their business.

But that's not the case with companies oriented more toward longer term growth or development. If an investor is looking at a development opportunity, he has to be fairly confident about where the underlying price of the metal is going before making an investment decision. There has been a lot of doubt in the marketplace about whether metal prices are sustainable at current levels.

TGR: In addition to some of the silver majors trading at healthy multiples, some of the gold majors are putting their free cash flow into higher yields. Yet, prices for juniors, even juniors with significant resources, continue to languish. Do you expect any of the majors—gold or silver—to wade into the takeover game?

CT: I do anticipate that. But you have to understand that a potential acquirer of a mining or exploration company is just as much an investor as Joe Blow on the street. Potential buyers have to be confident in the sustainability of metal prices before making any significant merger and acquisition decisions. A lot of companies or potential buyers remember that a couple of years ago the marketplace was very different from where it is now. We all are acutely aware that things can change.

TGR: Another factor in the mix right now is increasing risk. Some Latin American countries, including Peru and Argentina, are enacting policies that will increase royalties or taxes on mining profits. Could that be a deterrent for foreign direct investment and ultimately, for the average precious metals investor?

CT: There is a broad-based acceptance, especially regarding Peru, that taxes and royalty rates will increase in line with other South American jurisdictions. My sense is that as long as that is handled in a predictable and transparent way, it should not be an impediment for foreign direct investment.

What upsets the marketplace and upsets investors is the knee-jerk reaction we've seen from many jurisdictions with regard to adopting or even suggesting radical changes in the taxation and royalty regimes. That type of reaction causes a lot of concern with regards to the investment of significant funds in those countries and jurisdictions.

TGR: What should investors playing the precious metals market—be it in actual metals or equities—be aware of now that wasn't in play a few months ago?

CT: That's a good question. As far as precious metals or the mining sector as a whole is concerned, investors have to be aware that we are approaching the tax loss selling season. This might be an impediment for some mining and exploration stories through to early 2012.

Moving into Q112, I think a lot of attention will again be focused on the mining sector on the back of mining shows like the Mineral Exploration Roundup in Vancouver and the PDAC show in Toronto. Over the next six months, I expect we will see the mining sector as being a volatile space, but one that will garner a lot of attention.

TGR: Chris, thank you for your time and your insights.

Chris Thompson is an associate mining analyst at Haywood Securities.

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-- Posted 21 November, 2011 | | Discuss This Article - Comments:

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