Silver Mining Costs Exposed: Cash Cost Fallacy

House · Jul 11, 2013

Quite detailed but worth a read if you're into this kind of thing. Plus, there's pretty charts

There still seems to be a great deal of confusion about the true cost to mine silver. After I wrote my article "Can the Primary Miners Survive $18 Silver", I received a lot of replies that were all over the place. By that I mean, there seems to be no consensus of what is an accurate cost to mine silver. That is why I decided to write this article.

As I mentioned in prior articles, the reason why I started to research declining ore grades, fuel consumption and mining costs in the mining industry back in 2009, I really didn't see much in the way of good analysis on the subject. It wasn't until the last year or so, did these aspects of the mining industry really become mainstream.

In researching declining ore grades in the top primary silver miners, I wondered what kind of impact this would have on the cost to mine an ounce of silver. This was explored in my previous article "Silver Price to Rise as Top Miners Production Evaporates". The graph below was taken from that article.

As you can see from the chart, the average yield of the top 6 primary miners declined from 13 oz/t (oz/tonne) in 2005 to 8.1 oz/t in 2012. As these average yields declined, these top miners had to increase their processed ore 67% from 9.4 million tonnes in 2005 to 15.8 million tonnes in 2012, just to keep silver production at the same level it was in 2005.

Furthermore, as some of these top mine's average yields declined substantially, additional new mines were added by the company just to keep production flat. It is certainly true as ore grades decline, costs increase.

To get an idea how the percentage of costs have increased relative to pure silver revenue, let's look at one of the top primary silver miners.

A Different Cost Approach for Pan American Silver;
There are several ways the mining industry breaks down the costs to produce a metal. One is cash costs, where the mining company deducts by-product credits and change in inventory (plus a few smaller items) from the production cost. Then we have total costs which adds back in depreciation, amortization and other items on top of cash costs.

However, I believe those two methods do not provide the PROFITABILITY of the company as it pertains to costs of production to silver sales revenue. I have used Pan American Silver as an example on how production costs impact their bottom line from their silver revenue only.

If we look at the chart below, we will see a break-down in production costs to silver revenue. I obtained the silver revenue figure by subtracting by-product credits from total revenue. Then, the production cost was divided by the silver revenue to show a percentage (shown in the white line):

I decided to use this approach because there has been some commentary that the primary silver miners could survive for a while selling silver below their cash costs. I find that very hard to believe, but let's look at the results of the chart.

The quarter in which the ratio of costs to silver revenue was the lowest was during Q2 2011 at 56%, when the average price of silver hit a new average high of $38.17. In the next two quarters the percentage fluctuated, but remained relatively in the same range.

Then all of a sudden the ratio shot up to 93%. How on earth could this increase 33% over the quarter before? It was due to several factors:

1) Average Realized Price of silver fell approximately $3.00 compared to Q1 2012

2) By-product revenue increased $11 million compared to Q1 2012

3) Production costs increased $16.5 million compared to Q1 2012

4) Silver Sold was 700,000 less oz, than was produced that quarter.

I would imagine, if Pan American had sold about the same amount of silver as it produced during Q2 2012, silver revenue would have been approximately $25 million higher and the cost to revenue ratio would have been 75-77% instead of 93%.

In Q3 2012, the production cost to silver revenue declined as Pan American sold more silver than was produced that quarter. By the first quarter of 2013, you can see costs (in red) declined a bit, but silver revenues fell even more, pushing the cost to revenue percentage up to 81%. But, the real problem will occur in Q2 2013 as the average price of silver declined nearly $7 compared to the previous quarter (Kitco).

If production costs remain the same in Q2 2013 and Pan American sells the same amount of silver as it did the previous quarter, silver revenue is estimated to decline by 26%. Based on these assumptions, silver revenue will fall from $159 million in Q1 2013 to $122 million in Q2 2013, putting Pan American's silver revenue below its cost of production. (NOTE: this is just based on production costs to their silver revenue obtained from subtracting by-product credits).

The production cost per oz in the table above was calculated by dividing total production costs by payable silver ounces. Of course, this does not include any by-product credits, but it was an attempt to gauge the rise in this ratio since Q1 2011.

Regardless, the most important indicator to look at is the decline in estimated Q2 2013 silver revenue compared to production costs (remaining the same). We must remember, this is based on an average price of $23 for Q2 (according to Kitco). Currently the average price of silver in July is $19.50, and if the price remains at this level or lower, Pan American will see its silver revenue decline even further.
Primary Silver Miners Cannot Survive at Cash Cost Prices

As I mentioned in the beginning of the article, investors actually believe the primary silver miners can produce silver at or below Cash Costs. I have received replies to my previous article and listened to analyst commentary stating that the primary miners could survive at cash cost prices.

According to Pan American's Q1 2013 Report, their stated silver cash cost was $11.33 oz. If we consider the CLOBBERING that Pan American is going to receive during the second quarter of 2013 with average prices of silver at $23 an ounce, how are they going to deal with $20, $18 or even lower?

The big problem with by-product accounting is that it artificially reduces the so-called CASH COST of silver by deducting the by-product credits. So, the higher percentage of by-product credits a company has, the lower its supposed Cash Cost.

A perfect example of this is Hecla. In Q1 2013, Hecla stated a low cash cost of $5.02. If we look at a screen-shot of their Greens Creek Unit, we can see how a high percentage of by-product credits can lower ones cash cost:

Hecla's Greens Creek unit was the only mine in production in 2012 for the company. Even though Lucky Friday came back into production in Q1 2013, it was a very small amount. So, I decided to focus on the figures from their majority producer.

Here we can see that by-product credits were $44.9 million in Q1 2013. It turns out that Greens Creek by-product metals (gold, zinc & lead) account for nearly 55% of the total revenue, whereas silver is only 45%. So, it is no surprise that deducting $44.9 million from the production costs, would give Hecla a very low cash cost.

However, low cash costs do not guarantee a high degree of profitability. Hecla stated a positive $11 million net income in Q1 2013, but that was due to a gain of $21 million of derivative contracts. Even with the large derivative gain, Hecla's net income to revenue margin was only 14% during the first quarter.

Furthermore, that 14% margin was accomplished with much higher metal prices. Hecla had average realized prices of over $30 for silver and $1,620 for gold. Hecla will more than likely be suffering net income losses in the second quarter along with Pan American Silver.

That is why investors should not confuse a company's $5.02 cash cost with the ability to produce silver at $5.02 an ounce. Just because a mining company can substantially reduce its cash cost with a great deal of by-product credits, doesn't mean they can successfully produce silver at that amount.

By-product accounting has given the investor an illusion of a "Low Silver Cash Cost" in Hecla's example above as well as many other primary silver miners. It doesn't matter how low a company's cash cost is, but rather how high their profit margins can be that's important.

It would be one thing if Hecla was making substantial net income profits based on a $5.02 cost, but that just isn't that case. If it wasn't for Hecla's by-product credits consisting of approximately 50-55% of total revenue (Greens Creek Unit example) , they would be stating huge net income losses each quarter. Thus, Hecla's gold, zinc and lead revenue was just as important as its silver revenue.

I don't believe the majority of primary silver miners can survive selling their silver anywhere near cash costs as some analysts have commented. As I have shown in the two examples above, Pan American Silver & Hecla will more than likely be suffering large net income losses when the Q2 2013 results come out the quarter where average prices of silver dropped to $23.

So, what happens to the miners at sub $20 silver? Well, according to this new article, "The Miners Best to Survive a Downturn Dundee":

A survey of the silver sector released Wednesday by Dundee Capital Markets suggests Silver Wheaton and Tahoe Resources are best positioned going into the lower silver price environment, while Silver Standard, Pan American Silver, Coeur Mining and Endeavour Silver will require "more significant alterations to the current business plan" to adapt.

While Endeavour Silver has three operating mines, the analysts suggested "it is only the company's Bolanitos Mine which could survive silver prices significantly below $17-18/oz. Of the three mines, El Cubo is at the greatest risk of needing to be put onto 'care and maintenance'. Furthermore, with just over $40M of available credit at the end of Q1, we forecast the company could require additional funding during 2014 if spot prices remain below."

To lower cash costs at Fortuna Silver Mines, the company could close the Caylloma mine in Peru and cut exploration and corporate G&A by 30%, the analysts suggested. "We believe management is open to putting Caylloma on care and maintenance if lower metals prices are sustained."

Lichtenheldt and Morrison advised that, of Pan American's seven operating mines, "we believe at least 3 of these mines would be burning cash during 2014 if silver prices remain below $20/oz and could therefore be candidates for 'care and maintenance' if prices do not recover."

With only one operating mine, Pirquitas, Dundee suggested that Silver Standard's business and asset portfolio is better suited to a silver price of more than $25/oz. The analysts advised the company could operate at Pirquitas at a loss for a short time; "however we believe management is ultimately committed to profitability and would put Pirquitas on 'care and maintenance' if the outlook were for ongoing cash-burn."

If the price of silver remains below $20, the analysts at Dundee Capital Management believe the two best companies to weather the storm would be Tahoe Resources and Silver Wheaton. This is interesting because Tahoe is not yet in commercial production and Silver Wheaton makes its margins on $4-5 silver.

Furthermore, Dundee states that upwards of 6 or more mines from four companies quoted in the article above would be candidates to be put on "Care & Maintenance" if silver prices remain below $20. Also, as these companies burn cash by keeping some of these marginal mines producing silver at a loss, they are consuming funds that would have been future Capex spending for exploration, plant and equipment.

While this article only focuses on the cost based on primary silver miners, base metal and gold mining companies that produce by-product silver need their silver revenue to fortify their balance sheets. For example, GoldCorp's Penasquito mine sells 25% of its silver to Silver Wheaton at $4.02 an ounce. This doesn't mean that GoldCorp can afford to just give away all its silver at that price.

The table below shows how a decline in production and price can greatly impact Penasquito's gold cash cost:

In just 3 quarters, Penasquito's gold cash cost increased $1,036 an ounce, from a negative $425 in Q2 2012 to a positive $611 in the last quarter. Even factoring in 25% of the silver sold to Silver Wheaton's at $4.02 an ounce, Penasquito had an average realized price of silver of $25.54 during Q1 2013. What will Penasquito's gold cash cost increase to with the average price of silver $7 lower in Q2 2013?

Lastly, it is a shame that the silver producers are being hurt by the actions of the Fed & Central Banks. The silver mining companies are producing both a necessary industrial metal as well as an excellent store of value. Even if industrial demand has declined recently, investment demand should be enormous. However, as the Fed prints money, purchases U.S. Treasuries and props up the broader stock market, this has created artificial demand for increasingly worthless paper assets and less demand for physical silver (presently).

At some point in time, this sort of charade will end forcing investors to purchase physical assets such as the silver miners and silver bullion to protect their wealth. Thus, the death in artificial demand in one will cause a skyrocketing demand in the other.
Click to expand...

SD. Contains links to articles mentioned.

worldbubble · Jul 11, 2013

finally something of relevance

Travelgall · Jul 11, 2013

Wow. Detailed and if accurate V Promising for a floor in Silver.

BamaGuy · Jul 11, 2013

I didn't read the whole long post but I have to ask if you revealed that most silver isn't mined by primary silver mines but as a by product of other type mines?

Pirocco · Jul 11, 2013

I think this is the 3rd topic I saw this year specifically about this.
There's a detail worth a closer look: "primary" miner. And not all of them, but the top 6.
Primary silver mines account for 28% of total silver miners.
http://www.silverinstitute.org/site/supply-demand/silver-production/
So how representative for the silver market are these figures? A top 6 inside an 28% of a total.
Just like in those older topics I saw, this seems to be ignored.

col0016 · Jul 11, 2013

BamaGuy said:

I didn't read the whole long post but I have to ask if you revealed that most silver isn't mined by primary silver mines but as a by product of other type mines?
Click to expand...

I get that you're American but try and read the whole thing anyway, it's definitely worth it

BamaGuy · Jul 11, 2013

col0016 said:

BamaGuy said:

I didn't read the whole long post but I have to ask if you revealed that most silver isn't mined by primary silver mines but as a by product of other type mines?
Click to expand...

I get that you're American but try and read the whole thing anyway, it's definitely worth it
Click to expand...

Because it makes no sense to discuss cash costs if you exclude over 70% of the mines..

Cash costs to mine silver in my yard would be enormous.. The whole topic is a farce if you exclude by product mines.

BamaGuy · Jul 11, 2013

Now if this topic were titled

Reasons not to invest in primary mines

It prove a point..Primary mines can't mine long for less than spot price..

Another great reason NOT to own a primary miner is dilution of shares... THEY WILL keep mining at a loss as long as there are suckers who will buy diluted shares.

Pirocco · Jul 12, 2013

BamaGuy said:

Because it makes no sense to discuss cash costs if you exclude over 70% of the mines..

Cash costs to mine silver in my yard would be enormous.. The whole topic is a farce if you exclude by product mines.
Click to expand...

There is a whole set of such farces, being re-pasted dozens times, no matter where the price is driven to. Apparently, reality doesn't suffice to make people buy at any price, so let's create some articles about trading volume comparisons with a silver production, about total sums of loans regardless loan start/end dates, about shortages of coin type X and general shortage, about commercial hedgers / swap dealers quickly covering short positions alike a short position can continue to exist after the owner of the long position decided to end it, and some other stories.
According to http://www.silverinstitute.org/site/supply-demand/silver-production/
1. Cannington, Australia BHP Billiton plc. 32.23
2. Fresnillo, Mexico Fresnillo plc. 26.38
3. Dukat, Russia Polymetal International plc. 15.50
4. Uchucchacua, Peru Compaia de Minas Buenaventura S.A.A. 11.26
5. Pirquitas, Argentina Silver Standard Resources Inc. 8.62
6. Palmarejo, Mexico Coeur d'Alene Mines Corp. 8.24
On the right side are the 2012 million ounces produced.
If I sum these up, I get a total of 102.23 Moz.
According to http://www.silverinstitute.org/site/supply-demand/ the total silver production in 2012 was 1048.3 (this of course includes the 250 Moz of recycling, why would we ignore it, it's for sale, origin ground or origin waste doesnt really matter eh?).
100 * 102.23 / 1048.3 = 9.752%
So this story is about 10% of the silver production.
And cash cost is near to $9 an ounce for this 10% part of production, as stated on the same TSI page. With the spot price of around $20, there is, even in the case of this in terms of production 10% silver producers part, still some $11 profit to be made on every ounce. Of course, the miners themselves only receive a part of this $11, not all. The rest goes to the chain between miner and stacker. Coin producers, dealers, transport, etc. How many of those 11 dollars end up in dealer hands? In my region of the world, the amount precious metal dealers ten or more-folded (as indicated by their websites company histories). They all show these stories that get repasted over and over again. Get what I mean?

Fykus · Jul 12, 2013

so can someone give a tl;dr of what the cost per ounce is?

BamaGuy · Jul 12, 2013

Fykus said:

so can someone give a tl;dr of what the cost per ounce is?
Click to expand...

There's at least one bipartisan report that puts cash costs at $.8.88 per oz.. I dispute using cash costs instead of all in costs because it's accounting trickery akin to using gross revenue instead of net profit..

My personal belief is that silver costs around $12 to mine.

$12 coincidentally happens to be my buy back in price for silver based on the following theory..

Rough math but the oil bubble burst in 2008 at around $145 bbl. silver bubble at $49. Oil sank into the $30's so that would put silver to hit $12-$13 if it were to follow the oil bubble

Pirocco · Jul 12, 2013

BamaGuy said:

There's at least one bipartisan report that puts cash costs at $.8.88 per oz.. I dispute using cash costs instead of all in costs because it's accounting trickery akin to using gross revenue instead of net profit..

My personal belief is that silver costs around $12 to mine.

$12 coincidentally happens to be my buy back in price for silver based on the following theory..

Rough math but the oil bubble burst in 2008 at around $145 bbl. silver bubble at $49. Oil sank into the $30's so that would put silver to hit $12-$13 if it were to follow the oil bubble
Click to expand...

There are two approaches to a 'bubble' phenomenon. One approach considers the fiatcurrencies side of the price equation as the 'bubble', the other approach considers some specific markets/products as the bubble. Historically, it's typical to see basic products (as oil is) as residing the leading edge of the general inflation trend. If oil gets more expensive due to increasing production costs, then it's not the oil market/product side that is the bubble, but the fiatcurrency side. If oil gets more expensive due to (eventual futures based) stockpiling from the money for nothing club, then it's the oil side that is the bubble.
The crude oil futures market situation seems to confirm your statement:

Look at how the [green] and ofc also the [red+blue] trendlines deviate away from the zero. It's now sitting at close to 300,000 contracts of 1000 barrels, which is one of the peaks of the multiyear trend.
But about your correlation silver/oil, how did you come to it? Oil and precious metals move quite alot in opposite directions. Take for ex the last silver price downtrend, october 2012 to present day. Oil on the contrary, rose 23%. It's abit funny to everytime see much higher price expectations in late uptrends, and much lower price expectations in late downtrends. Yet, as proved everytime in hindsight, neither happened, and the money for nothing club sold at lower, or bought back in at higher, than 'expected'.

BamaGuy · Jul 12, 2013

I merely compared oil/silver because I experienced it.. .I see lots of similarities... The last $30-$40 of the oil gains happened in a few days just like the 80's silver bubble on speculation.Same as the 2011 silver bubble..

Oil is needed daily,so the rise back up as quicker. I feel oil should be around $60- $80 at this time. I think there is $40 of speculation priced in.However I don't see this ever going away because the population has gotten used to it.

BamaGuy · Jul 12, 2013

I'm not short silver at this time nor do I plan a short position. I do have a (not firm) plan to buy silver at these levels. I have a certain $$ I plan to use.

5% at $14
10% at $13
20% at $12.50
40% at $12.00
15% at $11.50
10% at $11.00

At this point i've completed my silver purchases. If it goes lower,I don't buy any more. If it doesn't go that low,then I just wait & or use that on another investment.

We haven't seen capitulation yet.. I could go in at a higher price if I see that.

pdkbffwleo · Jul 12, 2013

BamaGuy said:

I merely compared oil/silver because I experienced it.. .I see lots of similarities... The last $30-$40 of the oil gains happened in a few days just like the 80's silver bubble on speculation.Same as the 2011 silver bubble..

Oil is needed daily,so the rise back up as quicker. I feel oil should be around $60- $80 at this time. I think there is $40 of speculation priced in.However I don't see this ever going away because the population has gotten used to it.
Click to expand...

And the population has very little choice to NOT use oil. All nations need Oil. They can't live without it. Silver, on the other hand, a bit different. Oil and Silver shouldnt' follow the same trends. Entirely unique commodities.

If oil went to $400 a barrel by Monday, it would take years for other viable options to be available.

BamaGuy · Jul 12, 2013

If oil went to $400 a barrel by Monday, it would take years for other viable options to be available.
Click to expand...

Funny thing about oil...It holds us hostage but we also hold it (the price) hostage..

The cartel has to maintain a fickle line of keeping oil low enough for economies to be able to buy it. Lots of OPEC countries ruined their own countries when oil dropped like a stone in 2008.

I submit that for oil to go up at a rapid pace from here isn't sustainable long term. The world can't afford $200 oil.

pdkbffwleo · Jul 12, 2013

BamaGuy said:

If oil went to $400 a barrel by Monday, it would take years for other viable options to be available.
Click to expand...

Funny thing about oil...It holds us hostage but we also hold it (the price) hostage..

The cartel has to maintain a fickle line of keeping oil low enough for economies to be able to buy it. Lots of OPEC countries ruined their own countries when oil dropped like a stone in 2008.

I submit that for oil to go up at a rapid pace from here isn't sustainable long term. The world can't afford $200 oil.
Click to expand...

Correct. As I stated, those years for other viable options to be available is what holds us hostage. The world can't afford $200 oil, but the world certainly paid $150 for it a few years back. Meaning, we, collectively, will pay $400 for it, short term...

BamaGuy · Jul 12, 2013

The world can't afford $200 oil, but the world certainly paid $150 for it a few years back. Meaning, we, collectively, will pay $400 for it, short term...
Click to expand...

If I remember correctly the $150 oil was 1 trader who did it just to make it go that high as a joke.. The over $140 price was at most for a day or so IIRC. The high gasoline prices directly took $20+ out of the economy here every week &I think we all saw the resulting SHTF

pdkbffwleo · Jul 13, 2013

If oil goes to $200 tomorrow, I'll still drive to work, as most American's.

Just like when it hit $140's, same thing. We have very little choice.

We need a system like Europe...rail...that make sense. This stupid "high speed rail" bull shit is a waste of time and money. Buses don't work, unless you're armed with a .357

Pirocco · Jul 13, 2013

BamaGuy said:

I merely compared oil/silver because I experienced it.. .I see lots of similarities... The last $30-$40 of the oil gains happened in a few days just like the 80's silver bubble on speculation.Same as the 2011 silver bubble..

Oil is needed daily,so the rise back up as quicker. I feel oil should be around $60- $80 at this time. I think there is $40 of speculation priced in.However I don't see this ever going away because the population has gotten used to it.
Click to expand...

You moved here from longer trend similarities to short & speedy price movements.
It's not because something happens in a matter of days, that it isn't 'durable'.
High speed doesn't imply bubble.
It's even expectable to see speedy price movements in an economy, if corrections have been blocked for a prolonged time, and the blocking then fails, causing those accumulated corrections to happen all together.
A crisis is a market shift, a movement of resources from markets to government-sponsored/benefitted markets (cheap lending of savings and new money), and if it occurs it means that economical limits of the drained off market part were reached.

Silvers current $19 (or $20 as of yesterday) is now about the same as the peak in 2008 ($21-22), oil is now $100 and was $140 at that peak in 2008.
Oil, one of the biggest markets, most money involved, sits 40% lower and silver (not a small market anymore though still much smaller than oil) sits about the same.

About population gotten used to higher oil prices, weird description, they have to pay it (at least the nongovt sponsored part), whether they like it or not. It's a quite essential product. It's not like that people have the option to stop consuming oil, while a silver stacker can decide to suspend silver buying and keep the fiat until the temporary buyers again dumped.

So your comparison oil/silver, it's abit shaky, I'd say.
Of course, if others are willing to sell at your lower prices, the lower prices will come.
In current global economical state of affairs, and with the lessons silver buyers / sellers learnt in recent years, maybe some price stability or a much slower reasonable uptrend appears expectable to me. I learnt from my buying high mistakes, alot others too, and alot others also learnt from selling low mistakes. I'll target $18-19 spot silver for my next purchase. No reason to hurry, a worldwide operating central planning means a decades gradual detoriation of welfare, instead of a month/year fast correction. The end results are the same, though.

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Silver Mining Costs Exposed: Cash Cost Fallacy

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