Silver has erupted over 44% since the start of 2016 and over 13% since the Brexit vote on June 23. It is the best-performing asset for the first half of 2016.

The move is even more impressive when compared to other bellwether barometers: 

  • Gold: +24%
  • S&P 500: +7%
  • DJIA: +8%
  • USD: -2.75%
  • Nikkei 225: -11%

So, what’s behind silver’s vault higher while the competition has delivered meager gains?

Cyclical Silver

After it peaked above $48 per ounce in April 2011, silver entered a vicious bear market. It bottomed in December 2015 at $13.73. 

This multi-year price slump dealt big losses to all silver producers. Many producers had no choice but to continue operations and sell their silver for less than the cost of production. 

Ironically, while silver prices were trapped in a bear market, demand has steadily increased. 

Along with being a monetary metal, silver is also an industrial metal, with ever expanding uses. Silver has the highest electric conductivity of any metal, making it perfect for solar power, batteries, and automobile manufacturing. Industrial demand for silver might have slid in recent years (back to 2006 levels), but investment demand has never been stronger. Investor interest has been the mainspring for the growth of silver demand in recent years. Sales of silver bullion have more than quadrupled since 2002, and now account for 20% of total demand, up from 7% a decade ago.

With that review of silver’s fundamentals, let’s look at two of the best-performing silver related equities for 2016.

First Majestic Silver (NYSE:AG; FR.TO) 

First Majestic Silver Corp. (AG) is the second-largest silver producer in Mexico, with six producing mines in the country and a market capitalization of $2.49 billion. 

After several tough years due to low metals prices, AG posted Q1 2016 revenue of $66.5 million, up 22% on Q1 2015. Earnings from mine operations jumped to $9.4 million, up from $5 million for the same two quarters. First Majestic CEO Keith Neumeyer commented on the results, saying that the team’s hard work on optimizing operations has paid off. The proof is that the company now has an all-in sustaining cost of just $8.97 per silver ounce sold. This is a significant 35% drop from the year ago quarter.  

Given the recent rise in silver prices, this is a healthy boost to First Majestic’s margins. Neumeyer has stated that “for every $1 increase in the silver price, we can expect an $18 million increase in our bottom line.” First Majestic was the top-performing company listed on the TSX for the first half of 2016. The stock surged 297%—from $3.42 to $13.58 a share. Yet, even after this huge rise, the stock remains 40% below its July 2011 high of $24.94.

In 2011, while the stock was topping, the company produced 7.56 million silver equivalent ounces. This year, it is on track to produce 19 million ounces. The company now has a $600 million lower market cap and will produce 2.5 times more silver than it did when its stock price was 40% higher. These are two reasons why I think the stock price is headed higher… much higher.

First Majestic is also an optionality play within the silver industry. Optionality is the concept of buying and holding current deposits that are currently out of the money but are likely to be worth more in a higher priced commodity environment. Neumeyer has stated that the company has held back production in recent years due to depressed metals prices. With silver prices moving higher, Neumeyer said AG will begin to slowly ramp up production. But low metals prices have also been a positive for AG. It has given the company the chance to buy quality deposits at discounted prices, such as the Santa Elana mine in Sonora, Mexico. 

This is not the first time AG has acquired quality deposits at discounted prices. Between 2004 and 2006, First Majestic bought four silver mines that held over 100 million ounces of silver for a mere $12 million. A strong management team, ongoing improvements in operations, and quality assets lead me to one conclusion…this miner is one of the best ways to leverage the silver price in the coming precious metals bull market.

Silver Wheaton (NYSE:SLW) 

Silver Wheaton Corp. (SLW) is the world’s largest precious metals streaming company with a $10.85 billion market cap. The company name doesn’t tell the whole story. Yes, it is involved in the silver mining industry, but it derives 60% of its profits from gold streams.

What, exactly, is a metal streaming company? It’s when Silver Wheaton enters into a contractual agreement with mining companies, and it provides upfront funds for capital expenditure to the operators (such as Barrick Gold or Goldcorp). In return, SLW obtains the right to buy all, or a portion of, the gold and silver produced by the mining operation. Streaming agreements also mean that the metal is bought far below market prices. A typical contract gives SLW the right to buy silver at $4 per ounce and gold at $400 per ounce. That’s a hefty discount. Plus, the streaming model fixes SLW’s costs so it mitigates its business risks. This is a major advantage in an industry renowned for its operating hazards and cyclical nature.The model also helps SLW grow quickly through the acquisition of new streams, a far faster process than building an operational mine. Its fixed acquisition costs for gold and silver significantly leverage company earnings to the metals’ prices.

Like First Majestic, SLW has exploited depressed metals prices. It added two streams in 2015—Glencore’s Antamina mine in Peru, and Vale’s Salobo mine in Brazil. The streams were bought for $900 million each. They will boost SLW production by 5.1 million silver ounces and 70,000 gold ounces for the next two and ten years, respectively. With these two additions, about 84% of the company’s 2019 production will come from mines operating in the top quartile of their respective cost curve.

Silver Wheaton’s current portfolio totals 22 operating mines and eight development stage projects. The company had over $113 million of free cash flow from operations in Q1 2016. That number is projected to hit $500 million for the full year. This is good news for investors, as CEO Randy Smallwood has said shareholders can expect higher dividends given the rise in cash flow. In 2011, SLW streamed 25 million ounces of silver and 15,000 ounces of gold and had a $47 stock price. Production this year is projected at 54 million ounces of silver and 265,000 ounces of gold, and its stock trades at $24. Silver Wheaton’s stock price has doubled since the start of 2016, but remains 48% off its April 2011 high. The fundamentals suggest it could go a lot higher. When coupled with rising silver prices, I believe SLW’s excellent business model, stable of quality deposits, and strong management team will make it one of the best-performing silver correlated equities in the coming bull market.

It’s All About the Cycles

Silver has soared since the beginning of the year and has kicked its stocks into the best-performing group across all sectors. With political events, such as Brexit, sucker-punching global equity markets and spiking investor fears of the unpredictable, silver has made further gains, and this is during the summer months, a period when precious metals are typically stricken with the dog days of price apathy.

Although I believe we are now in a cyclical bull market, no trend is ever linear. Precious metals are notorious for wild price swings and big corrections. Expect equities to back-and-fill in the coming months. Long-term investors should not be put off by extreme volatility in equities. The evidence tells me that they will take out their old highs… and move higher still.

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