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.
THE KEY FUNDAMENTAL: The Precious Metal Investor’s Secret Weapon
As I mentioned in the beginning of the article, precious metal investors and analysts don’t realize there is a secret weapon at their disposal. This key fundamental is something even those at the FED & Central Banks are unable to manipulate. It is the EROI — Energy Returned on Invested.
There is a reason why that EROI icon above is apart of my logo on my website. The EROI is the most important fundamental relationship that determines the success or failure of a all living systems including all businesses, corporations, societies and civilizations.
The Collapse of the Roman Empire and the Falling EROI
There has been a great deal of debate on the reasons why the Roman Empire collapsed. Some say it was due to the decline in morals, while others say it was due to either the debasement of the currency, high taxation, corruption, expensive wars, decay of infrastructure, and so on and so forth.
However, the real reason the Roman Empire collapsed was due to the falling EROI of their civilization.
The EROI can be simply explained by how much energy is returned by the energy invested. Some like to use the abbreviation of EROEI, but I find the less letters the better. Even some of the top minds who research this subject use EROI to describe it.
The rule of thumb is this… the higher the EROI ratio the more energy profits which may translate into a higher percentage of financial profits and gains. Individuals need to realize ENERGY DRIVES THE WORLD MARKETS… NOT FINANCE. Finance only steers the markets. And as I have stated before, finance is presently steering the world over the cliff.
Let me give an hypothetical example of the EROI at work. Let’s assume a family owns a business and is doing so at an EROI of 3/1. For each unit of energy they use or consume, they have 2 units of energy left over as a profit…. not 3 as one unit represents the energy consumed. A break-even EROI would of course be a 1/1 ratio.
They take these 2 energy units which are converted to money by the market to maintain their household and have 1 unit left over to put into a local bank as savings. I realize some of you may not agree with this theory, but just follow along for a time being. Furthermore, if we were to assume that the other families in the town averaged about the same 3/1 EROI and deposited their 1 unit of energy profit as money in the bank, there would be a great deal of money (energy profits) deposited over a period of a year.
Let’s also assume this money was in the form of gold or silver. Just think about all the work and energy by all the families that went into producing that 1 daily unit of energy profit that has accumulated in the bank.
Now, one day two strangers ride into this town (circa 1800’s) with a few firearms. They go to the local saloon, grab a bite and a few shots of whiskey and then head over to the local bank. There, they calmly walk in and hold up the bank and ask for the all the gold and silver in the bank vault. After a few minutes work, they leave the town with a great deal of money.
If we think about the EROI of the bank robbers it could be something like 10,000+/1. If you add up the energy (money) they invested in their lunch and whiskey, plus all the energy they expended in riding to the town, robbing the bank and their grand escape, you will find out it was a fraction of a fraction compared to all the energy units that were now stored in those gold and silver coins resting in their saddle bags.
I realize this simple example may stir up some debate, but this very same method was in fact the very same business model practiced by the early rulers of the Roman Empire.
In the beginning stages of the Roman Empire, it took very little in the way of energy costs to raise, train and use the Roman Legions to win the battles to acquire more lands. These lands contained great energy wealth stored in either stolen riches, mines, agricultural lands, timber and human labor.
Here we can see that the EROI of using armed forces to acquire riches, wealth and lands by the Roman Emperors was quite similar to the two robbers stealing the gold and silver from the local bank. Sure, there was more energy consumed and more elaborate in the Roman Empire’s example, but relatively it is the same method.
Most of the lands the Roman Empire conquered in the early stages were no match for the well trained Roman Legions. However, as the Roman Empire grew, so did the energy costs to maintain its infrastructure, forts, and legions from invading forces.
Towards the end of the Roman Empire, the Emperors found themselves in a dilemma. They had the forces to conquer the Northern Germanic Tribes, but there was very little in the way of wealth. On-the-other-hand, the Persians in the south had a great deal of stored energy wealth for the taking, but the cost was too great. In both examples, the Energy Returned On Invested (EROI) was too low to maintain the Roman Empire’s bloated system.
So, as the Roman Empire stagnated under the weight of increased energy costs to maintain their huge lands, legions and its society, the EROI ratio declined to point where the Emperors had to resort to debasing their currency to maintain the illusion of prosperity.
The days of high EROI were now over for the Roman Empire. As societies become more complex, the EROI of the system declines. Typically, the rulers will try to fight the negative forces of a declining EROI by raising taxes, debasing the currency or other desperate measures. However, it always fails in the end.
Now, that we have a basic understanding of the EROI and its impact on complex societies, why is the EROI a SECRET WEAPON for the precious metal investor?
THE FED: The Violator of the EROI
Due to the Fed and Central Bank market rigging, the precious metal paper prices have fallen into the toilet. The forecasts of $1,000 gold by the MSM hacks doesn’t seem so ridiculous now that the price of the yellow metal is only $100 from that level.
Well, let me say this… they may be able to postpone the collapse of fiat based financial system money due to a falling EROI, but they will never be able to stop it. The FED and the majority of the fiat monetary mouthpieces have no clue on how energy or the falling EROI relates to the economy.
As I mentioned before, the world is driven by energy. Energy is the basis of our monetary system, whether you want to believe it or not. The majority of the people in the world’s economies have to abide by the RULES of the EROI. They work very hard to produce a small degree of energy profits in which they exchange for fiat monetary notes.
As the world’s economies become more complex, the EROI ratio declines. So the governments resort to increasing taxes, printing money and waging wars to obtain high EROI energy sources from foreign countries.
This is how the FED and Central Banks violate the EROI. Today, we are at the last stages of this CHARADE as the FED and Central Banks realize that printing money no longer provides enough bang for the buck. So, they now have to purchase their own Treasuries, Bonds and other more worthless paper financial instruments such as Mortgage Backed Securities.
As the FED purchases $85 billion a month of U.S. Treasuries and MBS, it adds another $85 billion worth of ENERGY IOU’s rather than real assets to its balance sheet. We must remember everything is based on energy. Thus, ENERGY = MONEY
A long dated treasury or MBS is nothing more than debt instrument only settled in the future by the economic growth based on the burning of energy. The FED is basically trying to postpone the falling EROI of our economic system by propping up the present economy by adding massive amounts of energy debts to its balance sheet –the same is also true for the U.S. Govt.
Thus, the FED has debased the value of the energy profits by way of fiat money. The public does not realize the loss of value because they have been indoctrinated to believe that fiat money is real money.
Why Gold & Silver Are Real Money
Gold and Silver represent real money because they are stores of what I call ‘TRADE-ABLE ENERGY VALUE”. Each coin of gold and silver contain a certain amount of stored energy value… which is paid in full.
Most precious metal analysts who say gold and silver are true stores of wealth, believe so because they don’t offer any “counter-party risk.” I agree, but I would like to add the following footnote. Gold and Silver don’t have counter-party risk because they are don’t have any ENERGY DEBTS attached to them.
The problem with most paper assets including gold and silver futures options and other derivatives is that their values are derived in fiat monetary system. Fiat money is based upon the debt of the respective governments via their treasury and bond markets. Again, treasuries and bonds are not assets… they are energy iou’s. The tremendous growth of the world’s bond markets is just another way of disguising the falling EROI of the world’s economies.
This recent take-down in the paper price of gold and silver is an attempt by the fiat monetary authorities to COVER-UP the true barometers of stored energy value. We must remember, just as the Roman Emperors debased their currency to try and offset the declining EROI forces, the Fed and Central Banks are presently continuing this same folly.
While some central banks participate in the debasement of their currencies, they only do so because they presently have no other choice as they are tied to the global fiat monetary system. However, these central banks are quietly acquiring large amounts of gold because they realize the historic nature of true stores of wealth.
Furthermore, the EROI ratios of the energy sources that run the world’s economies are continuing to decline. The United States EROI of oil and gas has fallen from over 100/1 in the 1930’s to under 10/1 presently. Even though there may be a great deal of Shale Oil sitting underneath the United States, it suffers from both a very low EROI ratio and high annual decline rate.
I am completely surprised by analysts who are putting out flyers and bullish analysis of the Shale Energy Industry. They honestly believe shale oil wells that suffer annual decline rates of over 40-50% are going to offset the world’s 5% global decline rate from existing fields.
According to the IEA, the world needs to add 4-5 million barrels a day of new oil each year just to keep production from falling. Any analyst who believes shale oil is the next “GREAT INVESTMENT” and energy savior, fails to comprehend simple 5th grade math. As I mentioned before, the world is full of lousy analysis.
Getting Back to the Silver Miners
When I provide data and information that reveals the reality of the silver mining industry, I do so to get to the real truth. I have a great deal of respect for the CEO’s, management, staff and employees of silver mining companies.
They actually produce a necessary metal for industry and provide a great store of energy value for investors who understand real wealth. The gold and silver miners are the true wealth creators and money providers in the world, whereas the present banking system we have actually steals and siphons this wealth. The are in fact a LEECH on society.
At the current $18 paper price of silver, nearly all the primary miners would be stating net income losses. Some of the miners may cut costs and spending to at least tread water, but other much higher cost miners would be severely impacted.
What the Fed is doing to manipulate the precious metals lower while inflating the value of PAPER ENERGY IOU’s such as Treasuries, Bonds, MBS, Stocks, IRA’s, Pension Plans etc and etc, is actually creating an ever-increasing unstable financial system.
The best thing to do to take advantage of much lower silver prices, investors should be purchasing silver bullion and coins by the droves. Even though it seems as if the paper prices of silver can keep falling, it seems highly unlikely that the FED and Central Banks would be stupid enough to allow the bankruptcy the ENTIRE PRIMARY SILVER MINING INDUSTRY.
Yes, I realize 71% of silver production comes from by-product metal producers, but I would also like to add (according to the 2013 World Silver Survey) the 221 million oz of the total 787 million oz of silver came from the primary silver miners in 2012.
The rumor that the FED may be orchestrating this huge take-down in the paper price of gold and silver to provide large profits to help recapitalize the very banks (who control the precious metals futures markets) may not seem so crazy after-all. If we think about it, how on earth could these bullion banks survive with record short positions in gold and silver right after the FED announcement of QE3?
The majority of the world has no idea of the power of owning gold and silver. As the global economic system continues to disintegrate, people will realize paper based ENERGY IOU’s are not real assets or stores of wealth. When the world makes the transition from holding increasingly worthless debt based instruments and into physical stores of wealth such as gold and silver, we will witness the greatest explosion of value in these TRADE-ABLE ENERGY ASSETS.