The outlook for the silver price, based on supply-demand fundamentals, is very compelling, while it is a very thin market, meaning the price is susceptible to sharp run-ups providing investors with good profit opportunities. At the same time, there are relatively few good stocks with exposure to silver; the traditional standbys are either bankrupt (Sunshine), mine more gold than silver (Hecla), or such that you might not want to own (Coeur d’Alene). Some of the biggest silver producers are diversified mining companies, with very little exposure to the white metal.

There are, however, a handful of solid companies with good leverage to silver, suitable for investors with different risk profiles. We’ll look at these in a minute. First, let’s look at silver itself.

Silver’s supply demand outlook is positive

The fundamentals for the market are strong. There has been a deficit between current supply and demand every year since 1990. At the beginning of this period, the deficit was met with drawdowns from large stockpiles.

Although the deficit has shrunk in recent years, known stockpiles have shrunk even more, representing today an estimated four months worth of supply. This compares with over 17 years worth of supply for gold, admittedly not a completely fair comparison. Nonetheless, known above-ground supplies have fallen sharply; according to the Silver Institute, identifiable silver stocks (including Comex, European dealers and government stockpiles) have fallen almost exactly in half from 1994 to today’s 700 million ounces.

So even as the current deficit has shrunk, there are fewer and fewer stockpiles to bridge the gap. This means the price must rise to reduce demand and increase supply.

Digital photography not a big threat

Demand has dropped marginally from the late 1990s, primarily because the recession of 2001 and 2002 reduced electronic demand. Demand for silver in photography has remains relatively constant over the past 10 and more years, despite the growth in digital photography (which uses no silver). Though this appears incongruous, it can be easily explained: digital photography use has grown, but only in North America and Western Europe. At the same time, in these regions, the use of disposable cameras, which do use silver to develop film, has also grown. Similarly, in the underdeveloped world, photography has grown in popularity, and it is primarily through traditional silver-based film.

Perhaps most compelling of all is the fact that some 70% of silver used in photography is recycled, so if the demand for silver in photography were to decline, so too would the supply of metal available for recycling. Moreover, other new uses for silver has arisen; flat screen televisions, for example, are significant users of silver.

In addition, there is a lack of new supply over the next few years. New mines supply will be flat to modestly rising over the next five or more years. Even in the “best” circumstances, if even known economic deposit were to come on stream, the increase in mine output-allowing for declines from mature mines-would be only 5% per year. So the outlook for silver and the potential for sudden price spikes is very real.

There are only a handful of pure silver companies

But the paucity of good-quality companies with sensitivity to silver remains. We like a handful, each with its own potential and risks, suitable for different types of investors.

One of our long-time favorites is the silver-indexed Freeport preferred D (FCXprD, NY), which pays a quarterly dividend and redeems based on the prevailing silver price. These partial redemptions, annually for the equivalent of half an ounce of silver, have nearly run their course; there will be a redemption of half the value of the issue in August with the final maturity one year later.

Thus buying the preferred today means one will receive about half that back in two months as a return of capital, and one is betting on the silver price appreciating over the next 14 months to make any profit. In addition, there is a quarterly dividend approximating to a 4% yield (at today’s prices). With the stock selling (at $7.27) at a modest discount to NAV-silver closed at $7.40-it is a relatively conservative way of investing in silver, though clearly not a long-term investment.

An innovative investment offers low-risk returns

Another relatively conservative investment is an innovative vehicle that came out towards the end of last year. Silver Wheaton (SLW, Toronto, C$3.77) neither mines nor explores for silver but acquires the silver revenue stream from other mining companies. It does this by making an up-front investment and a clearly defined cost per ounce. It is thus not dissimilar to a royalty company, and has modest risk, but positive upside should the silver price appreciate.

Its main risk at present perhaps is the small number of mines in its portfolio, but the company, run by Ian Telfer (CEO of Goldcorp which recently merged with Wheaton River, from which Silver Wheaton as spun off), has aggressive growth plans. It is arguably the least expensive of the silver stocks, certainly selling at a significant discount to the NAV of the producers and exploration companies.

The world’s largest primary silver producer

Pan American Silver (PAAS, Nasdaq, 14.40) is neck-and-neck as the world’s largest primary silver producer (and will probably overtake Coeur d’Alene this year). It has six producing mines throughout the Americas, with another two scheduled to commence production in the next two years. It production growth over its 10-year life has been phenomenal.

But it has production risk, and this has been amply demonstrated over its history, with production losses and difficulties at many of its mines at different times. Indeed, Pan American reported its first ever earnings at the end of last year. In the latest quarter, it was back to a loss as costs rose (with cash costs up 72 cents to $4.50 an ounce).

Nonetheless, the company is well run, has a solid balance sheet (with virtually $100 million in cash and no debt), and a strong growth profile. The stock is highly liquid and an institutional favorite, so in a sustained silver bull market, Pan American should be a prime beneficiary.

Top exploration company has matured

My favorite exploration company is Silver Standard (SSRI, Nasdaq, 11.77), though to call it such belies its tremendous growth in recent years, and its near-term productions potential. The company has among the largest silver resource of any company, with almost 1 billion ounces of silver at 17 projects in seven countries. But the company has no producing mines, preferring, until recently, to eschew production to avoid the pitfalls that often accompany mining, as well as to keep its resources until prices are higher.

Partly for this reason, and because it is among the purest of the silver companies (with over 2/3rds exposure to the white metal), the stock has arguably the most leverage to silver of any silver stock.

More recently, given the higher silver price-at $7.40, not far off its recent high, and nearly twice where it traded throughout most of the 1990s and 2000s-as well as the company’s greatly increased balance sheet, the “no-production” policy has shifted. Though the company intends keeping most of its projects “in reserve” for now, it is advancing towards production at several projects and will likely be producing at two (or even three) projects within the next couple of years.

Near-term production and two high-growth exploration projects

These include Manantial Espejo, a joint venture in Argentina with Pan American Silver, which will be the operator, and a second, one of two exploration projects returning exciting results, and at which Silver Standard is exploring aggressively.

One of these is Pitarrilla in Mexico, a grass-roots venture 18 months ago. Results have been very strong; one hole returned 385 feet of 2.4 ounces per tonne of silver (including 105 ft of 6.6 oz), and the project is already at the pre-feasibility stage. At its new Berenguela project in Peru, where Silver Standard has an option to earn the silver revenue from this copper-manganese mine, recent exploration returned strong results, including a phenomenal hole of 213 feet averaging 18 ounces of silver per tonne. Both of these projects has the potential to grow significantly through Silver Standard’s aggressive drill program.

In the past, given its lack of production, the company was forced to make several trips to the equity well to fund its ongoing exploration and acquisition work. Although the process was always accretive, as silver and gold resources per share grew consistently over the years, from less than 10 ounces per share in 1998 to over 20 ounces per share today (over $150 worth of metal in the ground for each share), nonetheless it kept a lid on the stock price.

Strong balance sheet and quality management

Today, however, as a result of these equity issuances (and their accompanying warrants), the company is extremely well financed, with cash of US$33 million and another $14 million of physical silver. Together with marketable securities, the company has over $50 million, with another C$14 million to come in from in-the-money warrants.

All in all, the company is in the enviable position of being able to fund all its activities, including its share of capital costs, from existing resources, putting it in a very strong position to negotiate with lenders.

Like Ross Beaty at Pan American, Silver Standard’s Robert Quartermain is known as a cost-conscious and ethical manager, as well as for his technical skills.

These four stocks offer the investor good leverage to the silver price in low-risk companies, three of which also have inherent growth potential. All are good buys at their current prices.
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Adrian Day is President of Adrian Day Asset Management, which offers discretionary accounts in both global and resource markets. He may be reached by phone at 410-224-2037, by mail at P.O. Box 6643, Annapolis, MD 21401, or on the internet at www.AdrianDay.com.