Is This the Perfect Silver Portfolio?

Silver, precious metals

Yesterday, I wrote an article in which I provided a model gold portfolio to investors. The goal of the portfolio was to diversify the various risks to which different gold vehicles expose investors while leveraging exposure to the gold price and providing some income. In this article, I do the same thing for silver.

Different challenges arise when constructing a silver portfolio.

  • There are fewer silver vehicles than gold vehicles, and the silver exposure in the case of many mining companies is diluted by exposure to other metals.
  • Silver miners are having a difficult time making money with the price sitting just below $20/ounce, and this makes a silver portfolio inherently riskier than a gold portfolio.
  • Silver mining is a very small industry, and most of the players are extremely small with market capitalizations less than $1 billion, or even less than $250 million. Investors who want a well-rounded silver portfolio may have to purchase low market cap companies. Those who eschew small market cap companies are extremely limited in the kind of silver portfolios they can construct.

With these concerns in mind, I have decided to include five investments rather than four, which is the number of investments I included in my gold portfolio. When applicable, I will point out when the aforementioned risks apply, and this will give investors the knowledge base needed in order to get the kind of silver exposure that fits their particular risk preferences.

With that being said, this portfolio will still give investors leverage exposure to the silver market, it diversifies risk, and it pays a dividend that yields more than the S&P 500 assuming that each investment comprises 20 percent of the portfolio.

1. The Credit Suisse Silver Shares Covered Call ETN (NASDAQ:SLVO)

This fund is designed to track the price of silver while selling covered calls against its silver holdings. By selling covered calls against silver, the fund is able to generate a significant amount of income — over 17 percent annualized. Furthermore, it offers protection to the downside if the silver price falls considering that by selling calls the fund is effectively taking a small short position against the silver market. This sounds almost too good to be true. The downside is that this fund offers limited upside if the silver market strengthens. By selling covered calls, the fund is giving the buyer of these calls the right to buy the silver holdings from the fund at a fixed price regardless of spot price of silver. For example, the fund might sell a covered call that forces it to sell its silver at $22/ounce even if the gold price spikes to $25/ounce.

That’s bad news if you are bullish of silver. However, the other four holdings I have chosen should perform extremely well if the silver price rises. Thus, this ETF is designed to be a sort of hedge, although keep in mind that it will lose value if the silver price falls, and it will gain value if the silver price rises. It is just that these losses and gains will be smaller than those of the spot price of silver.

2. Silver Wheaton (NYSE:SLW)

Silver Wheaton is a silver streaming company. This means that it makes payments to mining companies in exchange for the right to buy an agreed upon amount of silver at an agreed upon price. This price is significantly lower than the current spot price of silver. For instance, in 2013, the company’s average cost was slightly more than $4/ounce.

While many silver miners have been underperforming the silver price in the past several years, Silver Wheaton has substantially outperformed. The company has an extremely simple business model that has fixed costs and that eschews many of the risks of mining. At the same time, the company provides a useful service to mining companies by providing them with capital they need in order to construct their mines.

The company trades at a little over 20 times its expected earnings and it pays a small dividend, although this dividend is correlated to its cash-flow and so it will be leveraged to the silver price.

One thing investors should take note of is that Silver Wheaton recently made a couple of gold deals, which means that only 75 percent of its revenue will come from silver. Thus, in order to justify a position in Silver Wheaton, one has to be bullish of gold as well as silver. Nevertheless, Silver Wheaton is still one of the better ways to gain low risk exposure to the silver market, and I suspect that it will outperform the spot price of silver going forward.

3. First Majestic Silver (NYSE:AG)

First Majestic Silver is one of the purest silver mining companies with around 85 percent of its revenues coming from silver. The company also has relatively low operating costs, and it is focused on mining in Mexico, which is a relatively low risk mining jurisdiction. Given the company’s relatively low risk portfolio of silver mines, the shares have outperformed. At the same time, the shares are not cheap because there are so few alternatives to First Majestic that are so well run.

Nevertheless, the stock has been weak with the rest of the sector. It has also had to take a write-down because all of its assets are in Mexico and Mexico recently instituted a mining royalty of 7.5 percent.

If the price of silver rises, the company is going to perform extremely well. Right now it can earn about $3/ounce of silver it mines, so even a modest rise in the silver price to $25/ounce means that the company’s cash-flow potential will more than double. However, there are cheaper companies out there, and more aggressive investors might want to focus on these and pass over First Majestic.

4. Silver Standard Resources (NASDAQ:SSRI)

Silver Standard Resources is a really intriguing investment.  The company owns an incredibly large silver mine — the Pitarrilla project in Mexico that is going to be able to produce over 10 million ounces of silver per year for decades. The problem is that it is not economical to construct with the silver price where it is. If the silver price rises substantially, then so will the value of Pitarrilla. This Silver Standard offers more leverage to the price of silver than virtually every other silver mining company. Thus, the company has been waiting patiently for the silver price to rise in order to realize the full potential of this mine.

However, the company is also focused on generating near term profits and cash-flow. Recently, it has been shedding non-core assets in order to purchase a cash-flow generating gold mine — the Marigold project in Nevada. This means that Silver Standard is now a gold company as well as a silver company.  This means that Silver Standard is another investment that I am listing here that only works if you are bullish on both gold and silver. The good news is that the Marigold mine is going to generate cash-flow now, which means that the company will be able to use this cash-flow to finance the construction of its Pitarrilla mine instead of having to dilute shareholders by selling stock.

Ultimately, Silver Standard is going to do extremely well if the silver price rises, but it also needs gold prices to at least remain where they are. Also, investors need to keep in mind that because the Pitarrilla mine will take roughly 3 years to develop that Silver Standard is a long term investment. But with that being said, I can’t think of a better way for investors to play a long-term secular bull market in silver without digging through micro-cap and nano-cap stocks.

5. Pan American Silver (NASDAQ:PAAS)

Pan American Silver is a steady silver producer with eight producing mines throughout the Americas. While it isn’t growing its production, it is reducing its costs. It is also paying the best dividend of any silver mining company at just under 4 percent. The company works well for investors who are bullish on the silver price but who are concerned about other company’s large future capital needs.

For instance, First Majestic Silver is going to be constructing two mines in the next few years and Silver Standard is going to construct one huge mine. Pan American Silver is not spending a lot of capital, and it has a cash and cash equivalent position of around $400 million versus a $2 billion valuation. It can use this capital to acquire one of its smaller competitors or to continue to buy back its own stock and pay a nice dividend.

Ultimately, while this isn’t the most exciting silver investment it fits well into most silver portfolios.

Disclosure: Ben Kramer-Miller is long Silver Wheaton, First Majestic Silver, and Silver Standard Resources.