PAAS - SLVP May Not Perform Well Amid A Gloomy Silver Outlook

2023-06-23 01:01:23 ET

Summary

• Silver prices are expected to fall, global silver demand is likely to weaken this year, and conditions for silver mining in Mexico and Peru are not exactly good right now.
• The iShares MSCI Global Silver and Metals Miners ETF receives a Sell rating based on the worsening outlook for silver prices and fundamentals.
• The SLVP ETF is heavily invested in silver mining and exploration companies, which will be negatively impacted by the expected gloomy outlook for silver.

This analysis confirms the Sell rating for the iShares MSCI Global Silver and Metals Miners ETF ( SLVP ) given in the previous article .

The Sell rating was based on the expectation that lower silver prices would impact the silver and metals mining and exploration companies in which the Fund invests.

This analysis yields the same assessment as it assumes that the silver price outlook has not improved since then. It also forecasts further headwinds from weakening global demand and a less favorable environment for silver miners in Mexico and Peru, both major precious metals producers.

The Outlook for the Silver Price and Its Fundamentals

At the time of writing, the price for an ounce of silver traded through Silver Futures expiring July 2023 (SIN3) is $23,133, a significant drop from June 14, 2023, when the Federal Reserve pioneered further rate hikes in 2023 to continue to fight against high inflation. Like gold, silver doesn't like the prospect of higher interest rates as they lead to increased demand for fixed-income securities, which are strong competitors for the non-income-paying precious metal.

This means that the price of the precious metal is unlikely to recover from current levels, but instead assumes an increasingly negative underlying trend under the pressure of potentially higher interest income.

But the price of silver could have declined more than it actually did under the prospects of a hawkish stance reiteration by the US Federal Reserve In fact, there are some concerns on the supply side of the precious metal which are preventing the price to take a steeper trend downwards.

Indeed, as the Financial Times reports , Mexico -- the world's largest silver producer -- is undergoing a regulatory change that should make the path to obtaining the various mining concessions significantly more difficult. The possible new regulatory framework for the exploitation of Mexico's natural resources is viewed with great concern by major silver producers as the reform could result in the loss of positive momentum in capitalizing on growth opportunities. The changes in mining legislation, which the central government says would ensure significantly more sustainable mining and exploration activities, have 180 days to become fully enshrined in law. Should this happen, many large North American silver producers in Mexico could decide to significantly reduce their investments in new mineral projects, as well as slow mining activity in already-producing deposits.

As for Peru - the third largest silver producer in the world - the confrontation with a spate of licensing and social backlash poses a very high risk that the recovery of silver mining production will stagnate in the medium term, reports Latin America's leading business intelligence platform bnamericas.com . In such a scenario, the English business intelligence company CRU International Limited forecasts two significant copper concentrate deficits, which will occur in 2025 at around 300 metric tons and in 2026 at 500 metric tons, bnamericas.com also reports.

However, given the reduced global supply of silver, it will remain difficult to reach a consensus on a high price per ounce, as global demand for the precious metal will likely not increase further after its peak in 2022, but weaken significantly.

In fact, the Silver Institute predicts a 7.3% year-over-year decline in global silver demand to 1.15 billion ounces by 2023, as the industrial demand for silver is expected to be fully offset by a drop in demand for jewelry and a drop in physical silver investments due to lower prices, lack of volatility and reduced investment in India.

Additionally, this analysis anticipates that the increased cost of money to combat runaway inflation will impact industrial silver demand, and as such, its vision is not in line with the Silver Institute's projections for industrial silver demand. In fact, the prospect of paying higher interest rates on borrowed money will not encourage additional commitment to green infrastructure, using renewable energy to reduce dependence on Russia's fossil fuel products, or funding efforts for a low-carbon economy.

As a result, the operating profitability of US public companies that produce and sell silver will face multiple headwinds: price, weaker global demand, and deteriorating conditions for conducting mining operations in Mexico and Peru, the world's largest and third-largest silver producers, respectively. As for the latter factor, changing local conditions for mining in Mexico and Peru will not have a positive impact on the sales and profits of US-listed silver stocks as these companies have concentrated a significant portion of their mining activities in these two silver lands.

The market value of these US-listed silver mining and exploration stocks will likely reflect the deterioration in their key drivers, and the impact on an entire sector is easy to imagine at this point. So, this analysis assumes that it would be better not to increase positions in these companies, but to reduce them if there is an opportunity to make a good profit.

The iShares MSCI Global Silver and Metals Miners ETF Receives A Sell Rating Based on this Analysis

This analysis suggests selling shares of the iShares MSCI Global Silver and Metals Miners ETF ( SLVP ) as this fund tracks the investment results of an index composed of stocks of global silver miners and explorers.

As shown by the below screenshot from the website of the fund launched by BlackRock, Inc. ( BLK ) on Jan 31, 2012, and managed by BlackRock Fund Advisors, SLVP is almost entirely invested in US-listed stocks of silver mining and exploration companies.

Shares of iShares MSCI Global Silver and Metals Miners ETF were at $9.60 apiece as of this writing, giving it a market cap of $163.2 million as the fund has 17 million shares outstanding. The shares are traded on the Cboe BZX Exchange (formerly known as the BATS Exchange). The exchange is located in the United States while regulated by the Securities and Exchange Commission [SEC] and Financial Industry Regulatory Authority [FINRA].

The ETF has a net asset value [NAV] of approximately $163.45 million as of June 21, 2023, or approximately $9.615 per share. This means that the fund is currently trading at a 0.2% discount to the NAV.

Shares are also below the 200-day simple moving average value of $10.38, the 100-day simple moving average value of $10.73 and below the 50-day simple moving average of $10.87. The shares are also below the middle point of $10.195 of the 52 Week Range of $7.86 to $12.53.

Nonetheless, due to a worsening outlook for silver prices and fundamentals, and due to the strong positive correlation between SLVP and the price of the precious metal, this analysis suggests reducing the position and taking some profit from the investment.

The chart below shows the correlation coefficient [CC] between SLVP and silver futures expiring in July 2023 (SIN3).

The correlation is positive and very strong, not because of the value of 0.34, but because the curve describing the development of the CC over the past year is almost entirely present in the upper part of the chart (that is above the zero line).

This means that SLVP shares will most likely follow the same trend if the price of silver falls, as predicted by this analysis based on the various elements above.

This analysis has also determined a coefficient that can estimate how much, on average, the SLVP fund's market price could potentially fall if the price of silver falls by one percentage point. Known as the silver beta, this coefficient has a value of 0.95x and comes from a model that relates weekly returns of SLVP ETF traded on the Cboe BZX Exchange into a linear relationship with weekly returns of Silver Futures expiring in July 2023 (SIN3). This model is based on the assumption that SLVP is the effect and SIN3 is the cause in the linear relationship. The model was run over the last 52 weeks ending June 18, 2023. This analysis does not go further back in time as markets are likely to look more like how they were for the past 52 weeks than previous periods as most of the same factors are likely to persist. These are inflation, impending economic downturn, geopolitical tensions, and the war in Ukraine. So, the coefficient implies that if the price of silver loses $1 per ounce at the end of a market session during the expected downtrend in silver prices, the SLVP ETF share price should potentially fall $0.95 at the end of the same session. The silver beta of 0.95x has a coefficient of determination [R²] of 64%, which means that the model has a good degree of confidence in predicting the outcome, as this indicator ranges from 0% to 100%.

Headwinds from Problems Affecting the Silver Mining and Exploration Industries in Mexico and Peru

Additionally, the market value of the SLVP ETF on the Cboe BZX Exchange will certainly be impacted by the unfavorable scenario for silver mining and exploration activities in Mexico and Peru as the fund also includes investments in companies active in these two countries.

The fund manages 34 positions. The first 9 holdings are ranked by market value/weight as shown in the screenshot below and form a representative sample to show that the SLVP ETF NAV is highly dependent on silver production and exploration activities in Mexico and Peru.

Pan American ( PAAS ) is a leading precious metals producer in the Americas. Of the total proven and probable silver reserves of 479.7 million ounces as of the end of 2022, Mexico and Peru together account for 40.4%.

Hecla Mining Company (HL), a precious metals producer in the United States, is advancing drilling activities, surface and underground targets on the San Sebastian mineral property near the city of Durango, Mexico. Geophysical investigations are also being carried out there. San Sebastian accounts for approximately 8% of the company's $45 million in exploration spending, with a focus on evaluating metal mineralization near the surface and in the underlying deposits. Thanks to high-grade ore mining, San Sebastian has been one of the highest-grade silver producers in Mexico, producing a total of 12.45 million ounces of silver over a five-year period from 2016 to 2020. The company intends to resume silver production on the San Sebastian mineral claim.

Industrias Peñoles, SAB de CV ( IPOAF ) - a Mexican exploration and mining company for mineral concentrates and ores in Mexico, North America, Asia and internationally - recorded a 4.1% contribution from the Mexico segment to total silver sales in 2022, representing 28.7% of total sales of $5.523 billion.

Newmont Corporation ( NEM ) is a precious and base metals explorer and miner based in Denver, Colorado with minerals activities in America, Australia, and Africa. More than 77% of the company's proven and probable silver reserves of 568.14 million ounces (as of December 30, 2021) are held throughout Mexico and Peru. The Peñasquito mine in Mexico contributes significantly to the overall production of the precious metal.

MAG Silver Corp. ( MAG ) has just achieved commercial production from its principal asset, a 56% interest in the Juanicipio silver mine in Mexico, which produced approximately 3.2 million ounces of silver from March to May.

Agnico Eagle Mines Limited ( AEM ) - a Canadian precious metals exploration and mining company in the Americas, Australia and Finland - produced 1.1 million ounces of silver in 2022 from its two mines of Pinos Alto and La India in Mexico.

Wheaton Precious Metals Corp. ( WPM ) is one of the world's largest precious metals streaming companies and has a portfolio of low-cost, durable mineral assets, including the silver stream at Newmont Corporation's ( NEM ) Peñasquito mine in Mexico.

First Majestic Silver Corp. ( AG ) is a Canadian operator of precious metals production facilities at the following Mexican mines: the San Dimas property across Durango and Sinaloa states, Santa Elena in Sonora state and La Encantada in Coahuila state.

The fund has significant exposure to silver mining and exploration activities in Mexico and Peru. As such, I believe that the problems currently facing the silver mining and exploration industries of these two countries will create headwinds for the companies operating there and will therefore negatively impact the market value of SLVP shares.

The screenshot below - taken from the fund's website - shows how the market value of the fund tends to track changes in net asset value over time, which together with the distributions paid by the fund contribute to the total return.

The table above shows the cumulative performance of the iShares MSCI Global Silver and Metals Miners ETF as of May 31, 2023.

According to Seeking Alpha, SLVP pays a semi-annual dividend that was $0.04 per share as of June 13, for a dividend yield of 0.53% as of this writing.

The company notes that 'after-tax pre-liquidation' means "after-tax return on distributions. Assuming fund shares were not sold."

The company notes that 'after-tax post liquidation' means an "after-tax return on distributions and shares of the fund sold".

Furthermore, SLVP says that from August 10, 2020, market price returns are calculated based on the closing price and taking into account the fund's distributions. Prior to August 10, 2020, market price returns were calculated based on the mid-market share price and taking into account any distributions paid by the fund. The mid-market share price is calculated as the average of the bid-ask prices at 16:00 ET when most funds display the NAV.

Finally, the fund assumes an expense ratio of 0.39%.

Conclusion

Silver prices are expected to fall, global silver demand is likely to weaken this year and conditions for the silver mining and exploration industries in Mexico and Peru are not exactly good right now. Mexico is the world's largest silver producer, while Peru is the third largest silver producer in the world. Because the SLVP ETF has invested in holdings of silver mining and exploration companies, shares are unlikely to fare well this year.

Investors may want to free up some cash to invest in fixed-income securities. The Fed has hinted at an additional anti-inflation program through further rate hikes favoring fixed-income assets, such as bonds, over safe-haven assets, such as silver and silver-backed securities, including SLVP.

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