When considering diversifying an investment portfolio, many investors consider the four main assets classes – equities, bonds, cash, and property – before other less traditional assets. Becoming more common, though, is diversification into precious metals. Most often this is into gold, but, with the gold price so high, increasingly silver is the metal of choice for the canny investor.
Just like gold, silver has qualities that make it a good store of value in times of economic and political uncertainty and a good hedge against inflation. As a natural resource, supplies are limited and will become more so over time. Unlike gold, silver has far more industrial uses as well as being seen as a metal in the production of jewelry and currency.
How to invest in silver
There are plenty of ways to invest in silver. Investors can buy physical silver in the form of bullion coins and bars, Exchange Traded Funds are becoming more popular, and then there are futures contracts and silver certificates. But an often overlooked method of investing in silver is to invest within one of the four traditional asset classes, and buy the shares of silver mining companies.
Doing so gives exposure to the silver price, without the need, inconvenience, and cost to store coins or bars, nor the complexities of dealing in futures, and without the hidden management fees incurred within an ETF structure.
But an investor has to remember that exposure to silver through the shares of silver mining companies is not a direct exposure to the price of silver. There are other factors that affect the price of equities, such as tax, legal considerations, exploration and mining costs (including wages and transportation) and so on.
So when deciding in which mining companies to invest, an investor should consider the type of mining company he wants to invest in, particularly with regard to the risk assumed in the investment.
Type of Silver Mining Companies
There are three basic types of mining company:
These companies produce silver as a by-product of mining for other metals and minerals, such as gold, copper, or zinc. Silver is almost a secondary product, and as such these companies are less prone to be affected by the price of silver alone. Just like an investment portfolio that has been diversified, should the silver price collapse – or rise strongly – the value of a conglomerate will move less aggressively than a more focused investment into silver.
Conglomerates, then, do not offer an optimum equity investment into silver, but they do tend to be large, well-researched companies. This means that it is generally easy to gather information about such companies and conduct in-depth research. Because their products are diversified, there tends to be less price volatility, though this has the downside of usually lower returns.
Companies that fall into this category include the likes of Rio Tinto, BHP Billiton and Xstrata.
Junior Exploration Companies
At the other end of the risk scale are the junior exploration companies. These companies are small and often have high costs that build up rapidly as they hunt out silver deposits. Share prices are usually low compared to the conglomerates, because they don’t produce any silver. An investment into an exploration company is a speculative play on the speculative business of exploration: there is no guarantee that the company will strike a rich vein of silver before its capital runs out, but if it does then its value could skyrocket.
Often such companies are bought out by the larger conglomerates once they have struck silver. In this way the conglomerate does not incur high exploration costs.
Profits on the shares of junior exploration companies can be huge, but so too can losses. For this reason, most investors into this type of company will invest in the shares of several companies, thus diversifying risk while ‘hoping to hit the big one’.
Companies in this category include First Majestic Silver and Impact Silver.
Silver Specific Mining Companies
Sitting between the relative cautious risk of an investment into conglomerate mining companies, and the speculative risk of the exploration companies, lays the companies that are almost solely focused on silver mining.
Again the correlation to the silver price won’t be exact due to the outside factors on share prices as discussed above, but it will be far more akin than an investment into a conglomerate.
Increase the chances of investing well
Like any investment, the success of an investment decision will depend upon the research conducted prior to investing.
One of the attractions of investing into silver mining shares is the disconnect they display from the silver price on occasions. This predominantly is because of sentiment pro and anti- silver. When market sentiment falls against silver, silver mining shares will often fall further and faster in price than the underlying price of silver. A main reason for this is because of the relationship between the cost of mining and the value of silver mined: the more bearish the market is about the silver price, the tighter it will believe margins will become and the lower the earnings of miners will fall. When such sentiment reverses, the prices of silver mining companies often gain strongly, reversing the trend of under-performance versus the silver price into a period of out-performance.
When researching silver mining companies for investment opportunities, an investor should give consideration to the following factors;
- The quality and amount of proven silver reserves, including the cost of mining;
- Production forecasts;
- The quality and history of company management;
- Return on equity and assets;
- The company balance sheet (does it have a strong financial position, and good cash flow?)
In addition, other factors that will affect share prices of specific silver mining companies will be the exposure to political and environmental uncertainty, as well as labor relations.
The Final Call
Because of the factors discussed above, investing in silver mines is not the same as investing in the metal itself. But doing so does have certain advantages over storing bullion, particularly in cost and convenience. But buying shares of silver mining companies does offer a diversification of asset exposure within equities, and can also be used as part of the riskier portion of an investment portfolio.
Whatever the reasons for investing in silver miners, whether it be for speculation, hedging, or diversification, good solid research before an investment is made will increase the chances of spotting the next winner.
Always be aware that an investment in silver mining companies is not a pure play on silver, it is also a play on the company itself.