Markets are egregiously inefficient, which means that there are a plethora of opportunities for those investors who are able to spot irrational market behavior and exploit it. One such opportunity is in shares of the tiny silver mining company, SantaCruz Silver Mining (SZSMF.PK).
Over the past several months, shares of SantaCruz Silver Mining have underperformed both the price of silver and the price of silver miners more generally, as measured by the Global X Silver Miners ETF (NYSEARCA:SIL). However, the fundamentals do not support this underperformance — SantaCruz has recently made meaningful advances towards growing its resources and becoming a multi-million ounce producer. Not only has the company ramped up production at its flagship mine, Rosario, but we saw a huge boost recently in its total resources at the company’s (formerly) tertiary property — Gavilanes. With this in mind, SantaCruz shares should have outperformed the broader sector, and consequently, I think the shares have significant upside in the near future even if the price of silver remains at around $20/ounce.
An Overview of SantaCruz Silver Mining
SantaCruz Silver Mining has an interesting strategy: it plans to develop small and inexpensive mines on its Mexican properties in order to generate a small amount of cash flow in order to further explore its these properties. The company paid just $10 million in order to bring its flagship property, Rosario, into production. By the end of the year, this production should reach an annualized rate of 800,000 ounces of silver equivalents (i.e. silver plus lead, zinc, and gold priced in silver terms). By employing this strategy, management hopes to fund its own exploration and incremental expansions of its producing mines without seeking large amounts of outside capital. This is a very appealing approach because it limits the amount of dilution that existing shareholders have to endure.
The company has three primary properties — Rosario, San Feliz, and Gavilanes. Rosario is a small producing mine that contains about 12.5 million ounces of silver. Production has been increasing from virtually nothing over the summer to hopefully 800,000 ounces on an annualized basis by the end of the year. Furthermore, the silver here is high grade — 300 grams (about 10 ounces) per tonne, which means that the operation will likely be profitable and it will generate significant cash-flow that the company can use to expand its resource.
San Feliz has a smaller resource of just over 5 million ounces of silver equivalents. It, too, is a relatively high grade deposit, which means that once it goes into production, it should be profitable. Right now, SantaCruz is working on a feasibility study to determine the cost of developing the mine, how much the mine can produce, and what it will cost the company to produce an ounce of silver. This report has been delayed somewhat, but it should come out some time early this year.
Gavilanes became a valuable property in SantaCruz’s portfolio just over a month ago when the company put out a news release that stated that it contains a sizable resource. It is this recent development that was somewhat unexpected, and it is the primary reason why I believe the company’s shares should be outperforming other silver miners. Let us see why.
Gavilanes Becomes Pivotal
Prior to the December 17 news release, Gavilanes was SantaCruz’s least important property. True, it was being explored aggressively with tangible success, but it didn’t have a defined resource base. Meanwhile, the company’s other properties were far ahead of Gavilanes. As previously stated, Rosario was seeing initial production and San Feliz had defined resources and was undergoing a feasibility study. However, with the release of Gavilanes’ resource estimate, the significance of the project in the company’s portfolio suddenly became apparent.
In a nut-shell, Gavilanes has more silver than the company’s two other properties combined — even if we use the most conservative cut-off grade of 140 grams of silver equivalents per tonne of ore. While much of this silver is in the “inferred” category, which means that it has the lowest likelihood of being profitable to mine in mining jargon, the fact that the company announced such a large resource goes a long way in bolstering the case for SantaCruz shares.
The announced resource has the obvious direct quantitative benefit — the company has more silver so, statistically, it will be able to produce more silver and earn more money. But more importantly this impressive resource goes toward confirming one of management’s recent forward looking statements, namely that Gavilanes can produce by 2016. This speaks to management’s competence and credibility.
The fact that the resource is 24 million ounces of silver equivalents using the conservative cut-off grade indicates that production can easily top 2 million ounces annually. This would likely make Gavilanes the company’s largest producer. While it is difficult to predict actual production figures or costs without a more formal analysis, there is a high probability that the company will be able to develop a long-life mine (>8 years) with meaningful production compared to the company’s $62 million valuation.
This news probably should have sent the shares soaring 20 percent higher at the very least, and possibly more — it does not take much to get a small junior mining company’s stock soaring, but the stock is flat to slightly down since the announcement. Rather than attempting to rationalize this, I think investors should simply exploit the situation and buy the shares.
Before doing so, keep in mind that SantaCruz is a speculative investment. We don’t know how much silver the company is going to produce or how much it will cost the company to produce it. We also don’t know how expensive it will be to develop mines at San Felize and at Gavilanes. Therefore, investors should only devote a small portion of their portfolios to shares of SantaCruz, and they should try to buy on weakness.