Geopolitical Silver

Scott Wright, Zeal LLC
[Adam Hamilton's partner]
Jul 29, 2005

Considered a precious metal because of its rarity and alluring traits, silver has given investors and speculators a wild ride in today's commodities bull.

Though not experiencing the same popularity today as gold, silver's shining history dates back to the beginning of man and through the ages it has been a store of wealth and admiration. Today silver not only continues to hold these same sparkling qualities, but also provides indispensable industrial and technological functionality.

With the increasing popularity and usefulness of silver in today's day and age, more attention has been given to the gap between its annual supply and demand. As demand increases in our high-tech global economy, this precious metal is poised to continue its rise in price until this gap is brought closer together.

Even with its increasing popularity, silver continues to sport a volatile and small market compared to other commodities and has been largely ignored in the broad commodities markets. Even though silver has yet to pique mainstream interest, which I believe it will, it is certainly hard to overlook its performance in recent years on both the physical level as well as those equities that are directly leveraged to the price movements of the underlying metal.

Because of the fickle trading arena in which silver lies, investors and speculators who wish to continue to ride the silver bull will need to be ever-strategic and diligent in making their decisions. Not only do we need to understand the fundamentals and technicals of the individual companies in which we invest, but the geopolitical dynamics of where the metal is coming from.

In order to stay on top of the global silver market, we will take a top-down peek at the global silver mining industry and perform a high-level analysis of some of the major producing countries as well as look at some of the mining activity occurring within their borders.

When researching the various fundamentals of companies in which to invest, the international scope and dynamics of where a company does business should always be considered. Information like this may prove to be worth its weight in silver as investors and speculators alike place their faith and hard-earned capital into a given company.

Before we talk geopolitics, we need to lay the trail with some key information that all investors need to understand about how the silver mining industry works. What many people are unaware of is that silver is mainly mined as a by-product or co-product to other minerals. Interestingly, 70% of the silver produced in 2004 was mined in this fashion, which is actually a significant decrease from what it was in previous years.

Silver is generally mined as a by-product or co-product to copper, lead, zinc and gold. The ore that contains these minerals naturally contains other metallic elements such as silver. Companies that are primary miners of copper, lead, zinc and gold can sometimes extract an abundant amount of silver from their ore bodies and in turn become major global suppliers of silver.

What this boils down to is most of the top silver producing companies in the world do not regard silver as their main product or revenue source. In fact, only one of the top ten global silver producers in 2004 considers itself a primary silver miner. Many silver investors may not even be familiar with most of the names of these companies that rank in the top ten. Interestingly, one of the few that many are familiar with is elite gold miner Barrick Gold, which ranked sixth in global silver production in 2004.

Primary silver mines accounted for the other 30% of global silver production last year, a number that has escalated in recent years due to the current bull market. As investors and speculators look to leverage their capital into pure silver plays, those companies that consider themselves primary silver explorers and/or miners are the ones we want to pay particularly close attention to.

In 2004, 634 million ounces of silver was generated from global mine production, of which 53% came from just four countries. Mexico, Peru, Australia and China are the world leaders in silver production and provide some of the richest silver deposits on earth. We are going to take a look at these countries through our silver-tinted shades so we may paint a strategic picture of silver now and in the future.

Mexico: Mexico is a country very rich in natural resources. Its mining and agricultural industries have taken off since the ratification of NAFTA in 1994 as well as the implementation of numerous other trade agreements. In 2004, 99 million ounces of silver came out of Mexico, which stood as the largest quantity from any one country, just barely out-producing Peru yet again.

The Mexican mining industry has grown over the years and is primed to continue its growth into the future. Although there have been some isolated incidents in which property claims have been challenged by various ethnic groups, Mexico has been a relatively safe venue for miners to stake their claims.

The Mexican government has historically been pro-mining, especially since it brings up their struggling employment numbers. In recent years they have been welcoming of foreign capital and investment as proven by the droves of companies large and small staking property claims and constructing mines to take advantage of this commodities bull.

The overall Mexican economy has also been on the upswing in recent years as it continues to recover from its massive recession in the 1990s due to the devaluation of its peso. Its federal government has tended to operate a free-market economic system and has made impressive commitments to future economic growth. This style of government has been enhanced by its first freely-elected president in nearly 100 years who is a highly-active advocate of international relationships.

Mexico is home to the second and fourth largest silver producing companies in the world. Industrias Peñoles produced 45 million ounces of silver in 2004 and ranked as the second largest silver producer globally. Its stock, which is traded on the Bolsa Mexicana de Valores, is up over 500% since 2001.

Industrias Peñoles boasts the second highest producing silver mine in the world. Its mine in Fresnillo produced 32 million ounces of silver last year, which is three times as much as the next highest silver producing mine in Dukat, Russia.

Mexico is also home base for Grupo Mexico, which is the largest mining company in the country and one of the largest in the world. Grupo Mexico along with Industrias Peñoles are good examples of mining companies that produce silver as a by-product or co-product to other minerals.

Grupo Mexico happens to be the third largest copper producer in the world and the second largest molybdenum producer in the world. Its large copper mines that scatter the globe are rich in silver, so rich that this by-product ranks it as the fourth largest global silver producer.

Overall, Mexico is a solid and safe geopolitical region for silver miners and we continue to keep an eye on the activity within its borders. In addition to the large Mexican miners, there are several primary silver companies that are doing work in Mexico. Some of the major ones, Hecla Mining and Pan American Silver, have operational mines as well as advanced exploration projects in Mexico. And Silver Standard and Apex Silver both manage multiple exploration projects there that are rich in reserves and resources.

Peru: Peru is also a country very rich in natural resources. In addition to being the world's second largest producer of silver producing 98 million ounces in 2004, Peru is the world's number three copper producer as well as number six gold producer. Mining has been the lifeblood of Peruvian commerce for many years. It is reported that a staggering 55% of the country's exports in 2004 came directly from the mining industry.

Peru hosts three of the top ten largest primary silver mines in the world. Major miner Buenaventura is the largest Peruvian mining company as well as one of the most productive in the world. Though it is not a primary silver producer, it ranks in the top ten globally with its silver production. Its stock trades in the United States and has gone up over 400% since 2001.

Peru has also been a hotbed for up-and-coming silver exploration projects. Market darlings Silver Standard and Apex Silver have major projects along the Pan-American Highway, some in advanced stages, with much of the action in Peru. Pan American Silver also currently operates two silver mines in Peru that rank in size in the top fifteen in the world.

Geopolitically, the Peruvian government is not the most stable in the world. For many years Peru was led by military rule before it shifted to democratic leadership in 1980. This Peruvian government, though democratic, has operated on strict authoritarian measures which have really hurt the economy.

Infamous former president Alberto Fujimori and current president Alejandro Toledo have been deluged with allegations of corruption, bringing serious socioeconomic instability to the Peruvian people. Even with this rampant corruption, surprisingly Peru has one of the more stable governments in western South America and Central America. This part of the world is in the midst of a natural-resources explosion of epic proportions, but unfortunately this reflects the massively defective governments in other countries, not a good government in Peru.

Also synonymous with Peru is the insurgent Maoist guerilla group known as Shining Path. The Shining Path operates essentially as a terrorist organization with which any tenured miner or oil driller having worked in Peru is well familiar. Over the years Shining Path has been responsible for wreaking havoc on government and private industry. It has been responsible for stalling and shutting down several mining and oil projects, sometimes indirectly, through its terror tactics.

Fortunately since its leader's capture in 1992, the once powerful guerrilla elitists have been sacked and only a few small sects of rebels are still active. Occasionally its name will surface in the industrial sector, but for the most part it has resorted to the drug trafficking business. Today it should pose virtually no threat to the mining industry.

With that being said, news out of Peru last week reported an armed robbery at a Peruvian gold mine in which at least a dozen people raided and stole about a million dollars worth of dore bars, in the process killing two security guards. I wonder if these bandits understand the low purity of a dore bar? I'll be curious to know if they are sophisticated enough to either figure out how to refine it themselves or if they can find a buyer in the black market hmmmm.

Now this is not like stealing the Mona Lisa, as financially it is not a large heist, but this may spawn renewed worries about the safety of the Peruvian mining industry. There has not been a link to the Shining Path on this incident, but you don't normally see organized bandits performing such acts in most major silver-producing countries. Overall this is a minor incident in the grand scheme of things.

Another issue to keep an eye on going forward in Peru is the substantial environmental concerns present. Due to lax regulation of the foresting and mining industries over the years, some major pollution problems exist, especially in the capital city of Lima which houses 29% of the entire country's population.

If the government is forced to pin responsibility for past problems, it could go after the mining companies. I hardly foresee this happening though as mining is so important to the Peruvian economy. In fact, Peru now has a law stating that half of the tax revenues from mining must be used for social projects. This should end up helping the situation.

The Peruvian silver mining industry advertises itself as open to foreign investment and is poised to be the silver mining leader of the future. The Peruvian government is not a showstopper for investing in Peruvian silver miners, nor is the Shining Path or bandit thieves, but these certainly remain items of interest that will definitely need to be watched closely.

Australia: Down under and under down, there lies an abundance of natural resources. Australia produced 72 million ounces of silver in 2004, which equates to approximately 11% of world production, and contains the largest economic silver reserves and resources in the world.

Believe it or not, Australia's population is nearly 25% less than that of Peru. You wouldn't know it by its strong economy though. Australia's per capita GDP is in line with the top four countries in Western Europe. Australian government recognizes the sovereignty of the British monarchy, but it runs a locally democratic government similar to that of England, and has a strong free-market economy.

The strength of Australia's economy is due in large part to its natural resources. Along with its agricultural sector, its mining sector carries a big part of its success. Australia has also positioned itself well for the future by establishing large trade agreements with resource-hungry China, which is now its second-largest export partner.

Australia can rightfully boast of its Cannington mine, which happens to be the largest silver and lead mine on the planet. Most of Australia's silver is extracted and refined from lead bullion, and because lead is abundant in Australia, silver is there to follow.

In 2004 alone, nearly 46 million ounces of silver were pulled out of the Cannington mine. Only do the top four silver producing countries in the world produce more silver than the Cannington mine, of which Australia is one of them thanks to it.

BHP Billiton is the proud owner of the Cannington mine. BHP is a blue-chip natural resources company with a U.S. market capitalization of almost $90 billion. Even though BHP is the world's number-one silver-producing company, silver is just a small piece of the puzzle for its revenue and you will rarely hear it talked about in PM stock circles.

BHP Billiton is not known as a precious-metals mining company, but if you truly want some conservative diversification in this commodities bull, BHP could be a good place to park some capital. It is into just about every commodity in fuel, precious and base metals production. It also recently purchased one of the largest uranium miners in the world and will be able to capitalize on that bull-run as well. Its stock has soared in recent years and should continue to soar as commodities continue to roll.

Australia is also home to several other mining companies that rank in the top silver producers in the world. Many of the major mineral miners are advancing large exploration projects as well as smaller primary silver miners doing the same. Coeur d'Alene Mines recently acquired and operates a large silver mine in Australia and Silver Standard has an advanced project with significant resources on its east coast.

We will continue to see more and more silver come from Australia as exploration efforts continue to thrive and advance. Australia remains a geopolitically favorable country for the silver mining industry and we will most likely see the production gap between Mexico and Peru shrink in the years to come.

China: In addition to being the most populous country in the world, China is the fourth largest country in the world geographically and has the geologic makeup to draw massive natural resources. Even with its potential, its government limitations along with its remarkable economic growth of recent has been posing problems in accumulating the raw materials necessary to service its economy.

One of the main topics in the news today is the resurgence of the Chinese economy. Though still avowedly communist and not about to change anytime soon, China has begun to allow semi-privatization of various economic sectors giving non-state organizations and individual citizens more economic influence. With this as well as the allowance of increased foreign trade and investment, Chinese GDP has quadrupled since 1978, go figure.

The China silver mining industry is something of a mystery if you will. Similar to its brazen communist government, Chinese silver miners have until recently been children of the great red flag. Contrasting with most of the rest of the world where companies have international scope in their mining presence, the majority of Chinese silver has been mined under the protective umbrella of its government.

Though investors haven't been able to capitalize much on the Chinese silver mining industry, the future holds promise, but those opportunities so far have been few and far between. Similar to what the gold mining industry is experiencing trying to break into China, the silver mining industry is not finding it easy to stake its claims.

Most ventures that involve foreign capital are just that, ventures. Joint ventures and partnerships with Chinese mining companies are the extent of what we are seeing today. This is a start though. Several large mining companies and primary silver miners are starting to build these alliances and tap into this market. Just recently elite silver guru David Morgan took a trip to China to assess its future silver potential and perform a strategic study on how it will impact the silver mining industry. Needless to say, what he found was promising.

Even though China was the fourth leading producer of silver worldwide in 2004, it is reportedly running a silver deficit today. With the combination of its major industrial and technological uses as it is expanding its infrastructure, along with growing investment demand, China has actually been importing silver to keep up with overall demand.

China remains an interesting country to keep an eye on not only for the silver mining industry, but for mining in general. Now that China is gradually starting to open itself up to the outside world, opportunities will present themselves to foreign miners. We are keeping our eyes on those companies that position themselves to tap and profit from some of the richest mineral resources in the world.

The Rest of the World: Isn't it odd seeing Poland as the world's fifth leading silver producer? Poland is not typically a country that comes to the forefront of people's minds when they think silver. Poland happens to be a primary copper producer, in fact the top producer in Europe, and with all that copper it pulls out an abundant amount of silver. Its largest miner, KGHM, claims that between its three primary mines there lies some of the largest silver reserves on the planet.

Not only are we keeping our eyes on today's top silver producing countries, but also some up-and-comers. There are major deposits in countries such as Argentina, Bolivia, the United States and Canada that have been discovered, explored and are in the process of being developed. These deposits are largely being discovered by primary silver miners who are ramping up their efforts to capitalize on this commodities bull and are aggressively working to expand their resources and increase their mining output.

Well if most silver is produced by non-primary silver miners, how do I directly capitalize on the silver bull? Most of the companies that are not primary silver miners do still capitalize on the silver bull for the most part. Not only has silver helped boost their bottom-line profits in recent years, but their primary minerals have reaped the rewards of the commodities bull as well.

As miners in general, their stocks on the respective exchanges on which they trade have done fantastic since the birth of this bull, and will continue to do well as it marches higher. Because of their diverse array of products, their income statements tend to be less exposed to the volatility of silver prices as they flow and ebb. Though attractive in some respects, they miss out on the enormous upside potential of the silver bull.

If you truly want to capitalize on the great silver bull and leverage your capital directly to the price of the underlying metal, it is the primary silver explorers and miners that will get the job done for you. These primary silver companies are highly exposed to the market volatility of the commodity they explore and/or mine. They live and die by the price of this white metal. We see a high probability that silver prices will rocket north in the next leg of this commodities bull, and that will directly affect the profits and marketability of these companies.

If you are an investor or speculator who also believes the price of silver is going to continue to rise in unison with this bull, then this is the type of company you'll want to own. As you can imagine, the investment risk associated with these companies weighs heavy if the metal turns down, but the rewards can be legendary if the bull continues and you are invested in the right companies.

At Zeal we are actively profiling not only the existing primary silver producers, but the up-and-coming grass-roots explorers and producers that will make an impact on the future of the silver mining industry. In our research we are keeping our eyes on those countries that are geopolitically and logistically friendly to silver miners and watching the projects that are in progress.

Join us today as we continue our research on the commodities bull and those companies that are best positioned to capitalize on its fortunes. When buy signals are triggered we recommend these well-positioned companies to our Zeal Intelligence and Zeal Speculator newsletter subscribers.

The bottom line is the silver mining industry is poised for an enormous global expansion. The geopolitical nature of the various silver producing countries continues to influence our investment decisions and guide us to the companies best positioned to expose this white metal.

Primary silver producing companies will continue to thrive in this bull market and will steadily increase their global silver production.

Scott Wright
[Adam Hamilton's partner]
Jul 29, 2005

So how can you profit from this information?  We publish a monthly newsletter, Zeal Intelligence, that details exactly what we are doing in terms of actual stock and options trading based on all the lessons we have learned in our market research. Please consider joining us each month at www.zealllc.com/subscribe.htm.

Thoughts, comments, or flames?  Fire away at scottq@zealllc.com. Depending on the volume of feedback I may not have time to respond personally, but I will read all messages. Thanks!

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