A Precious Metal Play for All Seasons

As the U.S. government builds higher deficits, many investors have sought the safe haven of precious metals – especially gold. Rising government debt loads can trigger inflation and gold bugs see the yellow metal as a safe haven. Silver has often been seen as a “defense against inflation” play as well – with a key difference. If the global economy posts a solid rebound but inflation remains still, then silver should also rise in value, as it is used in a wide range of industrial processes. Truly an offensive and defensive play.

An up-and-coming name among silver producers is Silver Standard Resources (Nasdaq: SSRI), which is about to morph from an owner of silver mines to a producer of the precious metal. During the past five years, the company has been steadily acquiring partial or full interests in some of the most fertile mining regions. Now, with all of its assets in place, the company is ramping up production. And that should yield a robust spike in sales.

Silver Standard only began producing silver in December, and showed just $5.4 million in sales for all of 2009. Yet by the end of this year, two of the company’s major mining operations should be operating at full tilt. And that should yield revenues of more than $100 million if silver prices stay at their current level. As a pair of additional mines come on line during 2011, the company should see sales approach $200 million. By the end of next year, the annualized rate of production could approach $300 million.

#-ad_banner-#How that translates into profits depends on the spread between mining costs and the market price for silver. Right now, it costs the company about $9 to dig up, refine and transport an ounce of silver. On the open market, silver is fetching about $18 an ounce, so if the company can meet its target of seven million ounces produced this year, then it can make about $63 million in gross profit.

Of course, if the global economy cools once again, and silver drops in value, then the company’s take will be reduced. Don’t forget, rising silver prices would yield even fatter profits. Roughly speaking, for every $2 move in silver prices, the company can earn an additional $0.15 per share. That means the current consensus 2011 earnings-per-share forecast of $0.59 implies that per-share profits would fall to around $0.15 if silver fell to $12 an ounce. Conversely, if silver prices rose to $24 an ounce, then per-share profits would approach $1.00. It’s too soon to forecast 2012 profits, but as production is expected to increase another +50% that year from 2011 levels, gross profit would likely increase by a commensurate amount.

Yet you don’t want to buy this stock for its earnings power, but instead for the value of its assets. As noted earlier, Silver Standard has spent a considerable amount of time and money acquiring interests in the most prolific mining regions — especially in Argentina, Mexico, Peru and British Columbia. Based on the most recent purchase prices, the company’s stakes are worth roughly $2.6 billion, or $30 a share. That’s more than +50% above the current value of the stock.

Whether the stock reaches that price will be a function of supply and demand for silver. If demand builds, then the value of silver mines will rise in value. Of course, a slackening economy would make recent transactions in the sector look richly valued.

None of us holds a crystal ball as to the outlook for the global economy. But silver’s defensive and offensive characteristics make this a name to own.