Lately, it seems billionaire precious metals investor Eric Sprott is grabbing headlines almost daily.
Sprott believes in silver and gold as money, and he has little faith in paper currencies.
That explains his recent acquisition of a chain of currency exchange outlets, which he aims to gradually build into the safest kind of bank - one that makes no loans, and could eventually offer gold- and silver-backed checking accounts.
Leave it to Sprott to flip a long established business model on its head.
And now he's at it again.
Ever the investing activist, Sprott's latest move involves a "call to action" for silver producers, challenging a business practice typical of most - saving in cash.
Sprott has sent a letter to silver producers, suggesting that they reinvest some 25% of their earnings back into silver, rather than in cash at the bank.
On the surface, it doesn't look like such a dramatic step.
But after deeper analysis, it's clear such a move will accomplish two significant things for shareholders:
- It will heighten exposure to a commodity that the investor initially bought those shares for.
- And it will protect the investor from the risk of devaluing currencies the company would have held instead.
In fact, the move is brilliant.
And as I keep digging, I realize that the implications go well beyond these two shareholder advantages.
Silver At Cost Price, Or For Free
Silver mining is an odd kind of business, for the most part. You see, there are very few pure silver mines, and even fewer pure silver miners.
The nature of silver deposits is that they often contain other metals. Sometimes it's gold, but more often than not it's base metals such as zinc, lead, and even molybdenum.
So, much of the silver produced today is a byproduct of base metals production.
If the miner considers itself to be a silver miner, it will use the profits from producing and selling the other metals as credits against the cost of producing the silver. In some cases, that can lead to negative cash costs, meaning they get paid to bring the silver out of the ground.
At the opposite extreme, you have high-cost silver producers, whose production costs can run up to $15 per ounce. Though in the current environment of $30 silver, that's still not a profit to sneeze at.
The takeaway here is that a considerable portion of silver supply depends on base metals production. If we should see a significant economic slowdown, that could translate into fewer base metals coming out of the ground. By extension, that means lower silver production - perhaps much lower.
Detractors will say that silver is also an industrial metal. That's true, too. So if the economy falters, industrial demand for silver should tag along.
But the wild card here is investment demand. Sustained economic weakness, or a full-on financial crisis, could well send precious metals investors clamoring for the "cheaper" of the two, buying silver rather than gold. That would light the fuse on silver prices.
Any savings silver producers plow into silver bullion will make it an increasingly valuable asset, not to mention one that's increasingly scarce.
Beyond Unhedged Production
By now, scores of silver and gold producers have managed to buy back most, if not all, of their forward price hedges. And that's what most investors want, as they seek to maximize their exposure to the underlying metal's price.
I view saving in physical silver by the miners as the next logical step after doing away, to the extent it's possible, with their hedging programs.
But Sprott's suggestion would have them move beyond hedging.
What has become a pronounced trend for precious metals miners - at least those that are particularly cash-flow positive - is the institution of dividend payout policies. This comes as no surprise since, with high and sustained gold and silver prices, precious metals miners are very cash rich.
The most innovative among these include dividends tied to the underlying metal's price. Keep an eye out for this, as instituting dividends is sure to attract scores of new investors to the sector.
But as this precious metals market continues to progress, the miners' cash flow is simply going to explode. They'll need to find original ways to differentiate themselves.
And dividends will keep growing in what could well be a repeat of how precious metals stocks behaved during the Great Depression.
Could 70% Dividends Be In The Cards?
In the aftermath of the 1929 market crash, Homestake Mining rose continuously from $80 in late 1929, to $495 per share in late 1935, netting early investors a 519% gain in the process.
But that's just the capital gains part of the story.
In that same period, from 1929 to 1935, Homestake paid out $128 in cash dividends. In 1935 alone, the dividend reached an astounding $56 per share, or effectively a 70% dividend for those who'd acquired shares at $80.
As this precious metals bull market progresses, I expect to see a similar scenario play out.
My Own Call To Action
I admire Eric Sprott tremendously, but I think his move to encourage precious metals producers to save their earnings in their own physical silver will one day be taken to a totally new level.
What I'd challenge the silver and gold producers to do, under those kinds of circumstances, would be something quite radical by today's standards.
Let's consider that, as the precious metals bull matures, silver and gold prices will go up - a lot. The more people will want gold and silver, the more its demand will rise, contributing to its scarcity.
Now imagine that a silver or gold producer decides, in order to be innovative, they'll offer their shareholders a dividend payment in kind.
That's right. When everyone else is scrambling to get their hands on more silver or gold, the shareholders of that miner could receive their dividends in actual silver or gold.
Now consider the premium such a stock would command.
The fact is, we could well reach a point where precious metals become so expensive and so scarce, almost all the investment supply available would come from new production.
In that kind of scenario, which I consider not only possible but plausible, people would offer to pay a multiple of the price/earnings (P/E) ratio of that miner's peers, just for the chance to access the silver or gold.
In much the way Homestake's share price and dividends meant a massive windfall for its shareholders, those miners who'd offer a "dividend in kind" would leapfrog their competitors, swiftly placing them at the head of the pack.
I know it will take some time before we reach the right circumstances to implement this kind of strategy.
But if you ever see a silver or gold miner innovative enough to introduce a "dividend in kind," make sure you pay close attention.
That company could well be worth its weight in gold...or silver.
And remember, you heard it here first.
News and Related Story Links:
- Money Morning:
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- Money Morning:
Gold Price Outlook 2012: Miners Will Shine as Prices Soar
- Money Morning:
China Changing the Global Gold Market
- Money Morning:
Gold Prices Back on Track for $2,500 an Ounce
- Money Morning:
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