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Aurcana commentary excerpted from "My Affair With Silver ... And Where It Goes From Here"

by Stanley Barton
February 14, 2012


Aurcana Corporation [AUN.V] (AUNFF.PK) - $.84

AUN operates the 92%-owned La Negra silver/copper/zinc mine in Mexico and has essentially doubled the revenue and quadrupled EBITDA in 12 months ending September 2011. In May 2012, they will put into operation their 100%-owned Shafter mine in Texas, projected to be the 16th largest mine operation in the world, and second in the US only to Hecla's Greens Creek mine. On the Vancouver Exchange and US pink sheets, AUN has been under-the-radar, but it looks like that is about to change.

La Negra produces 1.7MM ounces of silver equivalent at $10.48 per ounce cash costs, and Shafter is expected to produce 3.8MM ounces in its first year at $8.27 per ounce. At $30/ounce spot price that equates to more than $.20 cash per diluted share each year. Silver grades are improving at La Negra as exploration continues. A new resource estimate is due during Q1 2012.

Aurcana has made some bold moves, making this one of the more risky investments in my portfolio. It had been flirting with bankruptcy and, in 2008, sold 50% of its silver stream to Silver Wheaton (SLW) to buy the Shafter mine. In 2010, it bought back the silver stream. In November 2011, they received $34.4MM in a private placement, which appears to be enough to get the Shafter mine in operation. In its effort to go from a tiny operation to mid-tier status, there have been warrant and option issues, leaving the share structure diluted to 558MM shares. However, it looks like the payoff is this year with significant events in the next few months: adding 33% capacity to La Negra, publication of upwardly-revised resource assessment and opening Shafter.

As I have gotten more comfortable with silver mining operations, I have found myself moving to higher risk/reward propositions. Now with these four miners in my stable, I am excited about the prospects for capital appreciation in the next five years. I know some readers will be critical that I have not gotten comfortable enough to add any pure exploration companies (non-producers), but I do have my eye on some. In the following discussion it may become clearer why I am shy about approaching those bold companies.

MY VIEW OF THE NEXT FIVE YEARS FOR SILVER

I think before making an investment, one should have a vision about where it could go and why. I have no crystal ball, but I do want to have logical expectations for an investment and a way to monitor its progress according to my vision. I also like to keep it simple enough so I can remember exactly why I made the investment.

Since my silver stock investments are in a ROTH IRA, my perspective focuses on how I expect silver to perform for the next five years. Since I am not trading these, I am not into micro-analysis, but I am more interested in the macro factors that will come into play during that time period. My expectation is that my investments in this portfolio will double in 5 years, or about a 15% average annual increase in value.

I think that the spot price of silver should increase 15% per year, and I am assuming that the miners' share prices will at least track that increase. Since the miners are actually leveraged, I think this is a conservative assumption.

There have been a number of studies analyzing the supply and demand for silver, comparing published production numbers against industrial and investment uses for silver. I consider this analysis admirably ambitious, but like my contractor neighbor describes construction estimates…it is a wild guess to the second decimal point. My logic tells me that the higher silver price has reopened dormant mines and paid for investments in increasing production on the supply side. The same increase in price has caused increased interest in physical silver as an investment in ETFs and others. I am not convinced that industrial demand alone will justify higher silver prices. The bigger influence will be the investment demand.

One of the supply factors that I do think will support the price in the near future is that silver miners will start keeping silver inventory instead of cash. Endeavor Silver (EXK) is choosing to withhold from the market some silver with the intention of selling when the spot price is higher. Most silver miners have large capital expenditure programs so they keep large cash balances. Easily they could hold 10 - 20% of that in their own silver, and removing that from the market supply would insure better prices. EXK is a stock I like, but I can't buy them all. Of course, holding off sales of their production will falsely make the income statement look as if they are underperforming.

Silver is linked to gold at a ratio lately of about 50:1. If gold is bid up in price, silver usually follows. Gold has almost no industrial use…its price is driven by fear and greed. The fear factor is a powerful and under-appreciated influence on the price of precious metals. Politicians, news outlets and investment advisors have learned what preachers have known for centuries: terrorism sells. A buck in the collection basket is insurance against an eternity in hell. Out-of-favor politicians must convince voters that the current decision-makers will lead us to Armageddon. Some "news" organizations build the terror angle around every facet of our lives to keep people glued to their commercials. I see this trend growing, and as long as this "media terrorism" continues there will be increasing demand for gold and silver. Political ideological wrestling has become a popular spectator sport that can only help silver prices.

Some of the doom and gloom may come to pass, but we cannot really predict when or how. My personal belief is that things are neither as good nor as bad as competing sides depict. For my analysis, I am assuming that over the five-year period we will probably have one earth-shaking disaster that will temporarily cause demand to overwhelm sellers. The longer-term effect of this event will be a propensity to hoard metals, contributing to the support of a gently up-trending price for silver. I also think that inflation will account for at least a 3% annual price increase in precious metals.

We should also have a downside forecast to let us know what could happen as we evaluate our risks. I think that silver should trade above $20 per ounce during the five-year period and if the spot price drops below $25 we are in the caution zone. It is notable that when miners produce estimates for net cost of production, value of proven reserves, inventories and other financial metrics, these are based on an assumed price of silver and its by-product metals. In most of these reports that I have read lately, that number is $20 to $25 per silver ounce. If silver drops below that price for an extended period, these metrics will fall in domino fashion. It could be similar to the housing bubble, where an unexpected drop in home value caused a chain reaction in related investments. Silver could free-fall below $20 as margin calls come into play in the commodities markets. Some who thought home prices would never fall now think precious metal prices can never fall….never say "never."

In my portfolio, I am not yet including companies that have no production. I recognize that with ever-rising silver prices these "exploration" miners could be the biggest winners. However, it is good to keep in mind that the payoff for these explorers is likely to be a takeover by a producer. With high silver prices, the producers are investing in expanding milling operations and exploring their own vast land resources. A prospect has to be very good to attract any real buyer attention. If silver falls to the $20 level, the values they put on their stakes may have to be revised downward, which would probably cause panic selling in their stocks. Producers will not have the cash flow to fund their own capital improvements, much less acquisitions. With no production cash flow and no buyers, the stocks of these exploration-only miners do not just drop, they can virtually disappear. As attractive as some of those prospects seem, it is too unpredictable making a move on those that are virgins to production.

Although I intend to hold for the long term, I would have to do some serious analysis of the situation if prices fell below $25 per ounce. A spot price of $20 per ounce in silver would imply a gold price of about $1000 an ounce, which I think would be a strong technical support area. The $20 level was also the resistance from 2008 to 2010, and that tends to become the support once it is handily breached. Therefore, my five-year plan is based on silver spot prices that trend upward to $70 per ounce by 2017 with $25 an ounce being the reevaluation trigger. If my vision is conservative, that is even better.

As for my silver antique investments, as my wife says -- they are not really investments because I will never sell them ... never.

Disclosure: I am long HL, RVM, EXLLF.PK, AUNFF.PK.

http://seekingalpha.com/article/366511-my-affair-with-silver-and-where-it-goes-from-here?source=yahoo