To The Moon

Summary

• A hold rating is confirmed for Gatos Silver, Inc.
• Gatos owns 70% of Los Gatos Joint Venture, focusing on silver production in Mexico.
• The company's profitability and growth potential make it a strong investment, but investors should wait for a possible more attractive share price.

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A Hold Rating for Gatos Silver, Inc.

This analysis confirms a “Hold” rating on shares of Vancouver, Canada-based silver company Gatos Silver, Inc. (NYSE:GATO) - which owns 70% interest in the Los Gatos Joint Venture (hereafter “LGJV”).

Gatos Silver, Inc. is hereinafter referred to as “Gatos” or “GATO”.

The previous analysis also supported a Hold rating in the sense of waiting for a more attractive share price for investors who either had a position in Gatos or were interested in opening one, as a lower share price level was expected to set the stage for a higher return as a result of a new up-cycle. The expected improvement in LGJV's profitability, supported by strengthening operations and rising silver prices in the markets, was seen as an effective driver of the share price.

At the time of writing, Gato's share price is up 21.85% since the May 13, 2024 “Hold” recommendation, outperforming the U.S. stock market as shown by the 7.08% change in its benchmark S&P 500. But buying the dips in early July 2024 and the first week of August 2024 the outperformance would have been even greater.

About Gatos: Its Essential Features

Gato's share price follows the cyclical nature of the Silver Spot Price (XAGUSD:CUR) as the stock exchange pegs the company's shares to the precious metal, as LGJV, in which Gato holds a 70% stake, generates revenue from the sale of silver equivalent ounces. Production is in silver equivalent ("Ag Eq Oz") extracted at the Cerro Los Gatos mine located 111 km southwest of Delicias, Chihuahua, Mexico. The mine is owned by LGJV (Gatos' 70% share and Dowa Metals & Mining Co., Ltd.'s 30% share), and produces lead, zinc, gold and copper in addition to silver. However, silver is by far the main commodity. The location of the production and its growth potential contribute significantly to reducing the investment risk. Volatility in commodity markets can sometimes cause concern, but the trader can handle it positively if he skillfully exploits the cycles. The Cerro Los Gatos mine is located in a silver and base metal-rich mineral district in the southern state of Chihuahua, Mexico, which is ranked first among the “top 20 producing countries” of The Silver Institute with 202.2 million ounces in 2023 and has a moderate investment risk (light yellow area) for mining and exploration activities, as shown in the Sprott ESG Mining Risk Heat Map 2024.

Source: Gatos Silver, Inc.: NI 43-101 Technical Report dated October 20, 2023

The Production Outlook for Cerro Los Gatos

Regarding the production outlook for Cerro Los Gatos, this depends primarily on three things, in addition to the price of silver in the future:

First, through continued efforts to remove the bottleneck in the mine, the mill capacity can be increased to 3,150 to 3,300 tons per day (“tpd”) (the upper half of the guideline range of 3,000 to 3,300 tpd). The company is on track to achieve a capacity of 3,500 tpd by 2025 and maintain this capacity well into the coming years, 40% above planned capacity. The trends in tons milled per day are consistent with Gatos' midterm target as they were higher in Q2-2024 at 3,240 vs 2,916 in Q2-2023 (up 11.1% YoY), and they were 3,225 in H1-2024, higher than 2,905 in H1-2023 (up 11% YoY). There seems to be no doubt that these are on a growth trajectory as the “tons milled per day” previously increased from 2,662 in 2022 to 2,935 in 2023 (up 10.3% YoY) and the increase accelerated from 2,894 in Q1 2023 to 3,210 in Q1 2024 (up 11% YoY).

Second, the mine life extension, on which the company will provide an update this quarter: The mine life of the Cerro Los Gatos mine was extended by 2.75 years from early 2028 through 2030 as a result of successful drilling, increasing the production potential now stored in the 2023 mineral reserve of nearly 8.1 million tons in July 2023.

Below is a table detailing Gatos' Proven and Probable Mineral Reserves as of July 1, 2024, broken down by metal class and showing average metal grades:

Gatos Silver, Inc. Web Site

Meanwhile, from July 2023 to Q2-2024, these reserves were consumed as follows: 9.44 million ounces of silver (4.77 million oz in H2-2023 and 4.67 million in H1-2024); 63.3 million pounds of zinc (28.4 mln lbs in H2-2023 and 34.9 mln lbs in H1-2024); 42 million pounds of lead (19.8 mln lbs in H2-2023 and 22.2 mln lbs in H1-2024); 5,450 ounces of gold (2,700 ozs in H2-2023 and 2,750 ozs in H1-2024); 14.89 million ounces of silver equivalent (7.31 mln ozs in H2-2023 and 7.58 mln ozs in H1-2024). H2-2023 metal ounces are from the entire 2023 ounces or pounds minus H1-2023 ounces or pounds.

The discovery in 2022 of the “South-East Deeps” zone (“SE Deeps”) provides a boost to the potential to further advance the life of the mine, as this new mineralization area, which extends in depth up to 415 meters below the current reserves, has updated the 2023 mineral resources of 0.4 million tons of Measured and Indicated Resources, with 4.58 million tons of Inferred Mineral Resources. Currently, the company is conducting extension drilling activities at SE Deeps, the results of which are consistent with the exploration team's suspicions of much more extended mineralization both along strike and down-dip than it is currently known. There are thus growth opportunities beyond the current reserves and resource estimates. However, from April 2023 to March 2024, the company was required to suspend the drilling project extending the known SE Deeps mineralization limits (currently 1 km laterally and 400 meters vertically adjacent to the existing SE mineral reserve). During these 12 months, the company carried out another project, completing 66,300 meters of infill drilling in the higher-grade areas of the SE deep zone. To date, these infill exploration activities have on average resulted in areas of lower silver grade but with an important occurrence of copper. The results will be used in the mineral reserve and mineral resource update planned for the third quarter of 2024.

Thus, there are impressive growth opportunities beyond current reserves and resource estimates, as the presence of “an established pipeline of prospects and more than 50 targets identified to date,” the company said, suggests with a high degree of probability that additional rich metal-bearing resources exist in the Los Gatos district, which consisting of more than 103,000 hectares of parcel land, practically offers a vast prairie where growth opportunities can realistically be developed.

Third, the regional exploration program: Extensive drilling and infill drilling indicate that the Cerro Los Gatos mining area may be much larger than previously known. In the Los Gatos District. Therefore, the focus is not only on near-mine exploration, but there is also potential across the district. The exploration team of the joint venture has identified several targets outside the immediate vicinity of the main mine following strong indications of ore presence from previous activities including drone surveys, detailed property mapping and surface geochemical sampling programs (these preparatory activities now point to 2 more targets for Lince and Los Veranos).

Gatos Silver, Inc.: update on the drilling and exploration programs in the Los Gatos district (“LGD”) in Mexico, Jul. 23, 2024

Drilling focus on the Portigueño area located approximately 2 km southeast of Cerro Los Gatos (“CLG”), the San Luis target located approximately 4.5 km northwest of CLG along the Los Gatos Fault, and the Cerro Los Gatos Central Zone Deep Extension target. The company indicated that to date, the drill holes in the Portigueño target area intersected extensive mineralization, including elevated, albeit narrowed, intervals of gold mineralization, in addition to “anomalous silver and zinc mineralization”, and “high molybdenum values”. Drilling at San Luis A returns abnormal values ​​of precious metals and elevated values ​​of base metals. In an area of ​​untested and unknown geology, the Cerro Los Gatos Central Zone Deep Extension is targeted to identify the potential for another zone similar to the SE Deeps system.

About Growth Opportunities in the Short Term

As for near-term upside potential, Gatos' 70% stake in LGJV would like to take advantage of rising precious metal prices with the following production of silver to be injected into the markets: Backed by the improvement in tons milled per day, as previously discussed, LGJV expects silver equivalent and silver production to be in the upper half of guidance ranges for the full year in 2024: Ag Eq Oz guidance range is 13.5 to 15 million ounces (versus 14.3 mln ozs mined in full-year 2023), while silver ounce guidance range is 8.4 to 9.2 million ounces (versus 9.2 mln ozs mined in full-year 2023).

The price of silver will receive upward pressures from the following factors:

• The deepest silver market deficit in the past 20 years is forecast by the Silver Institute in 2024 as silver demand again exceeds silver supply in 2024 after three consecutive years of outperformance starting in 2021. For the full year 2024, The Silver Institute forecasts silver supply at 1,003.8 million ounces (down 1% from last year), while “led by strong industrial consumption” silver demand is estimated at 1,219.1 million ounces (up 2% from last year). After 2024, demand for silver will remain robust for many years to come, driven by electrification and green energy technologies such as solar panels and AI data centers. The latter technologies involve silver in their powerful semiconductor chips needed for artificial intelligence. Instead, supply will struggle due to resource depletion, expensive operations and geopolitical tensions.
• Safe Haven purposes from investors: Many would still argue that gold is the “safe haven” investment par excellence, but we must say that silver is also sought after for the purpose. A strong indication in this sense came recently from this trend: while technical buying dominated among demand drivers in a recent round of price support, investors' use of the precious metal's safe haven amid Middle East tensions was evident not only in gold but also in silver markets, as noted by Kitco Metals analyst Jim Wycoff in an interview for Reuters.
• The easing of Fed's monetary policy, which according to market participants is likely to begin with the expected 25 basis point cut in the benchmark interest rate at the September 18 meeting. Fed rate traders estimate the probability of a 25-basis point cut at 73.9 percent at the time of writing, according to a CME FedWatch report. According to Trading Economics, “futures markets suggest investors have priced in 100 basis points of interest rate cuts for the Fed's three remaining meetings this year” (Sept. 18, Nov. 7, Dec. 18), as higher-than-expected initial jobless claims in mid-August and revised upwards non-farm payrolls for the year ended March added to concerns about too slow job growth.

At the expense of demand for US Treasuries, which pay interest based on a fixed rate, demand for investments in non-yielding silver commodities will instead increase in a cooling interest rate environment after the Fed loses monetary policy. This is the rationale.

Under the above circumstances, the price of silver has more steam to run upwards, and besides, its ounce is cheaper than gold, according to Scott Bauer, CEO of Prosper Trading Company for Kitco.com last week. The current gold/silver ratio of 85.4x (= $2,497.88/$29.26 in the spot markets at the time of writing) is encouraging more and more investors to prefer investing in silver over gold, helping the silver price to reach higher levels than now.

Scott Bauer said:

“Historically, when the ratio has topped 80, it has signaled that silver is inexpensive relative to gold,” Also, he said: “The last three times this happened, silver rallied 40%, 300% and 400%. When the ratio has fallen below 20, it has signaled that gold is inexpensive relative to silver.”

Trading Economics predicts that silver prices will hover at $28.94/oz at the end of this quarter and continue to rise to $31.05/oz in 12 months time.

The Cost of Extracting Metal at the Cerro Los Gatos Mine

Not just robust production and rising silver prices, but profitability, a key price driver for Gatos' shares, will also be boosted by the costs LGJV pays to extract the precious metals, as LGJV's operating costs look very competitive with most competitors.

LGJV forecasts full-year 2024 co-product AISC to be in the lower half of the guidance range of $14.00 to $16.00 per ounce of Ag Eq and byproduct AISC will be in the lower half of the guidance range of $9.50 to $11.50 per ounce Ag Eq. As a benchmark, the industry average for AISC, estimated by The Silver Institute, is $17/oz for 2023.

This scenario bodes very well for the profile of Gatos' 70% stake in LGJV: the industry could face rising operating costs as resource depletion requires increased mining effort. In addition, geopolitical risks and the de-risking strategies pursued by Western economies (which tend to result in divestments in non-Western countries in retaliation against Russia and China) could have costly consequences for mineral projects across the industry. Instead, the chart below shows that AISC/oz for LGJV is on a descending trajectory following the implementation of the mine life extension plan.

Gatos Silver, Inc. Website

This comparison increases the likelihood that the profitability of LGJV - the source of income for Gatos' 70% stake - will grow faster than most peers in the industry. And since Gatos' shares will likely be more attractive than other U.S.-listed small and mid-cap silver stocks, as rising earnings are a strong stock price driver, demand for the U.S.-listed stock of Gatos is well positioned with the outlined dynamic. On the one hand, this is the situation. On the other hand, a 3-year trend showing Gatos' shares outstanding remain stable at 69.34 million and with an improved financial situation as Gatos’ cash on hand was up to $108.9 million on 31 July 2024 from $70.6 million per March 31-2024 and no debt but $50 million in unused credit facilities, the partnership between these factors is such that it can avoid the need to issue new shares for financing purposes. After the Fed's likely interest rate reversal on September 18, 2024, debt will gradually become more affordable, increasing its chances as a financing solution over issuing new shares if the joint venture needs a cash injection. The outlook is also very positive for earnings and cash flow to support mining projects and growth, so while shares outstanding in the market remain stable, robust demand for shares of Gatos will put upward pressure on the share price.

That's How Gatos Performed Recently

The LGJV (ounces, prices, costs) triad has supported Gatos' share price so far this year through increased profitability and cash flow, and as of writing, GATO shares (+107.33%) have outperformed the Materials Select Sector SPDR® Fund ETF (XLB) (+7.61%), VanEck Junior Gold Miners ETF (GDXJ) (+26.45%) and SPDR® S&P 500® ETF Trust (SPY) (+18.41%) so far this year.

Source: Seeking Alpha

Driven by higher equity income from LGJV of $21.8 million in H1- 2024 (3.4x y-o-y), as higher Ag Eq Oz of 7.58 million (up 8.4% YoY) and higher realized metal prices of $25.80/oz (up 1.3% YoY) led to a 29.9% YoY increase in LGJV's revenues to $166.4 million, combined with lower by-product AISC/oz at $8.42 (down 14.1% YoY), Gatos' 70% stake in LGJV had higher net income, earnings per share and EBITDA.

While “tons milled per day” backed by mine de-bottlenecking efforts benefited production and costs, silver prices had the following upward catalysts, culminating in 2 all-time highs in April and May in the first part of 2024. With the price of gold ultimately acting as a driver for the price of silver, in the sense that when investors realized that they could also achieve their safe haven strategies with silver cheaper than gold, at one point in April the “silver gains were even hotter than gold” Carl Surran, Seeking Alpha News Editor reported on April 17: front-month Comex silver (XAGUSD:CUR) was up 14.3% in April 2024 and 18.8% since early 2024; while front-month Comex gold (XAUUSD:CUR) rose 6.9% in April 2024 and 15% in the period from the beginning of 2024 up to and including 17 April 2024. Subsequently, the upward trend in silver prices continued, with the grey metal, along with gold and copper, “scoring a place on the podium,” Yoel Minkoff, Seeking Alpha News Editor reported on May 21 amid an “Olympics of metals” for the wild world of commodities. After reaching its all-time high on April 19-20, silver continued to outperform gold as it continued to be seen as a cheaper safe-haven solution than gold amid geopolitical issues and macroeconomic uncertainties, yielding a total year-to-date gain of 32%, while gold posted an 18% YTD return on May 21.

Gatos' 70% stake net income of $11.7 million in H1-2024 turned positive from a net loss of $2.8 million in H1-2023, while basic and diluted EPS of $0.17 turned positive from a loss of $0.04, and EBITDA of $10 million shifted positively from a loss of $2.6 million.

Free cash flow was $26.9 million in H1-2024 versus free cash outflow of $7.9 million in H1-2023.

The Share Price: Investors May Want to Aim for Lower Price Levels

At the time of writing, shares under the symbol GATO are trading on the NYSE at $13.01 per share, giving it a market capitalization of $882.71 million. Shares are trading above the MA Ribbon and are currently well above the midpoint of the 52-week range of $4.30 to $14.45.

Source: Seeking Alpha

The stock has a bright outlook with big upside potential highlighted earlier in this analysis, but the investor may want to wait for a share price decline before eventually adding shares or initiating a position.

Since shares are influenced by cycles during the uptrend, this analysis predicts the possibility of a more attractive level amidst some expected headwinds. A 14-day Relative Strength Indicator of 60.17 also suggests that investors should wait for the time being as the upside range for further gains is much lower, and shares could be nearing the peak of the stock price cycle while there is still plenty of downside momentum.

Shares previously recorded dips around July 2, 2024, and August 7, 2024: This first decline occurred after silver prices cooled somewhat as the market became less and less convinced of a first interest rate cut in July and subsequently the Fed confirmed high interest rates in the July 31 meeting. Contributing to the muted silver prices that led to the Gatos dip in early July was a sense of optimism for a rate cut that was being delayed until September, as signaled by ING Groep N.V. (ING) analysts.

The dip in Gatos' share price in early August 2024 was the result of chaotic and large sell-offs around the world, triggered by panicked investors fearing a recession in the US after the unemployment rate had previously risen from 4.1% to 4.3%.

Fed Chairman Jerome Powell acknowledged in a speech at the Jackson Symposium on Friday, August 23, that the labour market is cooling, and inflation has eased. Market participants said the chairman gave a clear signal that interest rate cuts will occur in September. Since markets have been expecting such a move - a rate cut by the Fed in September - for several weeks, a 25-basis point cut is unlikely to surprise markets any longer, as stock prices must have fully internalized the event by now. But market participants went even further in creating their expectations: driven by fears about the labour market following the rise in the unemployment rate in early August 2024, market participants began to build their expectations for a 50-bps rate cut. However, we must highlight that the likelihood of that wider 50-bps range materializing is getting ever smaller, with Fed rate traders' probability of it falling to 38.5% at the time of writing, “compared to 50% before the release of the latest CPI data according to CME FedWatch Tools,” Seeking Alpha news editor Carl Surran reported on August 14, 2024. The latest CPI data was released on August 13. As this 50-bps rate cut loses momentum, the impact of the headwinds on silver prices will gradually raise the bar for a downward sentiment in Gatos' share price, ultimately leading to a dip or a more attractive price level.

Also, Gato's share price could become more attractive amid a potential new wave of recession fears: Just like two weeks ago, when stock markets were dragged down by traders and investors panicked, based on a 24-market beta of 1.66 for Gatos stock on the NYSE its shares will have a hard time escaping the bearish sentiment this time too if the signals are that the cycle is entering a recessionary phase. The recession fears benefit sentiment on safe-haven silver-backed securities, but initially, when it panics, the market is unable to distinguish silver stocks from the rest of the market by lumping everything together.

The following two indices are saying that a recession is looming in the US:

Economist Claudia Sahm, the designer of the Sahm Rule, believes that the US recession is likely to be three to six months from now. The Sahm Rule is an indicator that, performed on the last nine US recessions since 1970, has convinced most in the market about its intent to predict a subsequent one.

The inverted yield curve indicator (three-month US Treasury yields are currently higher than ten-year US Treasury yields: 5.142% versus 3.805%), developed by Duke University professor and Canadian economist Campbell Harvey, also signals that a recession may be around the corner for the US economy. Since World War II, this index has reliably predicted a recession 8 out of 8 times.

The stock has the following daily trading volumes on the NYSE market, which are not very high: Over the past 3 months, an average of 509,092 shares changed hands on the NYSE market (scroll down this Seeking Alpha page to the “Trading Data” section).

Investors should be aware that with stocks that have low liquidity, they may have difficulty adjusting their holdings quickly if new circumstances require it.

The stock of Gatos Silver, Inc. has about 69.3 million shares outstanding. A total of 41.3 million shares make up the float, which is freely tradable on the stock exchanges' open market, and institutions own 93.69% of the float.

Conclusion

Gatos Silver, Inc. is a Vancouver, Canada-based company that owns 70% of Los Gatos' joint venture to operate the Cerro Los Gatos mine in Mexico.

This company's shares are well positioned to gain in the coming period as the silver price environment is expected to be very favourable, and the company is targeting a significant mine life extension. This project will produce robust ounces of silver at low operating costs compared to industry peers.

The company's financial position is solid as there are funds to support the project and also various explorations as the Los Gatos district appears to offer good growth opportunities.

NYSE-listed equity prices for GATO shares could fall sharply in the near future amid headwinds from the Fed if this only cut interest rates by 25 basis points in September rather than 50 basis points; or from a new wave of recession fears in the economic cycle.

Investors can take advantage of the attractive share price levels to increase their position. For the time being, investors are suggested to Hold shares in the portfolio.