How Apex Silver swindled investors and Bolivia through hedging

Silver Stock Report

by Jason Hommel, May 4, 2006

About 6 months ago, Apex silver borrowed $225 million dollars, and did the minimum required hedging of silver, zinc, and lead, to secure the loan.  In those 6 months, silver and zinc prices have about doubled, and the mark-to-market losses are, I estimate, over $715 million dollars!

A loss that big, over 6 months, is like a loan at 900% annual interest, or more!  But the terms of the interest rate were hidden, buried in commodity prices.

This shows why companies cannot hedge in bull market, when inflationary forces are accelerating!  You can’t lock in dollar prices you will receive, when dollar prices are increasing wildly!  

Investors, make sure you don’t own any stocks that are hedged.  There is no such thing as “responsible hedging”.

The market cap of Apex silver, at $900 million, is barely larger than their loss.  

Furthermore, since Bolivia has stated that they intend to lay a heavy tax on the mines in Bolivia, the future looks very bad for Apex silver.  

Bolivia says to assume greater control of mining

LA PAZ, Bolivia, May 2 (Reuters) – A day after Bolivia’s president said the nationalization of the energy sector was “just the start,” the country’s vice president said on Tuesday the state wanted more control of the mining industry.

Vice president Alvaro Garcia said big mining companies must pay higher taxes and said the government would have a larger role in the industry, but he seemed to rule out a nationalization similar to that in the energy sphere.

Bolivia plans to take over mines, forests as next move

La Paz, Bolivia – Bolivia’s leftist government said Tuesday that it would extend control over mining, logging and other sectors of the economy after President Evo Morales nationalized the country’s huge natural- gas industry.

And yet, how can Bolivia levy a heavy tax on Apex, if Apex silver will show such a huge loss for years to come, as the hedges have a term of up to 7 years?  Looks like the government of Bolivia will soon get an education on hedges, to explain the shortfall of tax revenue.  If I was to advise Bolivia on what to do, I would tell Bolivia to force Apex to do what I advised Apex silver to do:  offer to pay workers, who want it, silver.  Such a plan on how to do that while paper money is in use is available here, in my Silver Coin Proposal:

The Mining companies in Bolivia seem to be withholding information from investors, and are not telling the full story, as the miners emphasize that there are no plans for “nationalization” of the mines, or that they do not know of any such plans.  Similarly, the mining companies are not telling the whole, updated story with regard to the mark-to-market losses on their hedges.

Apex sure has a hard road ahead, because they tried to take the easy road to riches, by trying to borrow their way to wealth.

Here is how I arrived at my estimate of Apex’s hedging loss.
see “Investor Relations”
see “shareholder information”
then “press releases”

Nov. 14th press release:
Apex Silver Reports Third Quarter 2005 Results, Progress on San Cristobal and the $225-million Bank Financing Facility

In the third quarter 2005, Apex Silver recorded a $9.6-million mark-to-market non-cash trading loss, primarily tied to the newly-established hedge positions required in connection with the $225-million bank financing to develop its 100%-owned San Cristobal open-pit silver-zinc-lead project located in southwestern Bolivia. All hedge positions required for the bank loan have been established. They include a combination of forward sales and a variety of call options (struck at different prices) covering approximately 10.4 million ounces of silver, 358,150 tonnes of zinc and 159,000 tonnes of lead over a seven-year period (the mine is projected to have a 16-year life based on existing proven and probable reserves and throughputs). These hedge positions represent about 3.5%, 12.6% and 14.7% of planned life-of-mine payable production of silver, zinc and lead, respectively.

Apex had a 3rd Q, 2005, $9.6 million, mark-to-market loss on hedges of:
10.4 million ounces of silver, 
358,150 tonnes of zinc 
159,000 tonnes of lead

Assuming prices at Oct. 1, 2005 for the hedges (which is generous, as they were already underwater by then):
About $.70/lb zinc in October 2005.
About $.45/lb lead in October 2005
About $7.90/oz. silver in October 2005

Value of Apex’s hedged metals on Oct. 1, 2005:
10.4 million ounces of silver @ $7.90 = $82 million
358,150 tonnes of zinc x 2204lbs./tonne @ $.70/lb. = $553,000,000
159,000 tonnes of lead x 2204lbs./tonne @ $.45/lb. = $158,000,000

Whoever loaned Apex silver $225 million, sure got a lot more dollars worth of commodities, promised to be delivered, than they paid for.  And since the time of this hedge, commodity prices for silver and started really taking off, moving up almost parabolic!  Whoever made the loan, sure knew something about commodities that Apex silver did not!

Here are the dollar values of Apex’s hedged commodities today!

10.4 million ounces of silver @ $13.69 = $142 million
358,150 tonnes of zinc x 2204lbs./tonne @ $1.50/lb. = $1,180,000,000
159,000 tonnes of lead x 2204lbs./tonne @ $.53/lb. = $186,000,000

Today, these hedges are underwater, and have a mark-to-market loss of about: 

silver: $60 million
zinc: $627 million
lead: $28 million

For a total loss of about $715 million.

How did Apex justify such stupidity, at the time?

“Our strategy was two-fold,” said Mark A. Lettes, Senior Vice President and Chief Financial Officer of Apex Silver. “First, to hedge the minimum amount of metal necessary to secure bank financing, and second, to maximize shareholder-value upside potential relative to the price of silver. Both objectives have been met as the company remains well exposed to potentially escalating prices of zinc, lead and especially silver. At the same time, our lenders have been provided with the requisite downside protection.”

Clearly, hedging the “minimum necessary” did not work.  Clearly, it did NOT maximize shareholder value!

Apex was warned.

In 2003, at a San Francisco mining show, I spoke with Igor Levental, Vice President Investor Relations and Corporate Development of Apex Silver, and I strongly urged him, that since Apex silver had millions of dollars in cash, and was, at the time, waiting for higher silver prices before going into production, that he might as well buy silver while waiting for higher silver prices.  I went over the bullish case for silver with him.  He dismissed the idea out of hand.  Again, about 6 months later, I spoke with Igor again at a mining show in New York, face to face, and again, without any justification or rational thought, he ignored me.

Igor thought that buying silver, while waiting for higher silver prices, was a foolish idea.  The company ended up doing the exact opposite, and hedged silver, sold silver, at just under $8/oz.!  Who knew the near term producer would be so foolish?  I gave them the benefit of the doubt back in 2003 when I wrote:

Miners to Use Silver as Cash – 27 November 2003

Apex sure seems like a large company, at $900 million, with their 8 billion pounds of zinc in the ground, averaging a grade of under 1%. 

I revealed the fraud at Apex 3 years early:

JANUARY 13, 2009 / 12:44 PM / 10 YEARS AGO

UPDATE 1-Apex Silver Mines files for bankruptcy protection