Investors: First Majestic Silver Corp. (NYSE/AG) Acquisition is Sign Silver Prices Have Bottomed

majestic silver acquisitionThe silver mining industry is showing its first signs of consolidation amid falling prices for precious metals. First Majestic Silver Corp. (NYSE/AG) is acquiring SilverCrest Mines Inc (TSE/SVL.TO) for $154 million as margins are squeezed by an exodus of capital from the commodity sector. (Source: MarketWatch, July 27, 2015.)

The grey metal has been in steady decline for years, losing more than two thirds of its value since 2011. Nearly 30% of the loss has come in the last 12 months as investors stayed bullish on stocks even in the face of severe headwinds.

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Falling silver prices have also crushed mining stocks, with SilverCrest fell by 21% this year, while First Majestic lost nearly 36% of its market value. The merger is perfectly timed to save both firms from the ugly side of a revenue crunch, allowing them to simultaneously pool resources and cut costs.

Who Wins With This Deal?

The deal offers a clear benefit to First Majestic: the Santa Elena mine in Mexico. Production in the first quarter added $2.99 per ounce to SilverCrest’s free cash flow, a healthy sum given the current operating environment. Not to mention that First Majestic’s output will jump by 26% and they get a cash infusion of $30.0 million.

Granted, it will also take on $15.0 million on the liability side, but the acquisition still nets the company a significant amount of insulation. Each SilverCrest shareholder will get 0.2769 common shares of First Majestic, meaning they will effectively own 21% of First Majestic by the end of the transaction.

It will also keep them in good stead for a potential rise in silver prices. The bull market for stocks has proved more resilient than we first anticipated, but it won’t last much longer. Here’s why.

Investors Will Need Safety, and Soon

Optimism on U.S. equities remained strong despite a showdown between Greece and its creditors, a stock market crash in China, and a strong dollar. The ‘irrational exuberance’ of market participants can be traced to central banks, many of whom have been printing excessive amounts of cash to prop up asset prices.

The Federal Reserve launched a bond buying program in the wake of the financial crisis, a move which expanded their balance sheet from $870.0 billion in 2007 to $4.5 trillion in 2015. The asset purchases were financed by a rise in the monetary base, which reflects a parallel rise in the Dow Jones Industrial Average. Coincidence? I don’t think so. (Source: Federal Reserve Board, last accessed on July 29, 2015.)

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The asset purchase program, known as quantitative easing, officially ended last year. However, the Federal Reserve has continued to scoop up residential mortgage backed securities to bolster the housing recovery, and also kept interest rates at historic lows.

In recent months, Janet Yellen has reiterated the central bank’s hope to raise interest rates before 2016. The Fed is trying to disentangle their support from markets without crashing the economy, which is difficult given how addicted investors are to cheap money. The entire recovery is precipitated on the idea that monetary stimulus could spark a real recovery, yet markets get skittish at the very idea of a rate hike. Why is that?

The obvious answer is that we didn’t have an economic recovery; we just had a stock market rally. The two are fundamentally different in the sense that one is a bubble and the other is not. When a rate hike reintroduces investors to reality, money will pour back into safe haven assets like gold and silver.