Conquistador Silver -- Ours for the Taking

Part 1: Nobody Expects the Spanish Inquisition!

If I asked you what happened in the year 1492, you’d probably say: “Columbus discovered America.” But have you stopped to wonder why the queen of Spain was financing expeditions to the West at that time? It wasn’t because some watery-eyed Italian named Columbus told her the world was round. Indeed, it is a tale of God, glory, and gold…lots and lots of gold — and even MORE silver.

What’s more, mines that the Spanish discovered and worked in the New World are STILL being worked today. In fact, some of the most undervalued silver mines in the world are in Mexico, and still bear the marks of the conquistadors. More on them in a bit.

So Columbus shows up and Queen Isabella of Spain is ready to hock her jewels just to send him on his way, right? Not exactly. 1492 is ALSO the year that the Spanish finally kicked the Muslims out of Spain. Moorish Grenada surrendered that year, and King Ferdinand became His Most Catholic Majesty of ALL Spain. And what a pain in the royal butt that was!

See, for 800 years, the Spanish had battled the Muslims. This holy war — the Reconquista, or crusade to reconquer Spain from Islamic invaders — was their entire reason for being. Centuries of constant fighting had created a pool of warriors born to the saddle and the sword and accustomed to booty. Their hearts burned with the wild religious fervor necessary for victory over the Moors. When in 1492 the last battles had finally been won, the soldiers of the Spanish Reconquista were suddenly unemployed. There were lots of holy warriors idling with nothing to do …but potentially plot rebellion.

The Spanish tried substituting other enemies for the Muslims. 1492 was also the year Torquemada, master of the Inquisition, engineered the expulsion of the Jews from Spain. But still, all these dangerous holy warriors were sitting around with too much time on their hands.

Spain needed a distraction…something for its holy warriors to focus their energy on. So when Columbus showed up and said he knew a shortcut to India, light bulbs — if they’d had light bulbs back then — clicked on over the heads of Ferdinand and Isabella.

There were lots of pagans in India…enough to keep a horde of fanatics busy for a good, long time. And besides, India was rumored to be fabulously rich in gold. For a risk of three ships, the potential payoff was huge.

Part II: A Mysterious, Gold-Rich Land

Hence, the Spanish crown found it wise to finance Columbus. He found the New World…and the soldiers of the Reconquista found their new purpose in life.

The Spanish explorers called themselves conquistadors and styled themselves after the Reconquista. They hoped to achieve the same goals of God and glory…with gold thrown in.

The first islands the Spanish discovered and conquered — Hispaniola, Puerto Rico, and Cuba — yielded some slaves, but no gold. But then the Spanish heard of a gold-rich land to the West… a mysterious land called Mexico.

The conquistador who led the expedition to Mexico was Hernan Cortez, a smooth-talking sharpie who previously weaseled his way into the good graces of the Cuban governor. The colonial Spanish made political appointments purely on the basis of loyalty, not competence. This was to be doubly disastrous for their New World colonies, because these “loyal” friends often betrayed their benefactors. Suspicion was rampant. The Cuban governor had second thoughts and was about to throw Cortez in prison when he hauled anchor and took off for Mexico.

Sure enough, in Mexico, the conquistadors found gold — and natives who were willing to trade it for beads, scissors, and trinkets. But they wanted more. “Go see the Aztecs,” the natives told Cortez. “Their streets are paved with gold.”

Part III: The Aztecs: Sun, Blood, and Sacrifice

The Aztecs are an astounding story themselves. They were an upstart tribe from the north — Aztlan — who moved into Mexico with nothing going for them but arrogance and belligerence. Yet they somehow surpassed more sophisticated neighbors and carved out a widespread empire that stretched across Central America.

The rise of the Aztec civilization was nothing short of meteoric. They absorbed the skills and accomplishments of their conquered subjects, and built on them. We might thank our lucky stars that we discovered them; another few hundred years and THEY might have discovered US.

The Aztecs terrorized everyone into yielding to their rule with tortures that could make Torquemada wince. They practiced human sacrifice constantly — their pitiless god, Huitzilopochtli, was the god of war and the sun, and he lived on a diet of human blood, usually slurped from still-beating human hearts torn from victims’ bodies.

The Aztecs also had a lot of gold, though their streets were not — much to Cortez’s disappointment — paved with the yellow metal. The Aztecs didn’t value gold except as a metal to make shiny things. They called it the “excrement of the gods” (I’m not making this up!) and traded it for the feathers and stones they prized more highly for their elaborate costumes.

Part IV: The Spanish Get Gold Fever

The Aztecs got word of the conquistadors and sent ambassadors, who were awed by the Spaniards’ white skin, metal armor, guns, and especially their horses. The Spanish were also fortunate that there was a legend that pale-skinned gods would return from the East. The Spanish snapped up gifts of gold. Cortez told the Aztec ambassador: “Send me some more gold, because I and my companions suffer from a disease of the heart that can be cured only with gold.”

It sounds like a line out of Monty Python, but the Aztecs were happy to oblige. When the conquistadors got to the Aztec capital, Tenochtitlan, they were treated like gods, and were given a palace built by the father of the Aztec king, Moctezuma II (when I was a kid, he was called “Montezuma”). The conquistadors discovered a bricked-up room FILLED with golden artifacts, which they chopped up and divided as loot.

And there was more gold to come! The Aztecs gave the new “gods” ensigns of gold and other gifts.

According to a contemporary Aztec account: “When they were given these presents, the Spaniards burst into smiles; their eyes shone with pleasure; they were delighted by them. They picked up the gold and fingered it like monkeys; they seemed to be transported by joy, as if their hearts were illumined and made new.

“The truth is that they longed and lusted for gold. Their bodies swelled with greed, and their hunger was ravenous; they hungered like pigs for that gold. They snatched at the golden ensigns, waved them from side to side and examined every inch of them.”

Remember, the Aztecs put no real value on gold; to them, the Spanish were acting loco.

And the Spanish rewarded their generous hosts by embarking on a campaign of gruesome slaughter that eclipsed the bloodthirsty sun god Huitzilopochtli. Eventually, out of a total population of perhaps 25 million in Mexico at the time, as many as 22 million died.

It helped that the conquistadors had a secret WMD — smallpox. It cut through the Aztecs like a scythe through wheat. The only germ warfare the Aztecs had to offer in return was syphilis; Cortez caught it. But that didn’t quench his desire for gold.

If it makes you feel any better, Cortez fell out of favor at court and died a lonely, bitter, broken man.

Part V: An Empire Built on Silver

The gold energized Spanish colonial efforts. Soon, they were pursuing their brutal quest for gold, glory, and God by massacring the Mayas, the Incas, you name it.

But as important as gold is to the history of Mexico, it doesn’t hold a candle to silver.

Cortez conquered the Aztecs in 1521. Silver was discovered at Taxco, near Acapulco, in 1524.

Soon, more silver mines were discovered in the north and west…thick, rich veins of silver that could sometimes be pried out of the rock like boards from a barn.

• How much silver? The yield from Mexico’s mines doubled the world supply of silver in less than two centuries. Today, about a third of the world’s silver has come from Mexican mines
• By the 1700s, Mexico’s silver mines were producing 9 million troy ounces of silver each year
• If you include production from Bolivia and Peru, from 1530-1800, approximately $6-8 billion worth of gold and silver was mined in the Spanish American colonies. During this time, the ratio of silver to gold shipped to Spain was about 10-to-1.

And yet while this wealth made Spain an international power — and the richest country in Europe for a time — the silver and gold provided no long-term benefit. It was a bad omen when the first shipment of gold to the Spanish king was seized by French raiders. The Caribbean’s rich history of pirates and privateers began.

The English, French, and Dutch, seething with envy, captured Spanish islands and set up their own bases, which also served as ports for every pirate and buccaneer that had his eye on Spain’s treasure fleets. And everywhere silver was discovered in Mexico, rebellion sprang up from the ground like devil grass. Peasants and Indians alike wreaked havoc on authorities who were too busy stamping out wildfires to govern effectively.

You probably know that the Apaches and Comanches troubled settlers of our Old West. Well it was much, much worse south of the border — they terrorized Mexico, constantly adapting tactics, running rings around Spanish forces like the huge armies were hobbled elephants. The nimble Apaches moved like ghosts, destroying commerce, livestock, and taking hundreds of lives.

So why didn’t people just pack up and leave? Because of the silver. It made that ground worth fighting for.

As bad as things were in Mexico, it was trouble in Europe that was Spain’s undoing…its finances were ruined paying for the 30 Years’ War — a good lesson for America and its expensive ($2 billion per week) fiasco in Iraq — and when New World silver production slipped, Spain began suffering perpetual economic depression, its economy ravaged by bouts of inflation and deflation. It could no longer protect its colonies, and Spain went into decline.

Part VI: Overlooked Silver Just Waiting to Be Scooped Up

Now here’s an interesting thing about those silver mines: In the old days, the Spanish/Mexican miners would only mine the visible silver. They didn’t realize that the black rock around them was thick with silver ore!

Plus, many of Mexico’s silver mines fell into decline. In the 20th century, as political winds shifted, as the price of silver cratered, it often became more trouble to mine the metal than it was worth.

But now the price of silver is rising again. And the Mexican government and people alike are eager to work with companies that will reopen and recapitalize the old mines.

And I believe this is a great time to buy silver. The metal is well off the highs it hit earlier this year, but its bull market is still intact. It has gone through a consolidation that is a normal and necessary part of any bull market. If you look at a chart of silver, you can see that it is coiling up like a spring. A big breakout should come next. I believe there are many forces driving silver higher. Here are some examples:

• According to research consultancy CPM, in 1990, there were around 2.2 billion ounces of silver held in aboveground stocks. As recently as 1995, there were 1.4 billion ounces of bullion in stockpiles. Today, there are probably only about 300 million ounces. That’s a 50-year low
• In 2005, there was a gap of 35.5 million ounces between fabrication demand for silver and the conventional supply from mine production and scrap. Industrial demand for silver is hot and getting hotter. Silver is the metal that is the best conductor of electricity. Uses for it are growing. Silver is substituted for lead by companies making electronics for the environmentally conscious European market
• The silver ETF, SLV, is a roaring success. It already has 104,208,000 ounces of silver. It recently filed papers to issue another 16,822,727 shares in its silver trust, representing, at 10 ounces per share, another 168 million ounces of silver. That will effectively increase the size of the trust by 150%. This is a huge new demand on the silver market — HUGE!

The supply of silver from mines has not been able to meet demand for years. There are new silver mines coming online, but they’ll probably be playing catch-up for quite some time to come…potentially for years.

Part VII: Looking for Undervalued Mining Stocks

For real outperformance, I look to the small-cap mining stocks themselves. Here are three things I look for in miners:

1. Large resources: The companies must have millions of ounces or be working on defining large resources in historically rich districts. This makes it more likely that the big boys will target them for takeovers.
2. Near-term production: Exploration is nice, but the biggest gains will likely come from miners going into production in 12-18 months. Amazingly, you can even buy producing Mexican silver mines for pennies on the dollar.
3. Great management: To me, this makes all the difference between a grand slam and a near miss.

You can find a bunch of incredible bargains south of the border, including silver mines. Interestingly, many of them are mines owned by Canadian companies, because that’s where a lot of the mining industry’s talent and entrepreneurial spirit is.

And some of them even list in the U.S. An example would be Silver Wheaton Corp. It is a Canadian company that also lists on the NYSE under the symbol SLW.

Silver Wheaton is the purest silver producer in the world and doesn’t own any mines of its own — thus, it doesn’t have to deal with the cost of plants or equipment. Instead, it has silver purchase agreements with three mines around the world, including the Luismin mines in Mexico, which are operated by Goldcorp.

• Luismin’s operations are comprised of several mines in the San Dimas district, on the borderline of the states of Durango and Sinaloa
• Its mining operations have produced approximately 95 million ounces of silver since 1991
• Luismin has proven and probable silver reserves of 45 million ounces and inferred silver resources totaling 188 million ounces
• It expects to increase its silver production from 9.5 million ounces in 2006 to 13 million ounces from 2009 onward.

Through contracts like the one with Luismin, Silver Wheaton produced 2.7 million ounces of silver in the most recent quarter, at an average cash cost of $3.90 per ounce. Now that’s leverage!

Silver Wheaton’s production should exceed 15 million ounces in 2006 and hit 20 million ounces in 2009. What’s more, SLW has other projects in the works that could add hundreds of millions of ounces to its resource base. I expect Silver Wheaton’s resource base to keep expanding, and that should pump up this stock’s share price.

I have no doubt that silver will be breaking out to the upside soon — and stocks like Silver Wheaton could lead the way.

In a few days, I’m flying down to Mexico to make an on-site visit to a mine that really interests me. It’s high in the mountains…far removed from civilization…reachable only by air. I LOVE it! This is the kind of exciting stuff that makes this job worth it.

Regards,
Sean Brodrick,
Senior Natural Resources Analyst,
MoneyAndMarkets.com
November 3, 2006