Silver in 2001 Part 2

In Part-1 I made a case that all is not right in the silver world because of three main reasons, the marginal mining operations are going out of business, supply has been in deficit situation for over a decade, and the price of silver has not even kept pace with the overall price level ( inflation). The fundamentals are basic economics and the price pattern of silver defies this basic law. There can be several theories developed but logic dictates a simple statement : something is just not right in the silver market.

I pulled this very basic summary from Pan American's web site: "Demand for silver has doubled in the last decade, while supply has risen only slightly. This has caused the known inventories of silver to sink to record low levels, a condition that normally results in a price rise in any commodity." "Normally", so perhaps my choice of words is poor, the silver market is not normal, period.

In an effort to keep the basics as simple as possible I have come to this conclusion. The bulls and the bears in the silver market have two different belief systems. The bears believe that there is so much silver available to the market that the price will remain low for a very long time into the future. The bulls believe that there is a very limited quantity of silver available to the market and the price should reflect this soon. That is about as simple as I can possibly make it.

First, I must give credit to the CPM Group in New York, N.Y. Most of what follows is based upon their "Silver Survey 2001." As I had expected, the first statement made by CPM in the highlights section, is "The physical silver market operated in a deficit for the eleventh consecutive year in 2000." This was hardly a surprise to any silver analyst. The deficit was stated to be approximately 117 million ounces. I was looking for a number of about 120 million, as most who have read my prior work know I like to average the deficit as 10 million ounces per month.

The next two areas that appeared in the Summary section were again not surprising to me. Mining companies are suffering from lower prices and fabrication demand was stronger than expected. Demand rose in total for the year, posting its strongest return since 1997. CPM explains that part of this was a shift to silver from palladium in some electronic and industrial applications. Additionally, strong demand for photographic products. Sorry bears, digital camera impact has yet to be felt.

The most important section to me, was the discussion of inventories. Here I expected to see the total bullion inventory to be in the area of 230 million ounces. This would be approximately last years total less the amount used (117 million). However, this was not the case. I think it best to again quote CPM directly, "A mistake may have been made a few years ago when statistics outlining a range of realistic levels of unreported inventories began to be included in these reports. These statistics had been complied and updated by our research group since the early 1970s for internal use, but had never been published because of their hypothetical nature." Reading further , CPM says "By publishing these numbers , the impression may have been given that the accuracy of these estimates was greater than it is." So, the bottom line is this, CPM now reports that the unreported bullion inventories at the end of 2000, is in the range of 175 to 400 million ounces. Reported inventories are at 133.8 million at the end of 2000 which is the COMEX, TOCOM, and CBOT (Chicago Board of Trade) added to U.S. and Japan Industrial holdings.

So, where are we really in the silver market? To give an exact number is obviously very difficult as quoted above. However, we do know that again more silver was used than was mined and above ground stocks were depleted further. Another very important point is made by CPM group which I personally thank them for, and it is this: a summary is made using a comparison between the end of 1996 and the end of 2000. CPM's estimate is that total silver stocks including coins and Government stocks are down between 22.6% to 38.1% depending upon whether the high or low inventory estimates are used. For reference the estimated total silver supply used at the end of 1996 was 1,453.7 million ounces.

Now it is time to check my work. If we use 22.6 % of the 1,453.7 million that is approximately 7 million ounces per month. This is lower than my usual factor of ten million ounces per month. Ok, let's look at the high end; 38.1% of 1,453.7 million is about 11.5 million ounces per month being depleted.

Has anything really changed in the fundamental analysis for silver. Yes, in my studied opinion it has, I am more bullish than ever. Certainly, I will admit there maybe more silver available to the market than previously thought. However, in an effort to be as objective as possible let's look a little further into the supply side of the silver equation.

The first point is that one of the few areas where the silver is price sensitive and that is in the scrap recovery area. Low prices, that we are now experiencing limit the amount of silver that is "scrapped". I would also point out that everything to do with mining and recycling of silver ( metals actually) are very sensitive to energy costs. The mining, smelting, transporting, and refining all take huge amounts of energy. This fact will put further pressure on the supply side of silver whether from a primary mine or even as a byproduct from other mining activities such as copper.

Probably the most bullish factor to me is just how much silver mining activity has ceased. The Cove McCoy mine in Nevada ( producing 11M-3M annually ) , the Chimberos Mine in Chile ( about 20M ounces annually) , the Sullivan mine in British Columbia closing this year ( 2M annually), Candeleria Mine in Nevada ( 3M annually), Mt. Isa mine in Australia ( 6M annually), and the Frisco Real de Angeles Mine ( 4.7 M annually). According to one of the more respected silver industry leaders the silver industry will lose almost 50 million ounces of silver from mining activity in the year 2001! To be fair I will have to look at new mines ready to come on line. Actually there are two rather big projects one is owned by Barrick, and another is owned by Apex. In both cases the mining activity has been put on hold. I am not trying to imply that there is not more silver available, I am implying that this silver is price sensitive. These projects are on hold because of price. If energy costs increase and/or silver prices weaken further these projects made stay on hold indefinitely.

In closing it is also important to point out that silver has generally been in a bear market for more than twenty years. There has been very little focused silver exploration during that time. Additionally, it takes nearly five years to get a new mine producing in South America. For North America it takes ten years from the time the discovery is made, permits issued, construction completed, and actual metal is extracted. Mining is very cost intensive and energy intensive. Much thought and study will be used to determine just what silver mining projects are feasible in the future. Mining companies are not going to react to a sudden price improvement nor could they if they wanted.

Fundamentally, the silver market remains one of the best areas to invest. The metal has few friends, another deficit had to be met by above ground supply, the myriad of uses for silver keeps increasing, and the bears ruled for Y2K. How long can silver deify the law of supply and demand ? I do not know, what I do know is the fundamentals never looked better, lease rates are increasing, the stock market (NASDAQ) will not recover to its former high, world currencies problems abound, energy costs have increased for good, and talk of recession and stagflation is everywhere. Will 2001 be the year of the silver bull? Again, I am not certain, however all factors are indicating that it will be.

Silver in 2001 - (Part 1)

David Morgan
March 13, 2001

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