The U.S. Geological Survey (USGS) released their September silver
production numbers this week and the results were incredible. Only 82.6
kilograms of silver were produced domestically in September versus 103
kilograms during September of last year. This represents a massive
decline of 20% and is part of a greater trend of declining silver
supply.
As you can see from the chart below, 2015 silver production started the
year higher than 2014. But in the spring, things started to shift. Production
dropped 4% in March and has been declining ever since for six straight
months. This trend of falling silver production culminated with the
sharpest decline on record during the latest period, down 20%! Indeed, many
analysts believe that we may have already seen PEAK SILVER production.
During 2014, production ramped up significantly in the winter months, but
this year is shaping up to be quite different. Even if production were to
rebound a bit in the coming months, we are still likely to see the gap versus
widen comparing this year vs. last year. And if production does not rebound
sharply, we are going to see declines of 30% or more in the coming months.
This is a significant development for silver investors, as sharply
dropping supply and steady demand is a clear recipe for higher prices.
Remember, sales of American Silver Eagles are on pace to set a new
record for the third year in a row. Total sales through the end
of November stand at 44.7 million ounces passing last year’s record of 44.0
million ounces.
Silver demand has also been hot in Canada, with the most
recent quarterly silver sales on pace to break 2014’s
record. Silver sales increased 76% year
over year from 5.4 million to 9.5 million ounces. Year to date through the
third quarter of 2015, the Royal Canadian Mint has sold 25.2 million ounces
of silver, on pace to surpass 2014’s record silver sales.
If we haven’t see the bottom in silver yet, these fundamentals factors
suggest that we are close.
While silver miners have reduced their costs in recent years, many are
still unprofitable at current silver prices. There aren’t many things that
you can buy for less than the cost to produce it. There simply wouldn’t be
anyone making the product anymore and silver is no different. These
conditions can persist in the short-term, particularly with the leverage
paper markets having such a large impact on pricing. However, I don’t believe
that the silver price can remain below the average cost of production for
long. Eventually the fundamentals force prices back to correct equilibrium
given the supply and demand in the marketplace.
I have long anticipated that as a growing number of miners would
suspend operations, pushing silver supplies down sharply. We are finally
seeing this manifest with the latest monthly production data. It holds true
for primary silver miners, but also for base metals producers where silver is
a by-product. They are also facing plunging prices in industrial metals and
are having a hard time remaining profitable. As they are forced to suspend or
shutter operations, silver production is going to fall even lower.
The decline in silver supply is not going to be a short-term
phenomenon. Not only is current production impacted as miners shut down
operations, but future production is also impacted as exploration budgets are
slashed. Even if the silver price were to double in 2016 and miners increased
cash flows, it would still take a few years to increase exploration back
to previous levels and have the type of production pipeline needed to sustain
production levels. Anyway that you slice it, the industry is likely to face
declining silver production for years to come.
I am not convinced that we have seen the absolute low in silver prices
quite yet. But this type of data is encouraging for silver investors and
suggests that the bottom may be near. Rather than attempting to time the
exact bottom, I think it makes sense to begin purchasing in tranches around
current levels. This is true of physical silver, but also the severely
undervalued silver mining stocks that could offer leverage of 3X to 5X during
the next upleg.
And although the FED finally pulled the trigger and raised rates by 25
basis points this week, there is plenty of evidence to suggest that silver
(and gold) prices can climb higher along with interest rates. There is also
the distinct possibility that the FED will not be able to continue raising
rates beyond a token amount and will need to reverse course at some point in
2016. So, I do not believe that precious metals investors should fear
increases rates.
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