By Jeff Clark, Senior Analyst, GoldSilver, and Adviser for Strategic Wealth Preservation.
The annual data for silver supply is in, and it shows that the structural decline in new supply for the silver market has strengthened. It is not temporary, and can’t be easily resolved or reversed.
The main issue is the deterioration in mine production, although scrap sources are falling as well. This is important because much of the bullion you and I buy comes from newly-mined silver. Secondary sales (bullion products that have been previously bought and sold) will always have a place in the industry, but to be prepared for the kind of rush Mike Maloney sees ahead, mine production will need to be healthy and rising. It is neither of those things, as you’ll see.
Let’s take a look at what is happening to the silver mining industry, as well as other supply sources. As you read through the research, see if you can identify the one and only factor that can reverse this situation…
Silver Mine Production
According to CPM Group, global mine production fell for the fourth consecutive year in 2019. This was before COVID-19 struck and temporarily shuttered operations, so a further decline this year is already baked in the cake. Most estimates I’ve seen are for silver mine output to drop by at least 10% in 2020.
Mine production from primary silver companies also fell last year, by 3.8%. It, too, is expected to drop by double digits this year.
Add it all up and you get a picture of mine supply that looks like this.
For as long as records have been kept on silver mine output, we’ve never seen a four-year drop this severe.
What’s going on? It’s largely the result of declining grades at existing projects, a lack of new discoveries, and very few new mines coming online. (And what is the cause of all that? That’s the factor you have to identify before the end of the article.)
Those trends have caught up with the industry. Here is the amount of silver produced from the top 10 countries in the world—looks what’s happened over the past four years.
The ten largest silver countries have produced 12% less silver just since 2016.
And when we zero in on the primary silver mines, we find that mine “capacity” (the amount of new metal expected to come online in any given year) has essentially disappeared.
The amount of silver produced last year from new primary silver operations was less than 6 million ounces.
In fact, only one new primary silver mine came online last year, the Sotkamo silver project in Finland. That’s it. All other new capacity came as a byproduct of gold and base metals mines.
And these byproduct producers are spending less and less on exploration and development of projects, and expansion of their existing mines. Check out the trend in capital expenditures the byproduct producers are expected to devote to mining activity over the next few years.
If these miners—who account for as much as 80% of all the silver produced in the world—spend less to explore and develop and expand, what happens to the amount of silver they’ll produce? Exactly. Less and less.
But won’t they produce more silver if the silver price rises?
For these miners, not really, because silver is not their primary source of revenue. Most silver from byproduct producers offsets costs for their primary metals. This means that as many as four out of five companies that produce silver will not automatically try to produce more silver if the silver price rises. This is partly why we say the decline in silver supply is structural.
Secondary Silver Supply and Bullion Inventories
Okay, but scrap is a big source of supply too—what about that?
Because of low silver prices, recycling has fallen.
Supplies of recycled silver have fallen by 28% just since 2012. They’ll rise when silver does, but it’ll take significantly higher prices to provide the incentive to have a material impact on overall supply.
Incrementum had an insightful take on recycling from the industrial sector… “The most important source of secondary supply of silver is the industrial sector. After averaging 4% of total supply in the 1990s, it has risen to 9% over the past decade. Will there be much supply coming from this sector during the next price surge? No, because this scrap supply is not as sensitive to price as it is to industrial activity. And industrial activity has been poor, and is set to get poorer.”
Okay, so higher supply is unlikely to come from the mining industry or scrap sources. Can’t new investors just buy it from existing investors?
Here is the amount of bullion silver available at exchanges, dealers, funds, and government inventories.
It amounts to just a little over one year’s supply.
All this is occurring at a time when demand for physical investment products is growing. CPM says bullion demand will grow 16% this year. It was up 12% last year, and prices were mostly flat—imagine what happens to demand when silver flies past $20… then $30… then $40. And if silver hits a new all-time high above $50, something we fully expect to happen, it will make global headlines and draw investors in like the proverbial moth to a flame.
Remember, in a rising price environment, investors buy, not sell. This fact will keep a lot of that silver off the market—yes, I’ll someday sell mine, but not until it hits three figures.
And what if governments want to buy silver? You can begin to see how demand could quickly and easily get out of hand.
The Only Way Out
So did you identify the one factor that can reverse silver’s structural supply dilemma?
I’m sure most silver investors did. Higher silver prices. That’s it.
And not just higher prices, but sustainably higher prices. In other words, management teams will have to be convinced silver prices will stay high before they’ll invest millions (and in some cases, billions) of dollars in new projects. They can’t lower costs much further, so this is the only realistic way to reverse the downtrend in mine supply, particularly from the primary silver producers.
I know a fair amount of silver mining executives. And I can tell you firsthand that while there’s a constant focus on replacing the ounces they produce, they are not about to pour seven-figure amounts of cash into a project unless they’re absolutely convinced—along with all the investors and bankers and funds and financiers backing these projects—that the silver price will be high enough, long enough, to make a profit for years and years to come.
Therein lies the problem. The silver price is just too low to solve the mine supply dilemma.
But couldn’t they discover a high-grade deposit that can produce metal at a much lower cost? Yes, but most companies aren’t looking for them. And those deposits are fewer and fewer in number and harder and harder to find… or they’re located in increasingly hostile political environments… or environmental concerns take precedence… or they’re expensive to prove up or get permitted. And in all cases, they take years to develop. Turning a new project into a mine is the opposite of turning on a light switch; it’s the equivalent of having to build the building first.
A rise in the silver price will help, of course. But the silver price is like a speedboat whipping around the waves; the mining industry is like a tanker trying to execute a turnaround.
The bottom line is that the low silver price has caught up to the industry and is, in essence, holding it hostage. Miners have been spending less and less looking for new deposits. They’re developing fewer and fewer new assets. Existing reserves and resources are depleting. And it’ll take lots of time and lots of money to turn it all around.
There’s little doubt that a new supply of silver will tighten further. And if this trend is still in force when the silver price begins its volatile spike to $50 and beyond, and demand spikes right along with it, what do you suppose happens to the price?
This is gonna get fun someday soon, my friends. I hope you’re preparing for it like Mike and I are: buying silver now before it ignites.
Senior Precious Metals Analyst
This article was originally posted in the Strategic Wealth Preservation Blog and copied here with the permission of the author.