With copper and other base metals hovering around decade lows there have been considerable cuts to capital expenditures for exploration and mine development it is predicted that silver production will fall.
The low prices of silver and base metals have also caused primary silver miners to cut investment in exploration and mine development. It also now sees a number of primary silver miners forecasting production cuts for 2016 as they shutdown non-economic production.
Recently Endeavour Silver (NYSE:EXK) announced that it will slash silver output by 25% in 2016 and during the year shut one of its mines in Mexico placing it in care and maintenance until silver prices rebound. I expect a number of the other primary silver miners to follow suit with the price of silver dangerously close to the variable cost of production for many primary silver miners.
For the full year 2015, Pan American Silver (NASDAQ:PAAS) reported cash costs of $9.70 per ounce and all-in-sustaining costs (AISCs) of $14.92 per ounce, not lower than the current price of silver. Pan American forecasts that cash costs for 2016 will be between $9.45 and $10.45 per ounce and all-in-sustaining costs of between $13.60 and $14.90 per ounce only slightly below the price of silver. This may force Pan American to consider placing uneconomic mines in care and maintenance until silver prices rise.
Meanwhile, for 2016 First Majestic Silver (NYSE:AG) has forecast cash costs of $ to $7.60 per ounce and AISCs of $ to $13.36 per ounce, leaving it vulnerable to any further decline in the price of silver. It has also reduced its capital expenditures by 18% compared to 2015 to $63.8 million.
Then you have Silver Standard Resources (NASDAQ:SSRI) which has forecast cash costs of $7.15 to $7.65 per ounce at its Marigold mine and $10.50 to $12.50 at its Piriquitas mine. This highlights that for the Piriquitas mine Silver Standards cost of production is only 21% to 45% below the spot price for silver.
While miners will continue production at exiting mines as long as the price of silver remains higher than their cash costs, the slashing of capital expenditures indicates highlight that there has been a significant reduction in exploration and development activity.
This decline in investment in exploration and mine development will have a long-term impact on the supply of silver because of the long lead times associated with identifying and exploiting new ore deposits, as well as with ramping up production from existing mines. As a result, I expect the physical supply deficit reported for 2015 to continue to into 2016. A supply deficit also suggests a reduction in global silver inventories, further reducing the amount of silver available for investors, the fabrication of jewelry and industrial uses.
I expect this constrained supply situation coupled with growing demand to drive silver prices higher over the long term, while placing a floor under existing prices.
Bottom line
Silver certainly appears sharply undervalued relative to gold and also after taking into consideration emerging supply constraints. Indeed, as industrial demand for silver rise there should be over the long term a solid rally in its price.
However, like any investment this is not risk free and there are a range of risks specific to silver that investors need to consider. Key among these are the risk of silver ETFs making sizable liquidations which would see a considerable amount of bullion enter the market impacting prices.
Then there is the risk of the U.S. dollar continuing to rally which because of the negative correlation with silver will have a sharp impact on silver. It is also worth considering that silver has far lower liquidity than gold, meaning it is subject to higher volatility and wider price movements over time.
Silver is certainly an investment worthy of consideration and a small amount belongs in every portfolio. Nonetheless, because of the risks involved and concerns over how paper silver contracts continue to increase price volatility I certainly wouldn’t be betting the farm.
