-- Posted 24 July, 2004 | | Source: SilverSeek.com

BSc(Hons)Lond., MSc, DIC, MBA, MIMMM, SEG
Consultant Economic Geologist
Mineral Consulting International (NZ) Ltd.

Investor Summary

The fundamentals behind the world silver market are looking increasingly strong. Silver bullion stocks of central and investment banks are at an all time low, or, in many cases, totally depleted. The demand for silver, especially in the diverse high technology and medical market segments (40%) is steadily increasing, as is the investment market segment in silver coins and bullion. The analogue or standard photographic segment, a substantial industrial market for silver, diminished in the last calendar year by a matter of a few percent only, despite the much vaunted demise of the silver market posed by advent of digital photography. A substantial proportion; i.e., 70% of the "Old Silver Scrap" market, comprising some 22% of the total market supply, was provided through the recycling of photographic film and paper. Hence, demand for silver in the photographic market is 85%, met through recycling within this segment. Furthermore, the "take off" of the digital camera market is restricted, in large part, to the young and relatively affluent (professional and young) market segments in developed economies. To make full use of digital photography, one requires a computer and/or printer infrastructure, plus expensive printer cartridges, re chargeable batteries, and photographic papers, that are, collectively, generally beyond the pocket of the mass market. Therefore, it seems unlikely that digital photography will become a substitute for mass-market traditional photography in the near future. Given the growth in general affluence of the Asian markets, the mass market for conventional photography is likely to expand at a faster rate than the growth of digital photography, offsetting any decline in developed countries. Therefore, to analyze the silver market one has to see outside the photographic market segment.

In contrast to gold, where the bulk of mine supply is derived from primary gold producers (i.e.; those mines mining gold as the principal product), the structure of the silver supply side from mining is totally different, and remarkably inflexible and "tight". Silver is primarily supplied as a secondary by product of base metal (copper, lead and zinc) mines, or, as a co – product with base metals in the tetrahedrite – silver sulfosalt dominated deposits or from epithermal gold - silver deposits. Standalone silver mines comprise one of the smallest market segments in the entire metal mining industry. Indeed, in the USA and Canada there are only two significant primary silver and silver co – product producers: Coeur d'Alene Mines and Hecla Mining Corporation, which together supply the "princely" total of 4% of world silver demand or 24 M oz. If one factors in all significant co – product and primary silver producers worldwide, the world mine production figure for these deposits amounts to less than 10% of world supply. This is an amazingly tight market geared to only incremental increases in silver demand. Should investment demand for the metal suddenly increase, the mining industry could not respond. Banks, Metals Traders or Investment Houses have virtually no silver stocks to draw down. Therefore, their influence on the market could be considered insignificant. In short, the silver supply side has virtually no scope to adapt to any significant change in demand. Besides, it would take a price of over US20 per fine ounce to encourage people to sell, "en masse", the family silverware. Even then a "fire sale" of silverware would not necessarily bring down the silver price.

Low silver prices for much of the last 40 years, apart from the short lived Bunker – Hunt market spike around 1979 – 1980, when an ill-advised effort was made to cartelize the silver market, have meant that mining companies have had virtually no incentive to look for "standalone", or primary, or significant co – product silver resources. Hence, very few new resources of silver have been found, apart from those discovered as result of base metal, gold or tin exploration. Whilst huge potential exists to discover substantial primary silver resources, for the longer term, from the following deposit types: epithermal vein; porphyry copper – molybdenum related stockwork vein; and, vein array systems worldwide, the mining industry will require a sustained silver price, probably in the range from US$9 to US$12 or higher, to explore for, and develop, such systems. Right now the mining companies are very wary of silver's prospects, given its past 30 year history, and remain to be convinced of the metals long term prospects, given its "Cinderella" image within the precious metals market.

Should a major economic downturn affect the base metal markets, due, say, to a collapse of the Stock Markets, Bond Markets and Real Estate Markets, with the broader implications of bursting the Chinese – Asian market bubble simultaneously, then several of the base metal miners may cut back on production, or be forced to high grade their deposits at lower production rates. Faced with overvalued stocks, bonds and real estate, and a collapsing US dollar, rising oil prices (towards US$ 50 – 55 by end 2004), accelerating inflation, and, finally (as the Fed's hand is forced), accelerating interest rates, the World's No 1 economy, the USA, looks to be headed for the "Economic Train Wreck of All Time". This will bring the Global Economy, including China, to its knees. Under this scenario, investment demand for all the precious metals could quite simply take off to levels hitherto thought improbable.

Given the foregoing scenario, silver producers would have absolutely no chance of meeting such demand, unless the silver price became high enough to encourage the base metal miners to expand their operations on the basis of earning large silver credits. The primary silver producers are too small and limited in number to make anything other than a marginal impact on the market. It takes years to find, evaluate and develop a new mine of any size. Obviously, small vein mining operations, such as those in the Idaho silver belt, or at Slocan in British Columbia, could be rapidly brought on stream. However, their contribution to supply would be insignificant. Should the above catastrophic scenario not eventuate, the fundamentals for silver are the strongest they have been for 25 years, and, therefore, silver is headed higher come what may.

Finally, it is worth noting that the worldwide silver market currently (calendar year 2003) consumes 880 million ounces of the metal annually, of which 714 Moz can be considered a real supply minus recycled photographic waste. Given an average silver price of US$ 5.25 per fine ounce, this values the world silver market at a mere US$ 3.8 billion or significantly less than 10% of the present market capitalization of PEPSICO, and equal to approximately 10% of the worldwide gold market, which in turn is still less than 50% of the market capitalization of MICROSOFT Corporation.

Introduction

Silver has for much of the last Century been the "Cinderella" of the precious metals sector; i.e., very much the poor relation of its more glamorous, and less geochemically abundant, companions gold and the platinum group elements. Silver has been a monetary metal for nearly as long as gold; since first evidence of its active smelting, dated at around 3,000 BC, was discovered by archaeologists in the Eastern Mediterranean and Asia Minor. Indeed, there were periods in European and Chinese history where silver was more highly valued than gold. This merely reflected the supply and demand equation existing at that time, and did not accurately represent the geologic abundance of these metals, as subsequent events have proven.

In the early and middle years of the 20th Century silver, and latterly gold, have been demonetarized by the International Banking Cartel (controlled by the huge European Banking Houses such as the Rothschilds, Warburg's, Baring's, Hambro's, and, more recently, powerful US based banks such as J P Morgan, Kuhn Loeb, Salomons, Bear Stearn's, Goldman Sachs, Shearson Lehmann and Rockefeller's Chase Manhattan – Citibank) in favour of increasingly unrestrained paper issuance (FIAT), and, in the "Computer Age", digital money. During the latter part of the 20th Century; i.e., since 1982, unrestrained lending and monetary expansion have accelerated at a frenetic rate. The USA's Federal Reserve Chairman, Sir Alan Greenspan, will undoubtedly go down in history as the most profligate (and seemingly reckless) monetary expansionists of all time. His legacy can only bode well for the precious metals.

The Supply and Demand Equation

The key markets for silver are Industrial Applications (40%); Jewelry and silverware (31%); Photographic film (22%); and Coins and Medals (4%). The greatest immediate threat to the silver market comes in the area of photographic film, where digital photography has replaced conventional photography in developed countries such as the USA, Canada, Europe, Japan and Australia. However, as noted in the Investor summary, the take off of digital photography is limited by the fact that overall costs include a higher unit cost when compared to conventional equivalents due to the need for re – chargeable batteries, printers, photographic paper, computers to optimize picture production, etc. The mass market, developing in Asia, in particular, will largely opt for conventional photography based on overall cost. Digital photography will remain the preserve of the wealthy and professional, who can utilize to the full the technical advantages afforded by digital photography in their work. To date, the growth of digital photography has been largely confined to the select segments within developed nations: the USA, Canada, Australia, Europe, and Japan.

The photographic market makes a very modest demand on the silver market, because most (85%) of the silver used in this market is recycled as scrap. In this respect, this segment of the market is almost "a zero sum game", and, therefore, has far less impact on the supply and demand equation than is currently thought.

During the 20th Century, whilst silver was being demonetarized, new markets developed which more than counterbalanced the decline in coinage fabrication. Silver has unusual physical and chemical properties, including its high malleability and ductility, and more importantly, silver displays the highest electrical and thermal conductivity of any element known, and possesses an electrically low contact resistance making it a very useful metal in some electrical equipment. Furthermore, silver displays an ability to endure extreme temperature ranges. Silver's best-known characteristic is its sensitivity to and very high reflectance of light, apparent in camera film and freshly minted coinage and polished silverware. Given these important characteristics, it will come as no surprise that silver has become increasingly important in "Hi Tech" applications and is now an "industrial metal" rather than a precious metal in the strictest sense.

The "Hi Tech" applications of silver in industrial markets are "niche markets", in which silvers’ unique physical and chemical properties mean that the threat of substitution by cheaper materials is highly unlikely, if not scientifically impossible, given present technology. These markets are very likely to be growth areas, both in developed and developing countries, because of their self-evident value in society in very significant applications. For an overview of these uses the reader is referred to the website of the Silver Institute.

Coinage, jewelry and silverware are potential growth areas, in particular in the Asian markets, again due to silver's great beauty as a polished metal, and in its function as the poor man's precious metal for those who cannot afford to buy gold. As FIAT currencies meet their "Gotterdammerung", people will increasingly turn to real value, as all other asset classes go into serious decline. The limitation here lies in coinage and investment ingot fabrication, which comprises a mere 4% of the market, and is confined to Mexico, the USA, Canada and Australia. This market cannot be suddenly expanded to meet increased demand, should the need arise. Besides, silver supply is largely “spoken for” by the Industrial and Photographic markets in the form of set contracts.

Originally, silver was mined largely as native silver from supergene enriched, high grade, vein deposits. In these deposits already high grade silver sulfosalts are weathered and oxidized, near the present land surface, to reduce the silver to its native form and upgrade the existing deposit to "bonanza grades", of the order of thousands of grams per ton. Such deposits were the target of medieval mining activities throughout Central and South America, Europe and Asia. By the 17th and 18th Centuries, the majority of such deposits had been worked out, in these areas. This mining activity made silver the precious metal of the day owing to its relative abundance, when gold was relatively scarce. However, from the 1850's onwards successively larger gold districts were discovered: as placer gold in California and New South Wales; and as placer, deep lead and bedrock vein deposit gold mines in Victoria, Australia; the placer deposits of the Klondike in Canada, and, during the 1890's, the mighty Witwatersrand Proterozoic (fossil) placer gold deposits of South Africa (more than 110,000 tons of gold metal) and the bedrock, vein array, deposits of goldfields of Western Australia, in particularly "the Golden Mile" at Kalgoorlie. Mining activities at these locations enabled countries to move towards a gold and silver standard as a basis for money.

During the early years of the 20th Century significant deposits of lead – zinc were discovered in the Central USA in the Ozark Hills and Tri – State districts, and in New South Wales, Australia, at Broken Hill. These mines all produced significant by product silver, largely from argentiferous lead ore, galena, at a time when supply of silver from primary resources was diminishing. This trend gathered pace in the immediate post WW2 era during "the golden days" of mineral exploration in the late 1950's to early 1970's when significant, and often large resources of carbonate hosted lead – zinc deposits in the USA and Canada (at Pine Point), and in Queensland, Australia, the giant Mt Isa and satellite Hilton deposits, were discovered. Furthermore, the huge Sullivan lead – zinc silver deposit was discovered in British Columbia. Progressively, the main source of silver supply shifted from primary silver producing vein systems to become a by product of large base metal mining operations. Increasingly significant quantities of silver were also being produced as a by product of the huge porphyry copper and molybdenum mining operations in the southwest USA, British Columbia, and South America, as well as from the expanding number of primary gold mining operations.

Supply of silver for calendar year 2003 equalled demand at 880 million ounces, and was comprised as follows in order of significance: Mine Production (68%); Old Silver Scrap (22%); Net Government Sales (9%) and Net Disinvestment (1%). There was no Producer Hedging in 2003 for obvious economic reasons.....why hedge when the only way for the silver market is up? It could hardly go much lower than it has been. However, as prices of silver rise, one may expect silver companies to hedge forward sales, in coming years, to lock in profits. Although, having said this, the USA's most famous primary silver producer, the great Coeur D'Alene Mines, remains proudly a "non-hedging company".

World Mine Supply

During 2003, the worlds’ 10 largest silver producing nations were as follows in order of production: Mexico, 93.8 Moz. (million ounces); Peru, 89.2 Moz.; Australia, 60.2 Moz; China, 46.8 Moz.; Poland, 44.3 Moz.; Chile, 41.6 Moz.; United States, 41.5 Moz.; Canada, 41.0 Moz.; Russia, 33.8 Moz.; and Kazakhstan, 22.9 Moz.

The worlds’ 10 largest silver miners are as follows: Industrias Penoles (Mexico) 48.4 Moz. (by product silver from lead – zinc operations at Fresnillo); KGHM Polska Miedz (Poland) 43.7 Moz (by product silver from copper operations); BHP Minerals Ltd. (Australia) 42.7 Moz. (from Cannington bonanza silver – lead - zinc mine); Kazakhmys (Kazakhstan) 19.5 Moz. (with gold mining); Grupo Mexico (Mexico) 19.0 Moz. (some primary silver operation as well as by product lead – zinc); Rio Tinto PLC (UK) 18.3 (by product of porphyry copper and lead – zinc mining operations worldwide) Moz.; Barrick Gold Inc.(Canada) 17.0 Moz. (by product of gold mining operations); Coeur d'Alene Mines (USA) 14.2 Moz (primary silver producer).; Polymetal (Russia) 13.3 Moz. (by product of lead – zinc and tin mining); and Xstrata (Mount Isa Mines) Australia 12.0 Moz (by product of lead – zinc silver mines at Mt Isa).

Surprisingly, Newmont Mining Ltd, a major worldwide gold producer, is only the worlds’ 13th largest silver producer (9.9 Moz), largely from its operations in the Carlin mining camp in Nevada, where silver is produced as a by-product of gold mining operations. Newmont has no major primary silver operations. Hecla Mining Company, a substantial primary silver producer, is the world's 15th largest producer with 9.8 Moz. This company operates substantial primary silver operations as well as having a significant and developing gold portfolio.

In terms of mine production, the following is a breakdown of where current mine production is sourced:

• Lead – Zinc deposits (Mostly Mexico, epithermal lead – zinc - silver deposits, and Cannington, Mid Proterozoic, lead – zinc – silver, sedimentary exhalative deposits) 31%;

  
  

• Copper deposits (primarily the Kupferschiefer of Poland and porphyry copper mines) 25%;

  
  

• Gold deposits (in particular Carlin type and Epithermal deposits) 14%

  
  

• Primary silver deposits (in particular "Idaho type" tetrahedrite – friebergite deposits and epithermal silver deposits) 28%.
  
  

The silver market is dominated by a few large deposits such as those in Fresnillo, which comprise a part of the 800 km long Mexican lead – zinc – silver belt, and the large Polish sedimentary (copper shale or "Kupferschiefer" deposits), or the Mid Proterozoic age, bonanza, lead – zinc – silver deposit at Cannington, in the world famous Mount Isa belt in Queensland, Australia. During calendar year 2003, Cannington mined ore at an average grade of 544 grams per tonne silver, 11.9% lead and 4.5% zinc, and is, at present metal prices, a bonanza deposit. The mine produces 34.85 million ounces of silver per annum from argentiferous galena and friebergite ore. Another major silver producer, for more than a century, has been the giant Potosi mining camp in Bolivia.

With the exception of Cannington and Potosi, these companies are driven by base metal prices, and not silver prices, and so they are unlikely to expand production unless the silver price rises to levels where silver credits comprise a significant proportion of overall profits. Therefore, as far as silver is concerned, they are "demand inelastic". However, these companies have considerable exploration potential on their own doorsteps, but are in no rush to develop this known potential. They are market driven by their primary products, the base metals.

In terms of the capability to expand production at higher silver prices, one has to look to the primary silver companies, such as Couer D'Alene Mines, Hecla Mining Corporation and the like. These companies are highly experienced in sourcing and defining epithermal, stockwork systems and vein – tetrahedrite type silver deposits, in the USA, Canada and Central and South America. There is tremendous scope for exploration, throughout the Canadian and US Rocky Mountains, to discover additional primary silver resources.

Low silver prices have meant that "Silver States", such as Idaho, have largely gone unexplored for decades. Sterling Mining, a primary silver exploration company, has acquired the highly productive, and formerly high grade (800 g/t + Ag ) Sunshine Mine in Idaho. This mine extracted silver from a swarm of friebergite and silver sulphosalt bearing veins for a period of approximately 100 years. The Sunshine District has much undiscovered potential, and Sterling will be a company to watch as it gets underway with the re – evaluation of this major silver mining camp.

Klondike Gold is now taking a good hard look at the silver resources of the Slocan lead – zinc – silver camp in BC, and should be able to go rapidly into modest production once silver rises above US$ 6 – 7 / ounce. It has a large choice of potential medium to high-grade lead – zinc – silver veins to explore and possibly develop.

In summary, the key issue in respect of mine supply of silver is that primary silver producers comprise a mere handful of professional mining companies, of which the USA has the two most famous; i.e., Coeur d'Alene Mining and Hecla Mining Corporation. If one factors out the 166 Moz of silver recycled from photographic waste, then of the remainder, which can be considered the real silver supply; i.e., 714 Moz, the two major primary silver producers, Coeur and Hecla, supply less than 4%, or 24 Moz. If the major Cannington deposit is factored in as a co – product silver deposit production stands at only 8.3%, or approximately 60 Moz. This is a startling fact! In other words, the real silver supply side is incredibly heavily skewed by production from the base metal and gold miners. A figure of 20% production from primary, or co – product producers, would be considered a tight market but anything less than 10% implies we are dealing with a situation which could lead to a major price spike should demand suddenly accelerate.

Should the demand for silver accelerate due to increased conventional photographic usage in Asia (China and India) or investment demand for silver rapidly accelerate (more likely), then the market is almost totally inflexible in respect to its ability to respond to any sudden increase in demand. Furthermore, the lead time required to explore, evaluate and develop new mines varies from 4 to 7 years depending on politics, economics, infrastructure, geography and financing. Given silvers’ past lackluster performance, and poor market perception, very few lending institutions would be inclined to finance the development of a substantial primary silver deposit. Therefore, any new production would have to financed internally by those companies sufficiently cashed up or with the collateral and understanding of the market necessary to finance the development. Given these constraints, it seems unlikely that much in the way of new silver production will come onto the market unless the silver price rises to allow companies like Mines Management to develop their large low grade silver resource. Even then, no new silver will come onto the market for 2 to 3 years whilst the project is being constructed.

Should the silver price advance significantly and stay above US$ 8 – 10 per fine ounce, then one may expect existing silver miners and silver exploration juniors to significantly expand their exploration activities throughout the Rocky Mountain and Andes chain from Alaska to Chile. This 7000 km chain has huge epithermal silver potential. Similar potential exists in the mountain chain extending from the Carpathians in Eastern Europe through Turkey and the Caucasus to the Zagros mountains, Tien Shan and Himalayan mountain chain. Additional significant potential occurs in the Ural mountains of Russia associated with Hercynian – Variscan tin – molybdenum granites and epithermal - porphyry systems.

A Very Preliminary Look at Silver Miners of Interest to Investors

For those investors looking to buy shares in a primary silver mining company on home territory; i.e. within the USA, and well managed with an excellent balance sheet, one can do little better than look at HECLA MINING COMPANY. This company was established in 1891, and is Coeur d'Alene's smaller brother, although of equal vintage. Both companies operate in Northern Idaho's silver valley, as well as throughout the Rockies and South America. With a respectable annual production of 9.8 Moz of silver, at the very low cash operating cost of US$ 1.43 / fine ounce, this is a very profitable concern. Furthermore, Hecla has produced 204,000 ounces of gold during calendar year 2003 at a very respectable cash operating cost of US$ 154 / fine ounce. The company has a good balance sheet, is virtually debt free, is very well cashed up and well managed. Furthermore, HECLA has excellent exploration potential. In view of these facts, HECLA will be the subject of the first fundamental report on significant silver producers during August as the writer feels that the company merits serious consideration. For the interim, Investors are referred to HECLA's website for further details.

As an Economic Geologist the writer has to profess to having an emotional soft spot for Coeur d'Alene Mines. This company is one of the USA's mining legends and is North America's most famous silver miner. Coeur will also be the subject of an in-depth fundamental study during August, which will be presented on the writers’ own website to be launched in early August.

Note: the author would like to thank Dr Gary Matthews for his very helpful contribution concerning the photographic market for silver.

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