first majestic silver

Silver in 2001

January 26, 2001

Part 1

At this time silver is sitting near a twenty year low, with the price under $5 per ounce. Opinions about silver's future run the gamut from complete pessimism to an almost religious optimism. Is silver poised to move lower or should we consider the voices of some of the silver bulls, who think $100 silver is still possible.

Fundamentals provide compelling evidence that at current prices, silver presents a greater opportunity than it did when it emerged from government control in 1967. The current changes in the quantities of money vs. real goods during the past decades, point to silver as being one of the market's most undervalued investment assets.

If the conditions during the 1970s proved silver to have been under priced at $1.29 in 1967, we must presume that silver is more of a bargain today. I feel strongly that this understates the current conditions in the silver market. Fundamentals provide that silver presents a superior investment today than it did when it escaped government control in 1967. The current spot price of silver, coupled with the pitifully small physical quantity, point to silver as being perhaps the best and most undervalued asset of all time.


Silver analysts focus on supply an demand and I do as well, however I wish to reestablish some fundamental economic principles that will help us to better understand all markets and in particular silver. When viewing economics from a long term perspective three absolute principles must be employed.

The first truth is silver producers are in business to make a profit. Producers will produce ONLY if the price they receive exceeds their costs by a sufficient margin to give them a profit. Thus, over the long term profit has an effect on production. No profit eventually leads to no production. One only has to look as far as Sunshine Mining, Hecla, or Coeur d'Alene to see how these "silver miners" have fared in the past few years. I suggest to the reader that they picture how an ounce of silver can be produced for under five dollars US by a silver miner. This is not necessarily the case for base metals miners such as copper, zinc, and lead which supply over 70% of the silver to the market as a "byproduct" of their primary mining activity.

The second economic principle is that prices are set by marginal transactions. It is the last bidder at the auction that sets the price. Increasing demand for anything by 7% , given a fixed supply, might result in prices being bid up by 25% or more. A decreasing supply of any good by 5%, given a fixed demand, would result in price increases to some multiple of the the supply decrease. The most recent example of this economic truth is in today's energy market, one only needs to look at California to see how the last bidder is setting the price.

Relative to silver this means that marginal silver users, whose needs MUST be satisfied, will bid prices to the level necessary to entice those last remaining silver producers to sell. This principle must be kept in mind as our essay continues.

This second principle combined with the first, leads to the economic truth : over the long pull the average price of a good must be higher than the marginal producers costs of production.

The third principle is also plain common sense. Production costs themselves are a function of price inflation. When inflation carries production costs up, the price of the end product must rise. History teaches us that over the long run, the price of all goods and services tend to rise in direct proportion to increases in the general price level.

To look at silver as an investment, we need to ask what is silvers balanced price. By balanced price I mean where the marginal producers ( silver miners ) are able to produce silver at a price profitable enough to cover all costs, and still remain in business. In other words at a price that provides enough profit to continue operations. Marginal producers are those that are on the edge of profitability.

There are only four main sources of silver:

1. Primary Silver Miners
2. By Product mines - Copper, Lead, Zinc, and Gold mines
3. Recovery of silver form scrap
4. Refined stocks

The lowest cost source of silver is scrap recovery and by-product miners. The costs of recovery from scrap tend to be low enough that this source will provide silver at at very low price. If the price of silver rises rapidly, this source tends to increase as people tend to sell their silver at a profit. Also, by-product mines continue to produce regardless of silver price as long as their primary product is being produced at a profit. So a rising silver price will have little effect on this source (by-product mines) of silver supply. However, it is extremely important to keep in mind that the general level of business activity will affect the output of by-product mines. For example if energy costs become restrictive enough to the cost of business then the amount of base metal production will suffer and consequentially the amount of silver available from this source will decrease. Thus the output of silver from these by-product miners will fall. We are currently seeing the start of a retraction in the overall economy with layoffs and prices trending upward due to the simple fact that energy costs effect nearly every aspect of economic life across the world.

Although scrap recovery does provide a cheap supply in cannot meet the total silver demand of industry. When the output from both by-product mines and scrap recovery are not sufficient to meet the total demand, the difference must come from existing refined stocks of silver.

Refined stocks have filled the gap between supply and demand for over ten years now. Since there has been an ongoing shortage the refined stocks can only make up the shortage for a limited time. Given the condition of usage above supply, we are facing a crucial point in the silver market. Since consumption is higher than production we have to know that refined stocks are being drawn down because there is insufficient supply form primary silver mines. That suggests that primary producers are not making a profit, and that the price is below the balance price. This is very significant because just as no one can escape the laws of physics no one can escape economic law ( at least not for very long).

Let's look back a truth number two; A decreasing supply of any good by 5%, given a fixed demand, would result in price increases to some multiple of the supply decrease. Increasing demand for anything by 7% , given a fixed supply, might result in prices being bid up by 25% or more. Where does this put us in the silver market? We have a decreasing supply coupled with an increasing demand. Yet the price continues to go down, this is against all economic law and is proof beyond all doubt that all is not right in the silver market. How long can this go on? The cause for this defiance of truth suggests that some outside force has been able to intervene into the market and disobey economic fact.

However, our study is over the long run remember? Over the long run any type of market manipulation regardless of it's source fails eventually. Can the silver market be the only exception to this basic human understanding or how the world works?

David Morgan

[email protected]

David Morgan is a widely recognized analyst in the precious metals industry and consults for hedge funds, high net worth investors, mining companies, depositories and bullion dealers. He is the publisher of The Morgan Report on precious metals, author of “Get the Skinny On Silver Investing” (Morgan James Publishing, 2009), and featured speaker at investment conferences in North America, Europe and Asia. His website at

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