In my previous article, I showed how current mining production volumes point to gold being around ten times scarcer beneath the ground than silver. This contrasts with the relative price of gold and silver, which currently stands at 81:1. Even using the historical average of 67:1, we can see the mismatch between production volumes and prices.
Silver enthusiasts use this to point out why the price of silver should be much higher than the current price of US$24–25 an ounce.
Another point supporting their argument is that gold has almost doubled since late-2015 while silver hasn’t gained ground over the same period. Therefore, price manipulation by bullion banks is likely the missing piece of the puzzle.
Personally, I believe there’s some truth behind it. I’ve noted a few proven criminal cases where bullion banks were convicted and fined.
What I’ll do today is show you another perspective that suggests why the current price of silver is reasonable.
How mining profit margins suggest that silver is fairly priced
Mining companies report every quarter their production volumes, all-in-sustaining costs (AISC), realised price of sales as well as other financial and operating metrics.
I’ve tracked these in the last seven years to help me gauge their relative performance.
One key metric I like to use is the profit margin per ounce of gold sold. This is the difference between the realised price of sales and AISC. A better-performing producer would have a higher profit margin.
First up, I need to point out that I couldn’t come up with an Australian-based analysis on this front. That’s because very few ASX-listed precious metals producers own silver mines. Those that do predominantly mine gold, producing silver, copper and base metals as by-products. Therefore they report their AISC in terms of gold-equivalent production.
Instead, I turned to major international producers such as Fresnillo PLC [LSE:FRES], Pan American Silver Corp [NYSE:PAAS], Hecla Mining Co [NYSE:HL], and First Majestic Silver Corp [NYSE:AG]. These companies report AISC in terms of silver-equivalent production.
Reviewing these companies’ silver mines, I found that the average AISC is around US$15–18 (AU$22–27) an ounce. They sell their silver at around US$24 an ounce.
In other words, the average profit margin for silver producers is between 33–60%.
How does this compare with the profit margin of gold producers?
The average AISC of major gold producers is around US$1,100–1,300 (AU$1,650–1,950) an ounce while they sell their production at around US$1,900 an ounce. Therefore, their profit margin is around 45–80%.
So gold producers enjoy a higher profit margin than silver producers. This seems reasonable as gold is scarcer.
It’s possible to argue based on average profit margins that silver is underpriced at current levels. However, I’d say it’s a stretch to argue that silver should be worth more than US$50 (AU$75) an ounce. That’d imply silver producers earn a profit margin that greatly exceeds the margin for gold producers.
Future catalysts for a silver rally
At this stage, I don’t want to claim that I’ve solved the puzzle behind the value of silver.
What I’ve shown is that silver isn’t as underpriced as we’re made to believe from the silver stacking community.
I think there’s more to it than looking at the relative mining volume of gold and silver, the production costs and profit margins as well as price manipulation in the commodity exchanges.
It’s important to also consider the factors that determine the future supply and demand for silver, which could influence its price in the future.
Based on data from The Silver Institute, the annual global silver supply in 2022 is around 1 billion ounces, of which 82% are from mining production and scrap recycling accounts for the remainder. Demand for silver in 2022 was 1.242 billion ounces and is expected to rise. This is largely driven by industrial and jewellery demand.
So silver is facing a supply deficit. The key factors driving demand are clean energy generation, 5G communications, and electric vehicles.
Like copper, lithium, and other critical metals, this deficit could continue unless more mines come into production in the future.
Demand can easily change as that’s driven by government policy, business strategy, and consumer preference.
However, bringing a mine to production takes more time.
There’re several undeveloped silver deposits worldwide. Bringing the deposit into operation involves several steps including obtaining permits, confirming the orebody, and reviewing the mine economics. Once that’s completed and the board is satisfied, the company needs to secure funding to build the infrastructure.
As current silver mines deplete and inflation drives up production costs, that could cause the price of silver to rise. After all, a lack of supply creates scarcity.
In the meanwhile, I’d suggest slowly buying silver bullion.
Gold is hard money while silver is still treated as an industrial metal. Therefore the price of silver will behave accordingly.
There are few ASX companies that produce silver. Your exposure to silver will lie with explorers.
With these companies, there’s no need to rush into them. They’re risky investments, bordering on speculation.
Interested in building your exposure to precious metals?
Check out The Australian Gold Report, my investment newsletter service. Here I recommend a core portfolio of gold and precious metals producers, including a late-stage silver developer that I believe gives you good exposure to the sector in solid value companies.
Editor, Fat Tail Commodities