Silver Plunges Below Marginal Cost: Commentary from a Retired Geologist

Last week as silver headed toward the $29/oz level, I received an excellent piece of commentary from a retired Canadian geologist that goes by the handle “Rhody.”  In it he states that at sub $30/oz silver is below cost, which I take to mean marginal cost.  For those not familiar with the commodity markets, marginal cost is the price that must be maintained to support new projects in order to keep supply growing to meet demand.  This cost includes capital investment in addition to all other costs as well as an implied return on investment.  I am not sure if Rhody included a return on capital in his $29/oz figure so it could be even higher.  In any event, he goes on to make some extraordinarily poignant statements on the overall macro backdrop in general.  So much so that I asked him if I could post it and he agreed.  Without any further ado…

Hi Guys:
Silver has now dropped below its total cost of production, which averages about $29.   Back in 2007, producers could produce silver at about $22 (which was above the spot price of the time as well) but at a 10% inflation rate, cost per ounce now, about 4 years later is going to be around $30.   Ignore mining companies that say they can produce silver at 5 or $6.   That’s just mining costs and ignores exploration, smelting, refining and shipping.   Back in 2007, if you looked at the top three miners, looked at their production and profits, you could calculate their total cost at $20-$24 back while the spot price was $18.    Essentially, silver has been produced below total costs since the 1930’s, which is why only 22% of silver mines subsist on silver alone and the other 78% survive on their other metal production with silver as a mere by-product.    No straight silver mine makes money, unless it is very, very high grade.

So as of this morning, we are below cost in the spot market.    This is back to normal for silver.   Silver has re-joined the ranks of food, and forestry as industries which operate below total costs.   100,000 third world farmers committed suicide last year because of their horrible economic circumstances.   Meanwhile there were food riots in middle eastern cities of North Africa, and Syria because of the “high” food prices.    Does anyone else perceive the logical disconnect here?    The problem of course is fiat money, and pricing commodities with derivatives that steal from everyone.

To get back to the thread below, gold and the dollar have risen together until 6 months ago when gold was crushed in the derivative markets but the Dollar held up.    The firm Dollar is because Europe is under attack and with it it’s banks and currency.    So Europeans pull their money out of their banks and buy either Dollars or gold as a flight to quality.    The Establishment doesn’t like the gold buying so a very effective campaign of disinformation, derivative based suppression, and selling by Western central banks has sent the gold market down by 15% over the past 6 months.    This cheapened metal has gone east, never to return.

Meanwhile the miners have been devastated and the Dollar has firmed.    This is the intent.    The World monetary system can be viewed as a huge tent, with a central pole (the U.S. Dollar), surrounded by secondary poles and tie downs.    The central pole has become unstable, and as it does, it is the secondary poles and the tie downs that rip out of the ground and fail first, eventually leading to the collapse of the central pole.    As the surrounding poles and tie downs (other fiat currencies) fail, their citizens flee to the remaining currencies that still survive, particularly the dollar, and its value rises because of the increased demand.    Some, but not a lot of this liquidity flows to gold and other tangibles causing price inflation.    So, in the end, gold and the Dollar will appear to rise together.    Well, gold has stopped rising, so we are not at the ‘end’ yet.    When we do reach the end, I expect a hyperinflationary event, which will drive gold in Dollars to levels which don’t bare mentioning, because in the end, no amount of dollars will buy an ounce of gold.   The precious metals have been purposely knocked down here.   People forget that although the metals are being slammed in the derivative markets, the decline has only been 15%, which is a moderate correction as these things go…..   This could be your last chance to buy politically cheapened ounces.   Don’t get upset, buy some more….

The dollar is terminal, for reasons that would take too long to describe.    Let us just say that a credit-based fiat currency is eventually destroyed by the build up of debt that it produces.    The Dollar’s debt burden has now become so huge that the entire world cannot support the interest payments to keep it viable, even at interest rates barely above zero.    So, you have two choices: hold dollars as a storehouse of value for your savings, or gold/silver.    There are other things you could convert your savings into, but they are far more cumbersome than Dollars and precious metals, so pick one or the other.    One is about to disappear, so choose wisely.

Rhody

P.S.   Yesterday, the 10 year U.S. Treasury dropped to 1.83% and even the CAD went below 2%.    Would you lend a government money for 10 years at interest rates only one third the real inflation rate???!    What is going on here is a manufactured perception that we are in a deflation.    This will be the excuse that the central banks use to impose another round of Quantitative Easing, probably this summer.    QE bails out the banks at the expense of stealing your savings via inflation.

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Thought of the Day – Bernanke is Concerned…Very Concerned

I haven’t turned on my television in months other than to watch Game of Thrones on HBO (I highly recommend it if you haven’t seen it although this season has been slow so far) so it was an interesting experience watching CNBC for the first time in ages on the plane.  Since markets are solely at the mercy of Central Planners at the moment, when The Bernank speaks on an FOMC day I try to watch.

Despite being someone that holds the Central Banking profession in extremely low regard, every now and again there is a soft spot for in me for these guys as I realize the impossibility of the situation they are trying to manage.  Overall, I thought Bernanke looked concerned and timid during today’s testimony.  He had the demeanor of someone with the world on his shoulders.  Although the testimony itself was a giant yawn (as was the FED statement) all did not seem well to me.

I continue to think that in his mind Bernanke believes the economy needs a lot more stimulus.  I don’t think for a second he believes we are in or anywhere close to a self-sustaining recovery.  While he tried to toe the line to incorporate the dissenting views of the committee, at times his true bias came out.  That is why stocks rallied and why they couldn’t break gold and silver despite heroic efforts.

Precious Metals
We may be at a significant inflection point for the metals.  Gold has had every reason to completely break down and crater if we were in what some people mistakenly claim to be a “bubble” (fiat money’s purchasing power is the real bubble).  The Chinese economy has crashed pretty hard, India’s economy is a mess and their gold market was closed for an extended period recently due to a proposed doubling in the tax and supposedly QE is off the table.  Well if all these key bullish factors went away why hasn’t the so called bubble popped?  The reason is because it is not and never has been a bubble and because the market understands the entire world will enter deflationary collapse without a tremendous amount of more money creation and the Central Planners of the world will not allow that.

I think the next couple of weeks will be very important.  TPTB have made many attempts to completely break down the gold and silver markets, but at the moment they both seem to be simply carving out the right side of a large reverse head and shoulders.  We shall see.  I suspect they will try again to break them before the June FOMC because they probably will have to do more stimulus at that time or risk a collapse into November’s Presidential election.  Retail seems to be out of the market on both the buy side and the sell side.  So it has been institutional buying holding up the market in the face of officialdom’s manipulation.  The stage is set here for a cleared market and a major move higher.  The only question is will there be one more major attempt to break the market?  Perhaps but I think such an attempt is likely to fail because if these markets were doing to break down they should have done so by now.

From NYC this afternoon,
Mike

Thought of the Day – House Flipping in Colorado

I overheard a very interesting conversation in a local coffee shop today between a realtor and a prospective client.  It was the sales pitch that really shocked me as I could have sworn I was transported back to early 2005.  She was using lines like “you’d be a fool not to buy with rates this low,” while also peppering the conversation with anecdotes about this “person she knew” that had just flipped a home for a 40k profit in just a few weeks.  America is back folks.

Does this conversation translate into any actionable investment ideas?  Not really, but it relates back to what I wrote several weeks ago regarding the equity markets.  That people that know better are once again drinking the kool-aid.  The one thing I do feel strongly about is despite ubiquitous prognostications of real estate brokers everywhere, housing is going to be in a deep slump for a very long time (unless we get hyperinflation of course, where anything is better than paper dollars).  Despite all attempts to revive housing and trillions of dollars printed and then spent by the government, all housing has done is bounced around the bottom.  Ex-hyperinflation I expect another major leg down within the next couple of years and even in hyperinflation I expect real estate will do poorly in real terms (ie versus gold).

It is at this point that I’d like to direct you to read a piece I wrote in March 2010 titled: Residential Housing: Why it Doesn’t Stand a Chance.  One of the focal points of this piece was that Americans would become a lot more like the Madrilenos that I lived with during my study abroad in Spain.  Basically a huge percentage of the population lived at home until marriage or even after and there is no reason that cannot happen here.  Not to mention the fact that the youth in America are not only likely to rent but also to simply shove more people in the same space.  All of the secular trends I identified back then hold true today and with over $1 trillion in student debt you better believe it is only going to get worse.  There is also the fact that household formation generally, ie marriage, is also likely to enter a secular decline much like has happened in Japan.  It has been and is my view that household formation in America is about to take a drastic turn lower and this will be the biggest headwind for the market.

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Thought of the Day – Bullish Reversal in Gasoline

While today was an interesting day in “the farce” on a lot of levels, I want to focus on gasoline.  In the morning it traded down to a new recent low, but it reversed hard to close with a more than 1% gain.  See chart below.

Well so what right?  Gasoline has pulled back recently and had a small bounce today you say.  Perhaps.  The reason why I think it is important is because equities were generally very weak and on days like that you wouldn’t expect to see such a divergence.  In addition, I think Obama’s latest very public political witch-hunt for oil speculators scared off longs in the energy market and that was part of the recent weakness. Here is my take on the speculator meme.  If that is correct, then the market may be trying to adjust itself back higher where it actually belongs in order to price out unproductive consumption in a world where a larger and larger percentage of global GDP represents an unproductive misallocation of capital due to the welfare state and money printing.  If this is the case, it will also be a huge thorn in the side of the Central Planners who are obviously attempting to smash commodity prices as much as possible before announcing QE3.

Precious metals and the FOMC
Also of note to me today was gold.  It was slammed hard but came back in very impressive fashion.  Silver not so much…In any event, the key day this week will be Wednesday when The Bernank and his cadre of clowns will announce their latest rate decision.  In the last couple of months the Central Planners have used any comment out of the Bernank to raid the precious metals.  Will Wednesday be the same?  No one knows but I suspect physical buyers are waiting in the wings to pounce this time if they try it again.

China is Headed for a Revolution of Some Sort
As China’s economy continues to weaken we are seeing increased signs of tension.  This quote from a Bloomberg article today really demonstrates how much of a tinder box this place really is.

Chinese legislators have amassed outsized assets, with the wealth of the richest 70 members of the National People’s Congress amounting to $90 billion last year, 12 times the combined wealth of the 660 top officials in the U.S. government, Bloomberg News reported Feb. 27.

My guess is that some savvy political mind will start to tap into domestic frustrations and blame those Chinese leaders in bed with the Western elites.  This will create further riffs between the U.S. and China going forward.  Read the Bloomberg article here.

Mike

Thought of the Day – The Incredible Shrinking Size of Sunscreen

As most of you reading this are probably well aware, the insidious tax that is inflation can come in many shapes and sizes.  The two main ways that it is manifested in our everyday lives is via price increases and shrinking portion sizes/lower quality.  I have noticed a lot of both in recent months but it is becoming apparent to me that the shrinking portion strategy has taken off into the stratosphere, at least for me in my everyday life.

It is this latter method of passing on inflation that really drives me up the wall.  While transparent price increases are clearly annoying, at least it is fairly clear to the consumer and he or she understands what has happened and that there may or may not be an economic choice at hand.  In the case of shrinking portion sizes, the price signal is much more subtle if present at all.  You may notice yourself going back to the grocery store more often but that might be all you recognize at first.  It is especially hard to notice in the early phases of inflation when the package size may shrink by 3% and the price increase 2% for example.  It’s only in the intermediate stages of the inflation that you really start to notice you are being screwed.  I believe we have entered that phase.

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Inaugural Thought of the Day – The Farce

The Farce
A couple of months ago one of my closest friends in the business spontaneously described the financial markets as “The Farce.”  I took to it immediately and from that day on pretty much every morning our first conversation over Bloomberg begins with “so how’s the farce today?”

Long time readers know that I am under no illusions that the markets were ever “free” in our investment lifetimes.  Let’s be real.  A small group of 12 Central Planners determine the most important price signal in the economy, ie interest rates.  They admittedly use this tool to manipulate behavior and markets.  So in some ways the financial markets as long as we have had fiat money and the Federal Reserve has always been a farce in the near-term.

That said, the prior farce is very distinct from the current farce.  At least in those days interest rates would manipulate behavior but beyond that basic macro backdrop the Central Planners allowed markets to generally do whatever they wanted until in their infinite wisdom they decided to pull the plug.  Ever since the banksters blew up the world in 2008, our Central Planners clearly made a decision that a new playbook was needed.  They needed to manage markets much more aggressively in order to “save the system” and restore confidence to the ponzi scheme that is the global financial system.  This increased manipulation was obvious to anyone paying attention in the markets, but investment managers were so terrified they justified it and largely continue to do so.

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