During the next 60-90 days a confluence of supply factors could culminate in a bona fide disruption in the supply of physical silver. This posting will list some of the possible factors but first some background. Silver has been stronger than gold on this latest rally and is now trading comfortably under 70:1 in terms of the gold/silver ratio. The silver ETF SLV has added back most of the metal it liquidated over the past few weeks on the basis of a strong premium to net asset value. In other words, SLV shares have been trading for more than the value of the underlying silver bullion (if investors are concerned about the silver not being there, they sure have a funny way of showing it). At the same time, backwardation in LBMA silver forward rates has been slowly disappearing. If a supply disruption is approaching, however, we could see LBMA silver backwardation return with a vengeance.
Now for some of the factors:
Precious metal refinery workers at the huge MetMex refinery operated by Penoles in Mexico have been on strike since February 8 and last week Penoles declared a force majeure that could effectively leave refinery clients wanting for gold and silver bullion. MetMex is Mexico’s largest precious metals refinery handling the majority of silver produced in Mexico. In turn, Mexico is the second or third largest silver producer in the world with production approaching 100 million ounces. Consider the following from a Reuters article last week:
“(Penoles) has been obligated to advise of the temporary suspension of its contractual obligations with providers and clients … This situation will continue if the strike is not resolved,” the company said in a statement.
and
MetMex refines more than 90 percent of all the gold and silver mined in Mexico and produced around 580,000 kgs of silver, 54,000 kgs of gold and 460,000 tonnes of zinc in 2007, according to statistics on Penoles’ website.
Obviously this could turn out to be a major development if the strike should continue for much longer.
Next, consider the shutdown of Doe Run Peru, a major lead smelter and precious metal refiner in Peru. The Inka Cola News site has further discussion of this situation and while the prospects of a “base metals supply squeeze” are interesting, I think the possibility of a silver supply squeeze is much more likely considering that Doe Run Peru refined approximately 35 million ounces of silver per annum. The industrial demand for lead has pretty much fallen off the cliff while silver demand continues to grow thanks to investors. Between Doe Run Peru and MetMex, we are talking over 10% of annual mine supply of silver and we are not done yet.
Now let’s look at Hochschild’s Peru mines hit by labor strike. These four mines conservatively account for more than 10 million ounces of annual silver production, and although it is not clear how much of this silver was being refined by Doe Run Peru, the strike at minimum complicates an already precarious situation.
Finally we have the less spectacular shutdowns of lead and zinc mines over the past few months. Indeed, over at our Metal Augmentor service we have documented literally dozens of zinc mine shutdowns and canceled developments. As many of you know, most lead and zinc mines are also significant producers of by-product silver. At a minimum, shutdowns at lead and zinc mines (not to mention copper mines) have likely stopped the trend of growing supply of mined silver over the past few years if not completely reversed it. When combined with the large individual supply disruptions noted above as well as the continuing investment demand as demonstrated by LBMA backwardation and silver ETF premiums, we are looking at a potential supply shock in silver during the next 60-90 days. Why 60-90 days? Because that is long enough for both the strikes and shutdowns to continue and for silver buying, perhaps even some panic silver buying, to start taking place.
Although the above presents an interesting speculative opportunity, I must warn that miners who rely on the above refiners (and perhaps other refiners as well) may not see much of a financial benefit from a supply squeeze that drives the price of silver higher especially if it turns out to be temporary (which is most likely what it would be). Instead, the best way to play the temporary supply shock scenario would be direct exposure to the price of silver. Trading risk would be reduced if silver declines back to the bottom of its trading range near the $12 level as that would be an ideal place to take a speculative position. I’ll have further ideas as well as updates on the situation later. Meanwhile if any of you are aware of other supply factors that could converge in the next 60-90 days please consider posting in the comments section.