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Miners With The Grade To Survive The Silver Downturn: Chris Lichtenheldt

Source: Kevin Michael Grace of The Gold Report (8/12/13)

It's one thing for a silver producer to make a profit at $28/oz and quite another to do the same at $20/oz, declares Chris Lichtenheldt, senior mining analyst at Dundee Capital Markets. In this interview with The Gold Report, Lichtenheldt examines eight silver companies, detailing which ones will be rewarded for high-grade assets and which ones punished for high costs. And he explains why one of his favorites is a silver company that doesn't actually produce silver.

The Gold Report: Silver seems to have stabilized at $20/ounce ($20/oz). Is this significant? If this support holds, can we expect upward movement?

Chris Lichtenheldt: I think $20/oz is a psychological level. Once we've stabilized above that, it's somewhat reaffirming that the drop could be over. But it is hard to say if it's all over and we're now back to upward moving prices because the price drop was rather unexpected and dramatic to begin with, so comfort will be slow to return.

It's too early to say definitively on the upward movement of prices. Some of the indicators we look at are futures positions and exchange-traded fund (ETF) positions. In futures, there has been a significant drop throughout the year in net long positions on the Comex. That has stabilized, indicating that the desire to short silver seems to be subsiding. On the ETF side, positions have been relatively stable. Taken together, those indicators suggest that perhaps the worst is behind us.

It's too early, however, to call for another bull run. The best we can hope for now is that volatility subsides and prices remain stable so that investors and companies alike can begin planning for this new environment.

TGR: We've seen many stories about shortages of physical silver, coins being sold out, etc. Do you think it surprising that the paper price of silver has fallen so substantially, notwithstanding this apparent hunger for the physical?

CL: It's a bit of a disconnect, no doubt, and it's difficult to reconcile. A lot of the information we get on the physical side is anecdotal, but it suggests physical silver supply is tight and in the long run, you would think that the physical silver market should determine price movement. That's why we tend to think that, over the long run, we will have higher prices; there is only so much silver to go around.

TGR: The silver-gold price ratio remains at a historic high of 65:1. Eric Sprott has said that the ratio should be closer to 16:1. Why does it remain so high? Do you think it's going to change, and, if so, in which direction?

CL: Over the past decade, the ratio has ranged from the low 30s to over 80. The average since the beginning of 2000 is around 60:1, so we're a little bit above that now. But silver tends to underperform relative to gold during times when both metals are moving down. Underperformance means an increase in that ratio. While anything is possible, I don't see a catalyst to take us back to 16:1 in the foreseeable future.

TGR: If the ratio has been 60-65:1 since 2000, as you mentioned, doesn't this suggest that silver has been moving and will continue to move in lockstep with the price of gold?

CL: While the average ratio has been around 60:1, it rarely spends any time there. Silver is usually either outperforming or underperforming. The crash in 2008 is a good example. Initially, silver dramatically underperformed gold, and that ratio reached into the 80s. Then over the subsequent couple of years, silver dramatically outperformed gold, and the ratio fell into the low 30s. So I don't think silver will move in lockstep with gold, but for a significant move outside the recent ratio range, I'll say again that we'd need some sort of catalyst.

TGR: From February to June, silver lost about 40% of its value. Were all the silver producers caught napping?

CL: The drop in price was many standard deviations beyond silver's normal behavior, so I don't think anyone could have fully expected it. Companies try to plan based on a range of possible metal prices, but the drop below $20/oz would have been outside any company's conceivable range. Significant changes aren't necessarily required by the very low-cost producers. But for a company with all-in cash costs in the low 20s and all of a sudden the silver price falls as it did, then a lot of changes are required.

TGR: How would you compare what has happened this year with the Hunt brothers' attempt to corner the market in 1980, when silver hit $50/oz and then fell to $11/oz two months later?

CL: It's a difficult comparison to make. The 1980 spike was much more short-lived and the drop was steeper and quicker, so I don't think any companies then would have been operating on the assumption of $50/oz silver. For the past several years, however, we've had very strong prices, which allowed for a lot of silver-dominant mines that likely would not have come into production otherwise.

TGR: Is there a "doomsday price" at which the possibility of silver production becomes tenuous? What if silver were to fall below $15/oz?

CL: Silver is a unique commodity in that nearly three-quarters of it comes from non-primary silver mines: mines that get their silver as a byproduct. This means they would likely produce this silver no matter the price. So the 40% drop in the silver price really impacts the 25% of production that comes from primary silver mines.

At $15/oz you would no doubt begin to experience a noticeable number of mine closures within the primary silver sector. We estimate that the all-in operating costs required to run an already-producing silver mine are somewhere in the high teens. So at $15/oz a lot of companies would be underwater.

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