Silver Backwardation: Prices About to Soar

The price of silver has been in so-called “backwardation” for several days now. That means that the price for immediate delivery has been consistently higher than the price for future delivery. In contrast, although the spreads have gotten very tight, in the gold market, we are no longer seeing overt backwardation. The last time we saw it, gold was selling in the mid $800s per ounce. Shortly afterward, the price soared to $1,000.

Normally, gold and silver exist in a state of so-called “contango”. In other words, it normally costs more to buy the metal for future delivery than for immediate delivery. This difference is said to compensate sellers for the cost of storing the metals. Backwardation, where the price for immediate delivery rises higher than the price for future delivery, is an abnormal phenomenon in both markets. Its existence implies that, at a given price, the demand is significantly exceeding the supply. Let us look, for a moment, at the spot price of silver, as reported by the www.Kitco.com, last night.

www.kitco.com The World Spot Price - Asia/Europe/NY markets MARKET IS OPEN (Will close in 16 hrs. 18 mins.) Metals Date Time (EST) Bid Ask Change from NY Close GOLD 03/05/2009 00:57 912.50 913.50 +6.60 +0.73% SILVER 03/05/2009 00:57 13.03 13.10 +0.12 +0.93% PLATINUM 03/05/2009 00:57 1055.00 1060.00 +9.00 +0.86% PALLADIUM 03/05/2009 00:48 199.00 204.00 +2.00 +1.02%

At that very moment, silver was selling on the futures market, at the following bid and ask prices. The fact that the spot price was higher than the futures price was not an isolated moment in time. It has been happening, time and time again, day and night, regardless of the generalized price level that happened to prevail at the time.

Comex May Silver SIK9 Bid: 13.035 Ask: 13.040

NYSE-Liffe May Silver ZIK9 Bid: 13.026 Ask: 13.040

In another slice of time, using the spot price feed of www.goldseek.com, we saw the following:

Live Silver Price

Bid|Ask	12.98			13.01
Low|High	12.95			13.11
Change	0.13			0.99%

Comex May Silver SIK9 Bid: 12.980 Ask: 12.985

NYSE-Liffe May Silver ZIK9 Bid: 12.975 Ask: 12.990

Note that changing the source of the live spot price feed, to www.goldseek.com, from www.Kitco.com, did not change a thing. The prices are different, because the time slice is different. However, the pattern remains the same. Silver, for future delivery, is selling for less than silver for immediate delivery. The relationship of higher spot to lower May futures prices held true throughout the trading session, and with various different quote reporting services. These anomalies, therefore, are not the result of quote service reporting errors. Still other quote services, not mentioned here, were showing the same.

The bid and ask patterns indicate that the problem is one of supply rather than demand. Sellers appear hesitant to commit to delivering physical silver. The “bid” price spread, in both the spot market and futures markets, show only a slight difference. In a normal market, of course, even that slight difference would not exist. In theory, futures bid prices should ALWAYS be higher than that of the “spot” market. But, in this case, the “ask” price is most important. The asking price for immediately delivered “spot” silver, has remained consistently higher than for futures silver, to a high level of statistical significance. It implies a shortage caused by a lack of supply, rather than increase in demand.

In the case of silver, supply shortages do make perfect sense. More than 60% of all silver supply is a byproduct of the mining of base metals, like copper, zinc, lead and tin. The demand for purely industrial metals has dried up, as a result of the ongoing economic depression. Many mines have been closed, and production at others has been reduced. Conversely, since the start of the economic depression in 2007, sales of silver bullion, coins, and shares of registered ETFs, backed by physical metal, have soared. Finally, with the closure of so many copper, zinc, lead and tin mines, byproduct silver production is becoming severely impaired. Investment demand, in contrast, is several hundred percent higher. Investment demand is now so high that the total demand is likely to be slightly higher than the total pre-depression demand, even adjusting for a significant drop in jewelry and electronic related sales.

In contrast, the bottom has fallen out of the supply side. Based upon my calculations, silver mining supply has probably fallen by 25% or more, based on the amount by which base metal production has been reduced. Since silver supplies have always been problematic, even in the best of times, this new phenomenon must be stressing the market. Supply and demand are out of balance, and there are only two ways to balance them. Either demand must be reduced, or the willingness to sell existing stockpiles must be increased. For either to happen, the price must rise.

To obtain exposure to the rising price of silver, one might invest in a number of ways. One might buy silver bullion, directly, or in the form of the ETFs. The biggest negative of the ETFs is that they are designed to meet the needs of large institutional investors. The SLV trust was created to fulfill their needs, and not those of smaller investors. The trust was written in a way that prevents smaller investors from withdrawing silver bullion, and preserves the bullion for banks and other large institutional investors. Bullion can only be withdrawn in minimum lots called “baskets” which involve the tender of millions of dollars worth of shares. This is also true of all the gold ETFs.

Another option is to buy silver futures. Sellers are happy to sell paper promises to deliver silver, because they do not expect to be required to deliver it. Over-leveraged speculators are regularly “harvested” by the short selling banks, who appear to periodically crash the price in order to chase the leveraged longs out of their positions, at a loss. However, as a well capitalized investor, you can force compliance with any futures contract you buy. Afterwards, you can hold your physical silver for a much longer period of time than they can afford to manipulate the price. The price will rise, over time, no matter what the manipulators do. Silver can be purchased on the futures markets at much cheaper rates than you must pay at an independent silver dealer.

The absolute cheapest way to buy silver, however, is to buy it while it is still in the ground. You can do that by purchasing shares in companies that mine silver. One of these is Hecla Mining (HL). Hecla will be particularly attractive to “value” investors. The share price is currently very depressed in comparison to the potential of the company. Long time investors have waited a very long time, and have had their hopes burned away, multiple times. Such investors are exhausted at the cusp of the stock rising, and now just want to be rid of their stock. That is a perfect time to buy a company with a bright future.

Hecla will finally start capitalizing on all its hefty investments. Hecla is a long term bet, but huge gains may be in store for patient stockholders. As a result of buying a large new mine in Alaska, the company increased silver production by 54%, and increased its reserves to 325 million ounces. Little known is the fact that the new mine is also VERY rich in gold. Hecla will mine between 55-60,000 troy ounces of gold, as well as up to 11 million ounces of silver this year. It will also produce tons and tons of lead and zinc, but prices for those metals are unlikely to rise until after the depression is over, which may be a long time from now. Accordingly, the value of its lead and zinc production is unlikely to add much to Hecla’s profits.

Unlike some other mining companies, Hecla’s mines are now located exclusively in North America and Mexico, rather than politically unstable countries like Venezuela. Large losses were incurred, as a result of the past closure of Hecla’s gold mining operations inside Hugo Chavez’s Venezuela, and that is part of why investors are exhausted. But, that is ancient history now. The company still has $30 million in cash, locked up in that country, however, waiting to be repatriated.

It bears mentioning that Bank of America’s analysts recently “downgraded” the company from neutral to “underperform”. Most analysts look backward, not forward, and lack of foresight is their primary failing. Big bank analysts also tend to be notoriously incompetent, so I pay little or no attention to them. They tend to downgrade after a company has already been doing poorly and after investors have already lost a lot of money. Conversely, they upgrade once the stock is at its peak, and investors are unlikely to earn much more by buying the stock. Bank of America’s opinion on Hecla Mining, is incorrect. For example, it is based upon a silver price of about $11 per ounce in 2009. Based upon the current backwardation in silver, the sale price is more likely to average closer to $20 per ounce, at least in the second half of this year.

Let’s do the numbers. First, we’ll need to make some reasonable assumptions. Let’s assume that silver rises back to $20 per ounce, and gold goes to $1,300 per ounce by the second half of 2009. Hecla will produce a minimum of 55,000 ounces of gold this year, and probably 60,000. Sale of this gold will substantially lower the cost of producing silver, which is its primary product. Hecla will produce about 11 million ounces of silver. 11,000,000 x $20 = $220 million. Diesel oil and virtually all other things needed for running a mine are much cheaper this year, as compared to last year. Accordingly, average production cost per ounce of silver will probably be less than $7.00, after the gold and the base metal byproducts are sold. That leaves $143 million per year in operating profit. There are 169 million shares outstanding. That means profits in the range of $0.84 per year. If Hecla sells at the same 23 to 1 forward P/E ratio as Silver Wheaton (SLW), it may sell at roughly $19+ per share by the end of 2009.

If you believe, as I do, that heavy inflation is coming soon, both the base and precious metals that Hecla produces will become substantially more valuable than even my estimates. In contrast, debt, which Hecla has plenty of, will be increasingly cheap, as the U.S. dollar devaluates. Hecla is the most leveraged against high inflation of all the primary silver miners. With high inflation, Hecla will outperform most other mining stocks, and certainly far outperform the market as a whole. Other, somewhat less speculative companies that would also allow you to gain exposure to the rising price of silver, include other primary silver miners, such as Pan American Silver (PAAS), and Silver Wheaton.

Disclosure: Long Hecla Mining (HL) and silver bullion.

Comments

[HonestMoney]

Stop playing into the hands of the Gold Cartel. No ETFs/gold certificates/pool accounts for me. Only physical bullion. goldmoney.com and bullionvault.com are also good.
----------------------...
As long as the hard money community continues to invest in paper gold and silver such as ETF shares, mint certificates and futures contracts, the rise of gold and silver will be greatly subdued until one of the triggering events listed above occurs. Physical off-take is the key to unlocking big profits in gold and silver. These paper investments are not producing as much physical off-take as people think because the sponsors of these assets are lying about their physical bullion inventories, or have leased them out or otherwise encumbered them, sometimes backing the gold and silver they have leased out with other paper gold and silver assets that may also have false backing.

The fact that the sponsors of the major gold and silver ETF's, GLD and SLV, are two of the most notorious Illuminist-controlled banks, HSBC and Barclays, should tell you everything you need to know about the ETF's and what they are really all about, namely, the preservation of CRIMEX precious metal inventories and the diversion of investment money from resource stocks to destroy their market values so the Illuminati and firms like Barrack Gold can scarf them up at pennies on the dollar, thus controlling not only existing gold and silver bullion above ground, but also gold and silver ores below ground.

The ETF's sponsors could be leasing precious metals directly to the CRIMEX for purposes of making deliveries for all we know. Investment in ETF's may turn out to be a Ponzi scheme, and we believe they are using your own capital against you by using that capital to purchase gold and silver which is then used for suppressive purposes of the Illuminati, like a bullion or central bank would do. Talk about shooting yourself in the foot! The worldwide orchestrated mint cutbacks in production and delays of delivery are also meant to help prevent wholesale gold and silver inventories of the CRIMEX from being bought out to produce coins, rounds and bars. ETF shares are also being naked-shorted to keep values in line with bogus CRIMEX values for precious metals. The bottom line is, you need to pay for and take delivery of your gold and silver, and store it in your safe at home. Period. GET A CLUE, PEOPLE!!!

news.goldseek.com/Inte...

2009 Mar 06 05:56 AM

[Cesato]

Strange understanding of the backwardation concept, to the contrary when backwardation is present it involves significant speculative positions which leads to a sell-off sooner or later. As you mentioned backwardation in Gold is receding so that the trend becomes more stable. This is why I stated yesterday that Gold would outperform Silver short term. I'm with the trend but I love to see a more step-by-step move in both Gold & Silver; those nasty rallies only force the price to a senseless volatility. I hope the precious metals do not inherit WS stupid behaviour, ETFs are playing with fire by continuosly messing with technical patterns. Price increases step at a time will provide more confidence in the bull trend and therefore ensure we reach over USD 1.000 in a decent and stable fashion.

2009 Mar 06 08:23 AM

[yellowhoard]

I am becoming progressively less enamored by US mining interests. The current leadership would have no problem nationalizing these properties in a crises. Therefore, as the likelyhood of greater profits improves, for the reasons stated above, the likelyhood of greater government "involvement" grows more likely.

2009 Mar 06 09:34 AM

[Vuke]

A good observation Yellowhoard. There appears to be a creeping tendency, world-wide, of governments declaring minerals "strategic", which, due to a grab bag of reasons, some certainly are.

Silver has more industrial uses than any other metal, a great many strategic, trumping coinage for sure. And, as Jason Hommell says, there isn't much left above ground.

Silver is a great product to buy and store under the bed for the kids education or insurance against run away inflation. For the more adventurous money can be made with puts and calls.

2009 Mar 06 10:10 AM

[sandspider]

Stay with Canadian mining companies which already have the socialized mentality built into them. Canada is more solvant anyway. 3 to 5 trillion $$ fiat currancy or what have you washing ashore very soon with high unemployment sets the stage for the worse of all worlds. Inflationary depression. Silver and gold...mines and coin. No paper please just give me the real thing or a stake in those producing the real thing. You can keep the change.

2009 Mar 06 10:16 AM

[Avery Goodman]

Folks, eventually, our witless representatives in Congress will realize that the bailed out banks (including AIG counterparties) scammed them. They are better at smiling and making people like them enough to vote for them than they are at thinking. Unfortunately, before they realize the level of error that they are engaged in, and what they have allowed these corrupt people to do to our nation, we will see massive inflation.

Let's assume, for argument's sake only, that the government tried to nationalize Hecla (or Silver Wheaton, Pan American Silver, Newmont Mining, etc.). The Constitution requires them to pay compensation. Since the net asset value of Hecla, for example, even now, approaches $4 per share or more by my estimate. Shareholders who buy today would cheer and gladly sell their shares to the government. Then, they would go out, and buy gold or platinum with the proceeds. They will have tripled their money.

2009 Mar 06 10:42 AM

[Whippet]

Agree with Vuke and yellowhoard. We have only begun to see clandestine government seizure of private-sector assets; a steady erosion in the value of the greenback will be a perfect opportunity for the messiah and his merry band of neo-socialists to demonize the precious metals sector, and his tree-hugging bankrollers will be first in line to shut down the US mining companies to protect both the environment and the dollar from the endless assault of capitalist pigs.
I know it doesn't make any sense; please forgive me for trying to crack into the thought process of our ruling Trotsky-ites.
SLW still seems pretty cheap by my analysis, and that's where I'm playing the silver mining industry. AUY is my gold play. Oh, Canada! And I thought THEY were Socialists...

2009 Mar 06 10:46 AM

[heartbone]

That is a GREAT observation yellowhoard.

Nationalizing a bank with virtual assets really makes no sense at all.
They would not dare touch their brother multinational corporations.
Whereas the Feds stealing the mines makes perfect sense.
Good advice is why I read these comments
and yours was well worth going through the rest for.

2009 Mar 06 11:49 AM

[sdcougar]

"If you believe, as I do, that heavy inflation is coming soon,..."

Nope, looks like deflation will be here for quite awhile.

"... as the U.S. dollar devaluates (sic)..."

Nope again. As bad as the dollars fundamentals are, it seems that it will continue to win the beauty contest in the leper colony.

2009 Mar 06 12:08 PM

[heartbone]

Avery, since when does the constitution matter?
It is only a goddarn piece of paper.

And under those economic circumstances such as "nationalization" (as if the Fed is part of the government)
who would want any Federal Reserve Debt Notes in exchange for mining company share paper value?

2009 Mar 06 12:19 PM

[Avery Goodman]

Inflation is not a function of winning the beauty contest between horrible currencies. It is a function of excessive money creation. All paper money can devaluate, together, and is devaluating right now. The relatively low inflation is unlikely to last past the summer.


On Mar 06 12:08 PM sdcougar wrote:

> "If you believe, as I do, that heavy inflation is coming soon,..."
>
>
> Nope, looks like deflation will be here for quite awhile.
>
> "... as the U.S. dollar devaluates (sic)..."
>
> Nope again. As bad as the dollars fundamentals are, it seems that
> it will continue to win the beauty contest in the leper colony.
>
>
>
>

2009 Mar 06 12:23 PM

[Avery Goodman]

You can exchange the Federal Reserve notes for gold or platinum or other things.


On Mar 06 12:19 PM heartbone wrote:

> Avery, since when does the constitution matter?
> It is only a goddarn piece of paper.
>
> And under those economic circumstances such as "nationalization"
> (as if the Fed is part of the government)
> who would want any Federal Reserve Debt Notes in exchange for mining
> company share paper value?

2009 Mar 06 12:47 PM

[GMiki1]

I also believe silver's future is bright for a number of reasons, including that it's the poor man's gold. I hold Impact Silver, SSRI, Sabina Silver, Canadian Zinc, and SLW--all of which respond when silver is up. The shorts will sooner or later have their backs to the wall.

2009 Mar 06 01:26 PM

[The Truth About Silver]

We dont have deflation. We have disinflation right now. Which I think will lead to inflation and, very possibly, some form of mild (hopefully, if there is such a thing) hyperinflation in the future.

2009 Mar 06 04:56 PM

[The Truth About Silver]

I also like Canada's Great Panther Resources (GPR.TO).


On Mar 06 01:26 PM GMiki wrote:

> I also believe silver's future is bright for a number of reasons,
> including that it's the poor man's gold. I hold Impact Silver, SSRI,
> Sabina Silver, Canadian Zinc, and SLW--all of which respond when
> silver is up. The shorts will sooner or later have their backs to
> the wall.

2009 Mar 06 04:58 PM

[Conan the Barbarian]

HL is a big favorite of H. Ruff. I own CDE which has a major producer in Bolivia. CDE claims it will ramp up silver production to a 20 million oz. annual rate. Last 10K, annual statement. Production costs overall about $6

That would make CDE the world's Leading producer, imo

2009 Mar 06 05:09 PM

[Alex Schwartz]

I'm curious if you believe CDE will be a good value play? They just posted earnings, beating expectations by .02, and they have a lot of new production comming on line this year. The biggest issue with CDE seems to be the share dillution by management over the years, very similiar to HL.

It might be a good long term silver play.

2009 Mar 06 05:42 PM

[Conan the Barbarian]

Alex, I hope CDE does a 1/10 reverse split or something like it to reduce the outstanding shares. CDE has been around for Decades. It traded in the $30's over 3 decades ago, were able to issue Convertible Bonds, etc.

At present levels, even with their bright silver prospects, I do not expect anyone to take them seriously.

But, "god willing and the creek don't rise", I believe they will survive and/or someone buys them first as an asset play.

2009 Mar 06 05:55 PM

[nmelendez]

Get outta CDE, Bolivia is in league with Hugo Chavez. Brazil has a big ongoing conflict with Bolivia due to govt confiscation of Brazilian company assets in Bolivia. Beware Bolivia and Venezuela. All other plays in SA OK. Personally prefer Brazil in all aspects, second Argentina/Peru and then Central American countries.

2009 Mar 06 07:19 PM

[5142152-337]

Terrific article, thank you!

SUPERB posts by all. Appreciate all the fine thinking out there! A great weekend to all!

2009 Mar 06 08:34 PM