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By Simon Lack

If you’re not caught up in the daily frenzy that is today’s silver market, it’s quite an absorbing spectacle. Daily volume in SLV, the silver ETF, has increased sharply in recent days and yesterday hit 217 million shares. That’s $8.8 BN in value and more than half the NAV.

Such activity may indicate the top in silver has been made. It’s certainly very hard to assess its fair value, not least because both supply and demand are notoriously insensitive to price changes. Most silver production occurs as a byproduct of other metals (gold, copper and zinc) and so the prices of those metals matter more for silver production than the silver price itself. On the demand side, investment (read: speculative) buying is the big swing factor, since the industrial processes for which it’s used require very little silver and are therefore reasonably indifferent to price. It’s a small input into, say, a cell phone and has no easy substitutes.

To illustrate how little mined supply reacts to price changes, RBC recently issued a report that included a table showing annual supply and demand (in summary form below).

2008

2009

2010

2011E

2012E

Supply

Mine Production

682

718

736

755

770

All Other

223

204

321

310

255

Total Supply

905

922

1,057

1,065

1,025

Demand

Investment Demand

18

121

178

185

145

All Other

887

801

879

880

880

Total Demand

905

922

1,057

1,065

1,025

Avg Silver Price

$14.97

$14.67

$20.19

$35.00

$35.00

Source: GFMS Data, RBC estimates

Mine production this year is expected to barely move, increasing by less than 3% even though the average price may wind up having doubled by the time we reach the end of the year -- a textbook example of almost complete supply inelasticity. As a result, it’s impossible to estimate a fair value for silver with any precision, which is part of what makes it such an interesting market.

Meanwhile, Coeur d’Alene (NYSE:CDE) has been sharing silver’s volatility with its own specific issues thrown in. CDE operates some of the few silver-dedicated mines in the world. We were drawn to the stock more than a year ago when it was trading at a substantial discount to the NPV of its mines based on proved reserves, although as silver rallied we reduced the position.

On April 11, a Bolivian newspaper reported that the government was planning to nationalize the San Bartolome mine, a significant source of CDE’s earnings and reserves. The stock soon sank and we exited our last piece. We thought we were finished with CDE, but as the stock continued to fall while silver rose, the NPV of CDE reached the point where the stock price no longer reflected any value for the Bolivian mine.

In fact, by our calculations, if you eliminate the 7.1 million ounces of annual production that CDE expects from San Bartolome this year -- and assume it’s lost forever with no compensation from the government -- the stock is around 25%, cheap relative to its NPV (though it does normally trade at a discount of between 18-28%). We think it’s unlikely it’ll lose the mine completely (indeed, recent reports suggest that the government is backing away in the face of local union opposition).

So we are long CDE again in our Deep Value strategy and in our Discount Arbitrage strategy, where we have hedged the silver risk.

Source: Silver and the Curious Price of Coeur D'Alene's Bolivian Mine