Is The Next Bull Market in Precious Metals Starting?

It's an old line that I've quoted often enough: the way to prosper in a bull market is to buy when there's blood in the streets; when the prices in the bear market that precedes the bull are close to their lowest levels.  It's a time when people at their most pessimistic about investing in that market.  That leads to the other pithy observation that every bull market starts when things are at their absolute worst, just as every wealth-destroying bear market starts when times are good and everyone is at their most optimistic.

In light of that, you might be interested to know that the gold and silver mining companies' stocks have been getting hammered for years.  Precious metals miners, as measured by the Market Vectors Gold Miner’s ETF, are down by about 70% over the last five years.  Over that period, gold itself is down about 8%.  There was a run up and loss of over 70%, but measured at the specific endpoints, the loss was the more moderate 8%.  The miners are feeling that 70% loss.  At the recent Sprott-Stansbury Natural Resource Symposium, the air was thick with gloom and doom sentiments from the miners. The sentiment that this is the worst the mining sector has looked in thirty years was in the air.

Mining execs say banks won’t return their calls. Promoters say they are thinking about taking their firms into cloud computing, video games, or Chapter 11.

“What do you know about cloud computing?” we ask.

“Nothing. But I know gold mining. And I know it’s no place to make money.”

The Washington Post ran an article under the headline "Gold is Doomed"; the Wall Street Journal said gold is nothing more than a "pet rock", and Bloomberg Financial said "gold is a textbook short".

Sounds like blood in the streets to me.

It's important to note that stock prices for the mining companies aren't very well correlated to the prices of the metals because their prices are determined by completely different mechanisms.  Mining companies are priced according to their costs, the effectiveness of their management, their P/E and other metrics familiar to stock traders.  Gold's price is set by the commodity exchanges and manipulators.  Miners need to spend to get the gold out of the ground.  Once it's out of the ground and off to refining, their work is essentially over - aside from exploring and finding new deposits.  In that sense, if you wanted to invest in mining stocks and also physical gold, you would go into the mining companies first.  It's the nature of the mining sector that it works slowly.  The rule of thumb is that it takes ten years from the time a deposit is identified until poured gold bars are hitting the streets.  The delay is worse in developed countries proportional to the amount of regulations they work under and the required number of tons of paperwork that need to be completed before mining can begin.

An apparent paradox here is that only big companies can afford to wait 10 years to get the mine production, but big companies are very rarely risk-takers so they wouldn't be exploring.  Conversely, a small company can take the risks of exploration but they don't have the money to wait 10 years to start making money off their discovery.  The way the paradox is resolved is that the small companies (called the juniors) do the exploration and early development.  If they don't find anything, they wink out of existence; if they do find a good deposit and get close to producing metal, they get bought up by one of the big companies.  

Silver has also been hit hard.  Silver peaked in early 2011 at $48.48;  this week it closed at $14.81, down 69% from its peak.  It's down 7.1% so far this year, but strangely, silver production was up in 2014 even with prices going down.  Has it reached bottom?  Has the next silver bull market already started?

• Like gold, silver fell as the U.S. dollar rose on the back of expectations that the Fed will hike rates.
• World demand for physical silver fell 4% in 2014, largely due to a record 19.5% drop in investment demand.
• Silver exchange-traded funds (ETFs) did not see big liquidations in 2014. ETF holdings grew by 1.4 million ounces and recorded their highest year-end level at 636 million ounces.

So why did miners produce more silver in the face of declining prices?  In this case, it's because they weren't silver mines.  About 75% of the silver mined is produced as a byproduct in other types of mines: primarily gold, copper, lead and zinc.  Mines that are primarily silver producers actually did cut some operations, especially the most expensive deposits to mine, and did other things to improve their efficiencies. 

There was a big drop in investment demand last year: 19.5%. This tells us that most short-term investors and sellers have left the market. We don’t know any “silver bugs” who were selling. That means that today’s bullion is in stronger hands. And that means that any new buying will have a strong impact on prices.

Silver bugs are likely to be buying and holding it as insurance; a "safe haven".  "If you can't hold it in your hand and you can't defend it, you don't own it" - right?  So is there any way to get that 19.5% of demand back this year?  Laurynas Vegys, writing at Bonner and Partners explains:

The Silver Institute expects more silver demand from investors this year. They say that the first half of 2015 sales of silver bars were the fifth highest on record.

Photovoltaics (PV) is another source of silver demand that many analysts expect to rise in 2015 and beyond. Global PV demand is set to increase by 30% in 2015, according to IHS analysts. China alone has plans to install 17 gigawatts of solar capacity by the end of the year.

The solar industry consumes a small amount of silver compared to jewelry and other electronics. Yet, if PV demand delivers in 2015, it will become the third-largest source of fabrication demand for silver.

Wild card: Tesla plans to put batteries big enough to power a house in every home. What happens if that takes root is anyone’s guess… but it will be big. Really big. And the impact on demand for silver would be just as huge.

Are the metals due to start back up this year?  I don't have crystal ball and I don't do well on the timing of predictions, but I see things in their favor.   The Fed is going to have start raising interest rates at some point.  The dollar shouldn't be as strong as it is (what I call "the least disgusting girl at the dance" theory).  Counter to that, the world economy is looking shaky again.  China's stock market is a mess, most investment houses don't believe the official government economic growth numbers that China issues any more (wise with all government numbers).  The scenario Jim Rickards talks about of global bank holidays which I covered in early May seems to be getting more likely; at least beyond "single digit percent probability".  During periods of uncertainty, people like the "safe haven assets" like precious metals.  They've been the fall back for a few thousand years.  It's believable they will be again.