By Ivan Y.

Most of the silver that mining companies extract from the ground is sold for cash. With a depressed silver price today, primary silver producers (SIL) are not making that much profit (if any) if you consider the costs of exploration, development and extraction. So silver producers are in a difficult situation. If they increase production to increase revenue, then they will exhaust their reserves quicker and sell more of their reserves at a depressed price. If they halt production, they will have to take a charge and pay ongoing expenses for care & maintenance.

Stockpiling Silver

A solution to their dilemma would be to continue mining operations, but instead of immediately selling the silver, they could keep a portion of it in inventory and sell it at a later time when the price of silver is higher. There is no law that says they have to sell right now. Some producers have royalty contracts with companies like Silver Wheaton (SLW) so they have to give up a portion of their production, but that is just a transfer of silver from one company to another. SLW could keep it in its inventory instead of selling it.

By selling fewer ounces into the market, the price of silver can be forced higher based on the law of supply and demand. Producers could sell fewer ounces but at higher prices, and maybe it would result in the same amount of revenue. Relatively speaking, there is not that much above-ground silver when compared with gold because most of the silver that goes into the market is consumed, whereas almost all the gold that has ever been mined is still around today. Today, it is estimated that there is a total of about 2 billion ounces of investment grade silver above the ground. The largest silver ETF (SLV) has about 330 million ounces of that total and the Comex vaults have about 167 million ounces. There is about 5 billion ounces of investment grade gold available. So the lag between a reduction in silver mining supply and higher prices should be shorter than it would be for gold.

From Surplus to Deficit

Here's an example that should illustrate the point of this article. Let's say that silver producers, regardless of whether they are primary silver producers like Silver Standard (SSRI) or miners that produce silver as a by-product like Goldcorp (GG), withhold 25% of their silver production from the market and put it in their inventory. In 2012, the total supply of silver was 1.048 billion ounces of silver according to The Silver Institute. That includes 787 million ounces of new silver that was mined. The remainder came from recycled scrap silver and from government inventory sales. In 2012, total fabrication demand was 897 million ounces,

which led to a surplus of about 151 million ounces. If silver producers had held back 25% of their production from the market, the mined supply would've been 197 million ounces less. That alone would've turned the surplus in silver into a deficit. Think of what that would do to the price of silver.

Why Don't They Stockpile?

So why don't silver producers keep more of their silver instead of selling it?

Final Thoughts

It's time for the management of silver producers, especially primary producers, to take a more proactive approach to combat the depressed price of silver. By not withholding production from the market, they are either saying that their company is too weak financially to forgo the extra cash flow or that they think the price of silver will remain depressed for the foreseeable future.

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