Silver Price Forecast: This Could Send Silver Prices Higher in 2016

Silver Prices Higher in 2016It’s been a scary two weeks for silver investors, with prices in free fall as investors run away from commodities. The entire precious metal category is suffering, but there’s a— dare I say it—“silver lining” to keep you from getting caught in the panic.

The grey metal has lost 28.44% in the last year, far more than the 15.62% decline in gold prices. Yet most of the headlines you see are about gold. I find it bizarre that investors ignore silver in favour of more expensive minerals. It’s an inexpensive commodity with strong real demand. Moreover, it acts as a great hedge against inflation.

That being said, we can’t ignore reality. Silver prices fell nearly 3.9% in the last two weeks, dragging several miners to the brink of insolvency. Pan American Silver Corp. (NASDAQ/PAAS) lost 20.85% in the same time period, while Hecla Mining Co. (NYSE/HL) shaved 13.69% of its market value. Despite its relatively high margins as a streaming company, even Silver Wheaton Corp. (NYSE/SLW) dropped nearly 19%.

When viewed side by side, the decline of silver prices and mining stocks paint a grim picture. But I think they offer a bullish argument on the grey metal.

Let me explain.

Shrinking Supply

In the last year, the three companies combined for a total silver production of 62.76 million ounces. Pan American led the pack with almost 26 million ounces, followed by Silver Wheaton at 25.67 million, and Hecla at 11.09 million. (Source: Silver Wheaton Website, last accessed on July 24, 2015.)

All three are trying to expand production and streamline costs at the same time. This means boosting efficiency while simultaneously taking on more debt to invest in new operations. Eventually the new mines would yield enough silver to finance themselves and pay off the debt. Unfortunately, low silver prices make this plan unfeasible.

If you look at Hecla’s cost of production, it illustrates my point. The company deducts something to call “by-product credits” to arrive at a cash cost of $4.81 per ounce. Yet it’s unclear why by-product credits should be deducted at all. The company seems to define them as units of cost associated with “physical activities of producing metals, including mining, processing and other plant costs, third-party refining and marketing expense, on-site general and administrative costs, royalties and mining production.” (Source: Hecla Mining Co., July 2015.)

Those sound like fixed expenses to me. How could you operate as a mining company without some related refining, marketing, or administrative costs? A better valuation of Hecla’s cost of production, without deducting by-product credits, is $25.02 per ounce. By that approximation, the company is taking more than a $10.00 hit per ounce.

Sky High Prices

What happens when a company makes continuous losses? Well, they either scale back their business operations or go out of business. I think that’s precisely what will happen in the silver mining industry. And it’s a good thing for the price of silver.

Think about it; what happens if some of the big mining firms shut down expansion plans, existing mines, or even close up shop completely? Well, supply would contract. The basic laws of supply and demand tell us that scarcity and value are positively correlated. The less there is of something, the more valuable it becomes. Silver is no exception to the rule.

Rather than buying up shares in mining companies that have to restructure their business based on falling silver prices, just buy actual silver and wait. Once the supply contracts, silver prices will shoot through the roof. If you don’t want to buy physical bullion, try an ETF like the iShares Silver Trust (NYSEAcra/SLV). The trust is trading at a serious discount, but it’s obligated to keep its funds in silver, meaning that it will also rise as the supply of silver contracts.