FREEGOLD REBUTTAL: A Case For Much Higher Silver Prices

The folks at FreeGold (FOFOA) believe that when gold revalues to $45,000, silver would fall down to $1.85.  They stated this in their recent article, FOFOA: Silver Dollar.  Actually, FOFOA’s original calculation was done back in 2001, when they saw gold revaluing to $10,000 and silver down to a measly $.50.  At the time FOFOA wrote that forecast, the price of gold was $261 and silver $4.37. 

These would be impressive figures, if they made any sense.  Unfortunately, the folks at FOFOA do what I call as “Forecast in a vacuum.”  Basically, they arrive at their philosophy and metal price figures without considering certain outside influences.  When I say vacuum, I am referring to the vacuum used in science class when air and outside forces were removed. 

FOFOA is guilty of this in spades when it comes to their understanding of silver.  Why?  Because FOFOA and its hardcore followers look at the world through shiny gold-colored glasses.  Here is one of their excerpts from 2001:

When the coming paper illusion price of gold is destroyed, sending its trading price way up and way down, several times, before shutdown,,,,,,,,,,,,,, the thinner paper markets of lesser metals will be absolutely devastated. Yes we will see $50.00 silver in our time,,,,,, $50.00 for a hundred ounce bar,,,,, that is! No less a relative price decline for the other metals is in store. Even if these actual dollar numbers prove incorrect,,,,,, relative inflation adjusted prices will show the exact same ratios to gold. The gain will truly be in gold!

Again, the folks at FOFOA believe the future value of gold is heading to the moon, while silver gets flushed down the toilet.  Now, I am not going to get into all the details why I disagree with FreeGold’s position on silver, however I am going to challenge a few noteworthy items in their article.

Here is item number 1:

What would happen in this Freegold scenario is that the price of silver would decline to a level that constrained silver mining at the margin. Now there are two kinds of silver mine production. There is primary silver mine production, and secondary or silver production as a byproduct of mining other minerals. According to the Silver Institute website, 31% of global silver mining supply comes from primary silver mines at an average cost of $7.74 an ounce. So if the price drops below that number, then we lose the primary silver mines, but we still have the 69% of silver-as-a-byproduct mines, which brings us back down to production levels we saw when silver actually was less than $7.74 an ounce, which was as recently as 2005. And don’t forget that it got as low as $8.88 in 2008.

The folks at FOFOA believe the price of silver will fall even during a hyperinflation as demand for industrial silver declines.  Thus, the falling price will kill supply at the margin…. which are the primary silver miners.  Here is where they start to cherry pick data.

FOFOA states that the primary silver miners average cost per ounce is $7.74 according to the Silver Institute (data provided by Thomson Reuters GFMS World Silver Surveys).   First of all, the $7.74 is a “Cash Cost” and not reflective of all actual costs.  To arrive at a cash cost, the company excludes many costs and deducts by-product credits.  Thus, cash cost accounting deludes the unsophisticated precious metals investor into believing it only costs $7.74 an ounce to produce silver.  Most primary silver mining companies need their by-product revenue to fortify their balance sheet.  The silver mining industry may list their by-product metal sales as credits, but these aren’t credits if the company suffers loses without them.

Secondly, the $7.74 cash cost figure is based on 75% of the primary silver miners.  It says so in the 2015 World Silver Survey.  The sample size GFMS uses to get their cash cost was 207 million oz (Moz), while total primary silver production was 270 Moz.  Basically, GFMS calculated that $7.74 using the largest producers and top performing miners.

Regardless, cash costs do not represent the profitability of a company.  As I mentioned above, the miners deduct their by-product metal sales to arrive at a low cash cost.  FOFOA actually links one of my articles discussing cash costs back in 2011.  Since then, my work has become more sophisticated into calculating the “Estimated Breakeven” for the primary silver miners. 

FreeGold, FOFOA provides the example of Hecla’s low cash cost to justify their $2.75 price for silver after the big gold reset:

Hecla Mining Company, who claimed its “cash cost” for silver as a byproduct was only $1.15 per ounce in 2011, actually had a “complete cost per ounce” of $23.88!  … Wow! At a $1.15 per ounce, $2.75 would be a 139% profit margin!

Hecla has one of the lowest cash costs, because they have one of the highest by-product metal sales.  Hecla’s 2014 full year by-product metal sales were a whopping 65% ($325.4 million) of their total $500.7 million in revenue.  By Hecla deducting their by-product revenue, they were able to state an ultra-low cash cost of $4.81.  However, my estimated breakeven for Hecla in 2014 was $18.87.

Furthermore, cash cost accounting is not a GAAP – Generally Accepted Accounting Principle.  The mining companies even state in their financial reports that cash costs have no “standardized meaning” in the industry:

“cash costs per ounce of silver”, which are used by the Company to manage and evaluate operating performance at each of the Company’s mines and are widely reported in the mining industry as benchmarks for performance, but do not have standardized meaning.

So, if a company has the same cost structure as Hecla, but a much lower by-product metal revenue, their cash cost would be higher because their deductions would be lower.  For example, if the company only had 80% silver revenue and 20% by-product metal sales, their cash cost would be significantly higher as their deduction was much lower.  Again, this has nothing to do with the profitability of the company. 

Here is item number 2:

But if the author was right about the “break-even area” for silver, then how on earth did mines produce 20,000 tonnes of silver (and scrap refiners another 6,300 tonnes) in 2005, when the price of silver ranged from $6.39 to $9.23 per ounce? And how did we ever survive 2003, when the price ranged from $4.37 to $5.96?

FOFOA’s statement here shows their ignorance as they fail to factor in the price of oil and its relationship to the silver price.  I discuss how the rise in the price of oil impacted the price of silver in my upcoming THE SILVER CHART REPORT.  Here is Chart #24:

I gather the folks at FOFOA believe the primary silver miners extract silver ore without the use of energy.  Quite clever of them.  Nonetheless, the price of a barrel of oil skyrocketed from $25 in 2002, to over $110 in 2011.  Did this not impact the cost to mine silver?  Are they kidding here?  Again, FOFOA is guilty of FORECASTING IN A VACUUM.

I would imagine FOFOA would say something like, “Well, if the price of oil falls back to $50 like it did in 2005, then the price of silver should decline to $7.32– its average price for the year.  That might make sense if we continue to analyze the silver market they way the folks at FOFOA, however things have changed considerably in the primary silver mining industry over the past decade.

This is also shown in detail in several charts in THE SILVER MARKET REPORT.

I gather the top primary silver mining industry’s 40% decline in average yield since 2005, may have slipped past the supposed critical thinking of the folks at FOFOA.  Which means, the mining companies have to either add new mines to makeup for the decline in production or process a great deal more ore to produce the same amount of silver.  This costs energy… which costs a lot of FIAT DOLLARS.

Here is item number 3:

But if you throw in a little economic deflation, what FOA called “our economic function” which will decrease the industrial demand for silver until much of the global malinvestment is cleared away, along with a little price overshoot to the downside and a sprinkling of all that supply overhang competing with the miners and scrap refiners, I think $2.75 might even be a little conservative. ;D

I don’t think silver will stay that low forever. As I said at the top of the post, it’s an exceptional metal with many great industrial uses. So, like America, where “a few solid economic ideals still exist and await the opportunity to rise like phoenixes from the ashes of a fiery transition,” I think silver has some fantastic industrial uses and will rise like a phoenix (more or less) after spending some time at around $2.75 per ounce (in constant dollars of course.

FOFOA believes the United States will rise like a phoenix from the ashes of a fiery transition, and consumption of industrial silver will increase putting value back into their low forecasted $2.75 price.  As we can see, FreeGold only values silver as it pertains to its degree of consumption as an industrial metal.  Silly people.

This goes against 2,000+ years of gold and silver’s STORE OF VALUE properties.  FOA believes gold will revalue higher as it will back all this worthless fiat money, but they fail to realize ENERGY IS THE KEY, not silly fiat money.  What happens to the global financial and economic system when the peak of unconventional oil production begins in earnest?

Does FOFOA make any forecasts to what happens to the value of the $105 trillion in global conventional assets under management when world oil production plummets?  How do they see the U.S. rising from the ashes when we finally witness the collapse of the highly leveraged shale oil and gas industry?  How does the U.S. run on 70% or half of the energy it’s used to?

The reason silver will increase in value in the future has nothing to do with industrial demand,  but rather as a result of investors moving out of increasingly worthless paper assets and into physical ones to protect wealth.  Silver is just as good as a store of wealth as is gold.  It just has less stored Economic Energy than gold.

Of course FOFOA will label me as a silver bug, but they fail to realize I am a STORE OF WEALTH advocate, who believes silver is the better value going forward.  This is due to a great deal less above ground silver in the world for acquiring as a store of value compared to gold.

While I base the value of silver currently on the price of oil, this will become less of a guideline in the future due to the implosion of the highly leveraged Treasury-Bond-Retirement-Insurance Fund-Derivative Market.  The world perceives there is a store of wealth in these supposed paper assets.  Unfortunately, they are (as I stated many times) nothing more than ENERGY IOU’s.  Energy must be burned to give them value.  And not only the same amount of energy next year, but even more or the entire house of cards comes crashing down.

This is not the same with physical gold and silver.  They STORE energy value in each coin.  No energy has to be burned to give them value.  They are ready to be traded for energy value locked in goods and services.  Gold and silver are true stores of value, while most paper assets are ILLUSIONS of value. 

FOFOA fails miserably in understanding this ENERGY = MONEY principle.

The Fed & Central Banks Prop Up The High Oil Price

Without the Fed and Central Banks propping up the economic and financial markets since 2008, the world could not afford high-priced unconventional oil such as oil sands and shale oil.  Without this extra oil supply, the Fed and Central Banks would not have been able to paper over the system.

Furthermore, the trillions in monetary liquidity on top of zero interest rates actually pulled future oil production forward.  This is why the world has experienced an eleven year global conventional oil production plateau.  Basically, money printing and debt allowed us to steal oil from the future.  This will come back to bite us hard when the U.S. Dollar finally collapses.  Why?  Because the decline in world oil production will be more severe when it finally arrives.

This will cause havoc to the majority of paper assets.  This scenario is not found anywhere in the FOFOA playbook.  Which is way they only value of silver by how much is consumed by industry.

Lastly, I actually believe silver will outperform gold in percentage terms in the future due to it being more rare and more affordable.   I explain this in my upcoming THE SILVER CHART REPORT.  There are 48 charts in the report.  Some of these charts are from my work over the past six years, all updated and including new ones never seen before.  There isn’t a single publication on the internet that explores the silver industry and market to the degree covered in THE SILVER CHART REPORT.

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