Precious metals miners rolling over again

The bullish case for silver is easy enough to make. It also makes sense that if the price per ounce eventually takes off, then the miners would do well.

Nevertheless, the problems that silver miners face are multifaceted and will be discussed further in the following sections.

Inflation

The next trigger that catapults silver prices higher will likely be associated with a notable rise in inflation that may already be in process. The Producer Price Index (PPI) was up last month significantly for the first time in a while and crude oil is again testing the psychological $100 level.

Still, inflation is a double edged sword for the miners because rising energy costs will be a huge drag on net earnings for these companies. This is especially true for the penny stock miners who are still in the exploration stage and will require revisionary financing going forward.

Tough Times for Miners

The entire mining sector has been miserable and positive sentiment is getting pretty close to zero. This might indicate a bottom is near, but the damage to the sector has been done.

The industry also suffers from a shortage of experienced geologists, and financing for these mining projects is hard to come by as a rule.

Furthermore, most silver comes from byproduct mining because primary mines simply could not stay in business for the lean decades leading up to the most recent bull market in silver.

Other Risks for Miners

These little silver mining stocks are notorious for experiencing short selling in the most egregious sense. This activity probably goes hand in and with the paper price suppression that happens in the COMEX futures markets.

In addition, miners often face nationalization risk when they explore and develop mines in foreign jurisdictions. Even if they do make a big strike abroad, their mining rights could be taken over by a local government needing money.

Other risk factors for miners include the increasingly difficult permitting process due to environmental concerns, as well as the ongoing challenge of managing both their mining prospects and any existing mines.

Miners Hedging Forward Could Face Disaster

In fact, as a last ditch effort to protect against falling silver prices, the mining sector is now seeing the re-emergence of forward hedging. The creation of such hedges allows these producers to lock in current forward prices. This would benefit them in case the market declines, but it would cause an opportunity loss if the market subsequently rises.

Such hedging is therefore not a completely bad idea — especially in a soft market — but with all the risks mentioned above and the likelihood of prices turning around at any moment, these hedges could turn into yet another disaster for the miners using them.  Option hedges may make more sense, but they cost money to purchase.

Furthermore, since investor holdings are denominated in fiat currency, however you slice it, even though major inflation is not occurring now, prudence would suggest that the United States will face a high probability of inflation in the near future.

In short, maybe investors would be better off placing a bet on a horse with 100:1 odds against it winning and a broken leg than on the present selection of silver miners.

About the Author

Jeffrey Lewis has been an advocate for silver purchasing for the past six years. He writes regularly about it at silver-coin-investor.com

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