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November
7, 2006
By:
Tom Szabo
SILVERAXIS.com
Base
metals are of peculiar interest to silver
investors because the majority of silver
production is a by-product or co-product
of base metal mining. More base metal mining
means more silver production and vice versa.
In addition, the shares of companies involved
in base metal/silver operations are obviously
influenced by both silver and base metal
prices as well as future expectations about
those prices. Silver is also found along
with gold at many mining districts, especially in
Mexico and South America, but the more important
relationship between gold and silver is
their unique status as the dual monetary
metals. And although I believe silver will
eventually see its salvation in tandem with
gold as real money makes its way back into
the global economy, there may be a near-term
risk to silver due to its sometimes fortunate,
sometimes unfortunate relationship with
base metals.
On
April 20, 2006, near the cycle peak to date
for silver and gold, I provided some commentary
to Resource Investor to the effect
that hedge funds were marching the
current bull market in natural resources
to an early death because of excessive,
manipulative speculation. The piece was
titled Analyst
Sees Funds Ruining Perfectly Good Resource
Boom. At the time, I didn't offer any
sort of explanation for this provocative
thesis and unfortunately I have been unable
to find time to do so since then. Luckily,
Frank Veneroso has recently put into words
and charts most of the discombobulated snippets
of thought concerning this topic that have
been circling in my head these many months.
I
urge every single metal investor to read
Mr. Veneroso's highly controversial and
contrarian (to metal bulls) analysis which
was originally delivered to the Geneva Conference
on Base Metals Investing on October 3, 2006
and published by Kitco on November 6, 2006.
Titled The
Coming Nuclear Winter For Base Metals,
this could turn out to be the seminal analysis
for the next phase of this commodities bull
cycle. On the other hand, it could turn
out to be a footnote in what might be a
record breaking future for hard assets.
Mr.
Veneroso provides his own way out should
the latter occur; his own data goes back
to the beginning of the Industrial Revolution,
which generally refers to the period
in Western history roughly bound by 1750
and 1850. The key here may be the word "Western",
since the rest of the world did not participate
to any significant extent. In fact, China
and India, home to almost half of the world's
population, might truly be in the middle
of what historians will call the Second
Industrial Revolution. If so, Mr. Veneroso's
position, that base metal prices are unsustainable
in part because they have never experienced
such an increase above the marginal
cost of production since the beginning of
the Industrial Revolution, may turn out
to be yet another victim to an unfolding
commodities supercycle.
The
tug of war between the optimists, who
believe China and India will dominate the
demand side of the equation with insatiable
appetites as far as the eye can see, and
the pessimists, who see a global slowdown
around the corner which will decimate the
commodities sector, is nothing new. In fact,
this diametric opposition has formed
the very backbone of the bull market in
metals for the last year or two. Waves of
fear, uncertainty and doubt followed by
bouts of greed-laced panic have characterized
the volatile trading in metals.
Yet
the prognostications have been rather
lopsided in favor of a continuation, if
not intensification, of the upward momentum
in metals and other commodities.
Most
of these arguments, however, have been rather
dogmatic in their logic. Take, for example,
the almost ubiquitous truism that the
commodities bull market will not reach
bubble status until the general public is actively
participating. Comparisons are made to the
dotcom mania where housewives were exchanging
stock tips about the next hot Internet IPO.
When the topic of conversation at cocktail
parties is ore grades and drill results,
so the argument goes, the smart money will
know to leave the table because the end
is near. I myself have been guilty of indulging
this fantasy, such as when I asked: Is the Spotlight Shining On Silver, Gold
and Commodities Yet?
I
tend to believe that the quality of analysis
within the metal bull community
has suffered greatly because most of
the dissent, with notable exceptions like
Paul van Eeden, has come from "official"
sources at the brokerage houses, investment
banks and the like generally bundled together
as "manipulators" by the
true gold and silver bug. A recent example
from the supposed "manipulators"
is the piece Global
Disconnects by Stephen Roach of Morgan
Stanley. Although this type of work is featured
on several sites including www.321gold.com,
it is usually dismissed with little apparent
effort by the metal gurus, as it is in the
recent piece, Base
Metals - A Good Alternative? Unfortunately,
the constant feeding of one's belief system
with platitudes is a surefire path to a
very dangerous situation: groupthink.
That
someone like Frank Veneroso would come along
and provide a detailed, well-reasoned and objective
analysis of base metals, the stellar performers
to date of this commodity bull market, should
be noteworthy. That he would slam the
natural resource community consensus
in such a forceful manner should be worrisome.
But what should really be troubling,
and this is something I predict will happen,
is that he is likely to be ignored by those
who have the most at stake. In fact,
he has been ignored for more than a year
as he has painstakingly documented the discrepancy
between base metal supply, demand and prices,
all the while pointing to manipulation by
hedge funds on the long side as the likely
culprit. The short shrift has occurred despite
Mr. Veneroso not being a stranger to
"gold-bug friendly" manipulation
theories, having been one of the most respected
gold experts relied on by GATA
for information about covert central
bank activity in the gold market back in
the days before conspiracies about
gold were fashionable.
Now
some of you may point out that Mr. Veneroso
has been predicting a crash in base metal
prices ever since copper was trading at
$1.50/lb. on its way to $4.00/lb. So why
should he be right this time? Well, being
wrong in the short term does not automatically
make one wrong in the long term. The potential
value of Mr. Veneroso's work probably
isn't in providing insight into what base
metals will do next week, next month or
even next year, but rather in generalizing
about what direction they are likely
headed in the next few years. His analysis
may not be very important to speculators
on any given day but it might make all the
difference to long-term "buy and
hold investors" in base metal (and
silver) mining stocks.
So,
which will it be? "This time it's different"
because China and India are industrializing
or "history is repeating" because
the laws of economics still function? Regardless
of which way base metals are headed and
whether or not their precious cousins are
dragged along for the ride, I personally
believe that it would be unwise to marginalize Mr.
Veneroso's work. At the least, he points
out some fundamental risks that have
been important historically and could become
even more important in the future, thanks
in part to the evolution of hedge fund
speculation. With hedge funds in the picture,
"this time it's different" may
just turn out to be true, but not necessarily
in the bulls' favor.
I'd
like to conclude by pointing out my running
soliloquy at www.silveraxis.com,
which
has
included numerous cautionary notes in the
past few months regarding base metals. I
too have been talking about a possible economic
slowdown amid what I view as a speculative
orgy in commodities, although with far less
eloquence and persuasiveness than Mr.
Veneroso. But my point hasn't been that
silver, which is similar to base metals
in that most of its demand is industrial,
could join base metals in a downward
spiral. Sure, that is a very real risk and
the basis for my current careful posture in
the silver market. At the same time, it
should be noted that the risk to silver
is mitigated somewhat by the fact that declining
base metal production would eventually also
curtail silver production. In any case,
I don't see the downside in the price of
silver being anything other than a buying
opportunity because I believe physical silver
should be constantly accumulated in moderate
doses over a very long holding horizon spanning
generations.
Rather,
what has me cautious and vigilant is the
simple fact that most of the large, attention-grabbing silver
projects out there are really silver-rich
base metal projects which would be negatively
impacted by falling base metal prices even
if silver prices were not dragged significantly
down. In short, I believe natural resource
companies with a large amount of base metal
exposure are less than ideal candidates
at the present time for those seeking investment
opportunities in silver. One possible solution,
according to this line of logic, might be to
focus on silver projects which are gold-rich,
since gold is more likely to weather the
coming economic uncertainty than base metals.
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