CHINA'S SECRET SILVER SOLUTION
A Special Report
by David Morgan
Precious Metals Analyst, www.silver-investor.com
Publisher and Editor, The Silver Investor
November 24, 2004

In this report we analyze the impact of newly industrialized China on the world’s silver markets. Pressure from China’s compressed industrial revolution - along with that from worried citizens turning to silver as a store of wealth - could soon trigger explosive price hikes in the silver market. Investors can anticipate this critical trend through purchases of physical silver or by buying shares in certain silver mining companies. Ironically, one of the best places to look for opportunities to invest in silver may be China itself. (Could the solution to the looming precious metals’ crisis lie in China’s own back yard?) The first of several reports featuring China and silver.

INTRODUCTION

I have been criticized by some readers for not providing enough investment ideas and have often responded by pointing out that in the silver markets, unlike gold, there is a very small universe of companies to choose from - and only a few regions of the world that offer meaningful opportunity for silver exploration and development. Lacking a broad universe of producers and a wide array of properties, I am often reluctant to offer up “new ideas” - worried they may not meet my standards, or those of serious precious metals investors.

Today, probably for the first time since I’ve been writing about the evolving silver boom of the 2000s, I can suggest a new investment idea to readers with tremendous excitement and full confidence: China.

China is open for business. China’s leaders know they have to make changes or risk losing the silver they need to support the country’s powerful but compressed industrial revolution. They’re privatizing silver mines and looking for operational partners.

In this special Silver Investor report, I intend to act as your guide on a journey through a modern industrial giant - one that will explain why China’s silver-mining privatization offers one of the most compelling investment opportunities I can ever remember introducing to my subscribers.

China Is Privatizing

I am writing this report before leaving the beautiful environs of my Washington state home on Sunday November 21st for a by-invitation-only trip to Beijing along with many other mining industry professionals to attend various high-level meetings with senior government officials and mining bureau representatives. (Please do not email me asking for names due to the sensitive nature of the trip and to avoid compromising the security of those who are traveling with us.)

I look forward to the company of my traveling companions. Many, like me, have sacrificed much personally to cultivate necessary and important relationships in China - knowing that cultivation was absolutely necessary and would provide critical access to China as it evolved into a key player in global silver markets. Now with China solidifying its promise as an industrial power, we are seeing it becoming a critical factor in silver as well. As I said, I have been expecting this - but I am also aware it is catching others off guard. Upon returning expect another special report indicating pertinent details of this trip.

Silver - why should I hide my enthusiasm? I wrote in a recent report that new China silver-mining initiatives could spawn a silver stampede similar to what we witnessed in the gold industry in the 1900s in America. And I have also stated that we are on the cusp of a kind of explosive realignment in the price of gold - but one in which silver’s price adjustment will feel more like a “nuclear explosion.”

China! Soon we will leave Beijing and travel north to where many of China’s richest and largest silver discoveries are contained within wider regions that may partake of a similar geology - and where additional exploration by local Chinese companies may have confirmed the presence of continuous ore bodies. If geological patterns are to be believed, I am told we may bear initial witness to one or more of the very largest silver/lead/zinc systems in the world.

Now I’d like to take this opportunity to state - once and for all - that it is silver, NOT GOLD, that offers the better precious metals opportunities in the 21st century. News reports, for instance, have told of silver purchases by Bill Gates, George Soros and Warren Buffett. These three billionaires - usually on the winning side of important investments - are said to be heavily weighted in silver, thus contributing an unintentional but implicit endorsement of an unfolding Silver Stampede.

What do they know that you don’t?

I have been among the very few voices shouting about silver’s potential for more than five years now. My readers - the ones that acted - have been the beneficiaries of a recent near-doubling of silver prices - but believe me, that is nothing compared to what is to take place over the next few years.

PART ONE: SILVER HISTORY & OVERVIEW

Silver may well be the “hot” money metal of the twenty first century, as its use in high-tech equipment continues to complement its value as money metal. But the beauty and value of silver has been apparent for thousands of years. Long known as the “people’s” metal and “white money,” silver is economical, and affords the benefits of gold without the steep a price.

Silver castings and carvings date back more than 5,000 years on Greek islands and in Asia Minor. In China, silver mines are traceable to 400 BC. Recent discoveries of silver ingots, bars and plates date back to China’s Tang Dynasty some 1,500 years ago and contain carvings made during casting as well as tax and labor information.

Workers unearthed silver ingots with carvings and inscriptions that date back to China’s Yuan Dynasty, some 700 years ago. They made a pact not to tell, distributed the ingots and went home. Only much later after the story had been leaked, and with great difficulty were the workers eventually persuaded to part with their ancient silver ingots. Silver was highly valued by these workers. Silver is ever in demand!

Privatization Makes Silver More Popular

While silver is one of two “money metals,” - the other being gold - it alone is utilized by manufacturing, especially high-tech manufacturing and must be replaced, in size, every year. Until recently, the world’s silver stocks and active mines have seemed sufficient, if barely, to provide both for those who purchase it as a store of value and those using it for high-tech industrial purposes.

A shift in the supply/demand equation caused by the powerful awakening of China’s economy - and its 1.3 billion citizens - has called all this into question. China’s rural economy is being powerfully transformed by a compressed industrial revolution lasting a decade instead of the 70-100 years that the same process took England and America.

Everything about China - from infrastructure to housing to education and entertainment - is changing, modernizing and privatizing with breakneck speed. Revitalized, privatized, commercial markets are the stars of the show, but communist officials remain in the director’s chair. Their mission is to integrate capitalism onto a dying communist system with as little culture shock as possible. It is an increasingly difficult task, one given that 500 million or so rural Chinese workers are expressing continued impatience with the progress - and fairness - of their country’s modernization.

The old Soviet leadership’s approach to the marketplace consisted mostly of denying capitalism’s strengths before declaring victory and engineering a quiet surrender. But China’s leadership has decided to build China’s wealth rather than redistribute it, thus enabling private markets, entrepreneurialism and at least a modicum of human action. Many more than might be imagined are rooting for China’s success. While it can probably be said that the world’s largest corporations have identified China’s 1.3 billion citizens as a critical additional consumer group, other powerful stakeholders are also in need of a solvent, peaceful China and are looking to China to provide expanded generations of those well versed in the capitalist system of free enterprise.

The West’s various Treasury officials - especially anyone associated with the U.S. Treasury - are giving China all the moral support they can. After all, the Chinese government and affiliated institutions are critical purchasers-of-last-resort at U.S. Treasury auctions now that the Japanese are tapped out and the Europeans have turned sullen. Much is gained, and by many, should China prosper.

There is a specter haunting China! It is one of the country’s huge masses of working poor and additional millions of frustrated male adolescents gathering together to seek sudden change. The uneasy prospect floats like sullen wisps of fog through Beijing’s vast, public places and lurks moodily behind many government proclamations rationalizing - and justifying - China’s newfound competitive approach.

Are the politically powerful ambivalent? From the first uncoordinated moves towards decentralization of government authority in the 1970s, to the sudden and unexpected unleashing of pent-up entrepreneurial energies in the 1980s, to adoption of more formalized policies in the ‘90s that recognized the competitive changes the initial policy of regional decentralization had wrought, China’s leaders have at various times encouraged, accepted, tolerated - and occasionally lashed out against - the changing face of communism.

Will it all prove too much for China to handle? Bottlenecks and silver shortages - signs of things to come? China’s silver usage is up, and has been every year, currently hovering around 40 million ounces, though there are estimates it could easily rise to 100 million ounces. Even then China would not be utilizing as much silver per capita as many Western nations.

The Silver Institute points out the following about the industrial uses of silver (“fabrication): “A primary factor affecting the price of silver is the available supply versus fabrication demand. In recent years, [the world’s] fabrication demand has greatly outpaced mine production forcing market participants to draw down existing stocks to meet demand. As these available sources continue to decline, silver’s fundamentals continue to strengthen.”

Fabrication demand is an obvious reason why silver is in such short supply. A recent press release by mining company and silver-producer Silver Standard (which recently decided to expand to China) explains it this way: “The Chinese economy has grown at an astonishing pace … with annual silver consumption increasing from 24 million ounces to 47 million ounces. China appears to have an insatiable demand for all metals [including] silver. …”

An analysis of China’s use of silver in metric tons reveals that annual silver consumption grows year over year. This kind of growth is technically unsustainable. Just now, the Silver Institute’s 2004 World Survey reveals that China’s silver demand has finally surpassed production, putting China formally in deficit. Since China’s main fabrication use for silver is electrical components/ electronics (with brazing alloys running second) chances are that so long as the country remains a leading industrial producer, its silver usage will grow along with its silver deficit.

There seems little doubt - at the Silver Institute anyway - that China is behind tightening silver stocks. “… Since 1998, the Chinese have made a substantial contribution to global silver supplies,” reads a supply/demand summary in the 2004 Survey, “via the run down of domestic stocks of the metal.”

What probably is more troubling to Chinese officials is that China’s own silver production has remained fairly flat for four years in a row. World production, too, has been flat for the first half of the 2000s. When production is down, China faces the need to push even more strongly for increased production.

INITIAL OBSERVATION: China’s dedicated millions of workers season their high-tech production with silver - not a lot but enough, over a year’s time, to add to up a sizeable quantity. Dear reader , you have traveled this far with me - now sit with me here with me and watch the flickering picture on the big, white screen. I think it is telling us a dramatic tale. 

Please focus on the stresses affecting the silver market. There’s production demand, certainly. But there is another demand altogether straining Chinese - and world - silver supplies. It has to do with silver’s intrinsic value as a money metal; its ability to retain value during periods of high inflation as well as high growth and high inflation and low growth. It seems the 2000s are struggling with the same low growth/ high inflation scenario (some call it “stagflation”) as the 1970s. Toward the end of that decade, silver peaked at $50 and gold at $800. Contrast that to today’s prices, where silver is around $7.50 and gold still fairly close to $400.

Let’s talk about ratios. Silver and gold are famous for maintaining a price ratio with each other of approximately 15 to 1 for century upon century; it has only been in the 20th century that this ratio ceased to hold. However, in the 21st century I expect the ratio to achieve a ten to one ratio, highly favoring silver as a vital industrial commodity and wealth maker! A 2004 Silver Institute graph of precious metals and copper prices starting in October of ‘03 reveals that the price of silver now tracks the price of copper more precisely than gold. This means that available stocks of silver are being purchased, along with copper, primarily for industrial purposes.

The bullish commodity trend in the 1970s lasted nearly a decade - with some hesitations - and there is no reason to believe the 2000’s version is going to be any shorter-lived than previous ones. As of this writing, the silver/gold ratio is approximately 50-to-one, leaving plenty of room for silver to outstrip gold and close the price differential rapidly. While the distortion of the silver/gold ratio has happened before, it takes an extraordinarily powerful surge in demand to do so. One that China has initiated and will sustain.

Below is the demand-side conclusion to which we are inevitably led.

1) The combination of a rapidly declining U.S. dollar causes millions to turn to silver as a store of wealth; in large part supported by U.S. and European banks’ focus on expanding credit demand around the world.

2) China’s accelerated industrial revolution will continue to demand a greater share of the world’s silver supply - increasing demand for electrical power (superconductivity- silver use), Transportation (MagLev train- silver use), Water purification (silver use) and eventually, into aeronautics and space applications.

3) China’s untapped domestic potential for new exploration and development make the future price of silver go ...

Boom! (Silver - prices blown sky high - still the indispensable metal for China’s future!)

PART THREE: PRESENT-DAY ANALYSIS OF CHINESE SILVER DILEMMA

The Soviet Union. Churchill had an apt term for it - something along the lines of a “riddle wrapped inside of an enigma.” That could certainly apply to China too. China’s leaders seem recently to have come to a decision, or have they? I believe so.... It seems to me that old men have finally been pushed into what is at least a two-part decision regarding raw materials. The first part involves overseas’ purchases that allow China control of critical markets where its domestic stockpile is low. This would explain, for instance, the recent purchase of Noranda, the world’s largest base metals producer.

And the second part seems to involve exploration and development of raw material domestically - if enough of the key element seems available. Even here, however, China has a problem - at least it did so long as it stuck to developing multi-year industrial plans, just as the Soviets did. But when it came to mining, these plans were either useless or counterproductive because they ended up funding mines that failed a few years later. Yet these failing mines still received generous development revenues as if nothing had happened - at the expense of promising, mines that were starved for capital because their potential was not established when the multi-year plan was finalized by the Chinese bureaucracy.

Based on my invitation to China, it is my perception that Chinese mining officials are feeling more acutely than ever the need to reach out to others in the profession outside of China to help with the rationalization and professionalization of their mining industry. Like almost everything else in China, this is not exactly a new trend. It’s been going on - with starts and stops - for over 15 years in various configurations. Perhaps a little history is in order …

The Chinese government first became serious about encouraging foreign investment in China early in the 1990s - and according to Goldletter International, “One of the specific aims of the 1990s initiatives was to try and attract foreign investment into the Chinese gold mining industry. However, the lengthy and complex approval process, the limited and poor quality of designed exploration projects, coupled with a legal system that was unclear about ownership and without guarantees of tenure, was enough to deter most candidates. In addition, the mining taxation code did not encourage investment.”

The Chinese kept trying. Eventually, late in the 1990s, they hit on the idea of transferring federal authority to China’s provinces- making the process of foreign investment in China’s mines more flexible and inviting. Now China’s provinces - as Goldletter International tells us - “[had] obtained the autonomy to approve Sino - Foreign Joint Ventures for mineral exploration and mining.” Almost immediately this new version of the law began attracting foreign corporations including many public Canadian mining companies - most with a focus on gold - eager to partner with provinces via Sino-Foreign Joint Ventures.

With some changes, the Sino-Foreign Joint Ventures approach is still in force today and remains a fairly customized procedure. Some proposed ventures need federal government approval while others don’t - mostly depending on whether the project’s size exceeds $30 million and does or does not involve precious metals. The provincial government in question and simply registered with the central government can approve projects that do not demand Chinese central government approval.

Recently there have been some meaningful elaborations. Again, according to Goldletter International, “In December 2003, the Chinese Government issued a white paper on China’s Policy on Mineral Resources, which stresses that China will depend on exploitation of domestic mineral resources to guarantee the needs of its modernization drive. ... Sinoforeign co-operation in the exploration and exploitation of mineral resources will be increased. ...”

You can see from the above information that my statement at the beginning of this report that China is “open for business” is generated by close observation of actual recent events. China is becoming increasingly pro-market and business-friendly, at least as of this writing. When it comes to the silver industry, additional initiatives, not mentioned above, include the following:

• Creation of exchange-oriented private silver trading;

• The removal of a bank monopoly regarding the selling of silver;

• The lifting of import restrictions

• Contemplation of further significant actions intended to rationalize the silver market in light of increased activity and overseas participation.

Until very recently, China’s provincial government’s joint venturing occurred primarily with gold companies. But now China is actively seeking mining companies with a special focus on silver. Recently, several major, North American silver mining companies - Minco Mining & Metals Corporation (Minco) and Silver Standard Resources Inc.- announced a strategic alliance to jointly pursue silver opportunities in China. Under terms of the strategic alliance, Silver Standard will invest C$2,000,000 in Minco Silver to acquire a 20% interest in the new venture. Silver Standard will have preferential purchase rights to participate in future financing of Minco Silver in order to increase its interest up to 30% in Minco Silver. As part of the strategic alliance, Minco Silver will be the exclusive entity for both Minco and Silver Standard to pursue silver projects in China.

I am pleased to see that Silver Standard is headed toward China. They are successful and well run firm, and they will do well in China. When I first recommended Silver Standard the stock was at $2. Today it trades as high as $15.

The gates are open. Foreign silver investment has finally come to China.

PART FOUR: CHINA’S SECRET SILVER SOLUTION

When it comes to silver, China’s leaders seem to have opted to exploit what China may possess internally rather than acquire outside mines, mining entities and infrastructure. The question I must ask and then hope to answer at least partially during my travels in China (knowing such an answer may not ever be fully forthcoming) is how did those in charge of silver production and extraction in China reach their conclusions? Someone, somewhere, knows - or believes - China’s silver regions are fertile enough - once privatized anyway - to provide for China’s manufacturing and monetary needs well into 21st century. This is an astounding conclusion!

Conceptually, the part of China’s rolling privatization that holds the most promise is the obvious inefficiency with which its government-managed silver mines were operated. Most of us can agree that even good governments are rarely equipped to handle sophisticated industrial projects - especially ones as tricky as mines. China’s government, as previously constituted, anyway, was, from most accounts, nothing like a good government.

China’s current production - fourth in the world - was thus achieved under tremendous handicaps imposed by the political structure. It was achieved within the context of rigid multi-year plans and without profit incentives such as bonuses and options packages. But here is the point that those who are interested observers of Chinese silver-mining privatization should ask themselves: If China, with all its problems, could generate enough silver for a fourth-place ranking under the previous regime, then what might be accomplished when these silver producing properties are properly managed and exposed to appropriate modern technology?

Below are just three of wide spectrums of methods to replenish production:

Retrofitting mines in anticipation of price appreciation: If one accepts the inevitability of higher prices for silver (as I do) then one should create a plan to retrofit a number of China’s defunct mines - to put them back to work as the price justifies the production.

Exploration of claims adjacent to hot spots: Another path to success may lie in staking and exploring claims nearby “hot” spots where significant silver is already being mined - and where new world-class discoveries have recently been made.

Use of Technology to Expand Yield of Historical Mines: The application of modern mining technology when it comes to exploration and production, may add years to the lives of some of China’s more famous silver mines while reinvigorating newer production sites.

I am sure that these and many other ore extraction techniques will add tens of millions, even hundreds of millions of ounces, to China’s silver reserves. The managers who will plan strategy for China’s production of silver and those investors who will support them are helping to provide necessary resources for China’s continued progress.

As you can see from this report, I find China’s silver-mining privatization profoundly stimulating and gratifying. I am excited about going over to visit China’s most promising silver regions and mines. As an analyst, I welcome the opportunity to observe those with an “inside track,” but I am trying to embark on this trip without any preconceived notions. 

It took a great act of faith in the early 2000s to spend time and energy preparing for what I have come to believe from my own research is a new silver boom. Silver may turn out to be the biggest commodity boom of all the commodities, yes even bigger than oil and gas. Those few who did prepare for this day certainly deserve to have their foresight rewarded. And I truly believe that China’s search for silver is not just going to generate a world-class silver company or two. No, it’s probably going to create brand new entities - silver mining companies on a huge scale. 

I would also venture to say that partnerships and joint ventures are probably the way that most foreign participation will occur in China. Distrust is always a factor - especially among the mid-level communist cadres - and so is fear of changing political and social realities. Yet I cannot think how these people would ever make the case that China should go on in the old way, not maintaining mining properties while setting wildly inaccurate production goals.

Even now, the torch is being passed from China’s old mining operators - those lodged collectively within the bosom of the state - to an emergent class of savvy mining entrepreneurs, private, wealthy individuals and their families who have begun to use clout - their Guan-Xi - to participate in some of China’s most profitable and lucrative silver mining sites.

If you have read to the end of this report, it’s my hope you have learned something of China’s deepest and most fascinating silver-money secrets - those from which substantial profits may be derived. Below, for those who still struggle, are three conclusions I believe you should derive from this report.

1) Vast silver fields are waiting to be explored and developed in China: Top Chinese officials apparently have reason to believe - or have been led to believe - that there exist world-class silver reserves within the country that demand to be explored or placed into production.

2) Fields are placed where prospectors have never even made a thorough investigation: Silver has already been mined in China for some 3,000 years, mostly in the eastern regions. The areas most available that promise additional major discoveries lie in and around the northern and northwestern sections of China and Inner Mongolia.

3) China is correct to maintain in-country production of silver: New exploration techniques combined with advanced production technology might just allow China to make a silver mother lode discovery that might just match or perhaps exceed anything found in other silver-rich regions such as Mexico or Peru. At the same time, new uses for the “white metal” continue to develop and further tax supplies. In my next report, we will discuss the feasibility of finding such “super sized” ore bodies and track the movements of well-known prospectors who might be exploring now. We will also launch a fairly rigorous assessment of what regions and mines are likely candidates right now to help China fill its rapidly increasing silver deficit.

Question: What is China’s Secret Silver Solution?

Answer: Vast bodies of silver-rich ore available for exploration and production right now, right in China’s back yard …

© 2004 David Morgan. All rights reserved.
Bio and Editorial Archive