3 reasons a powerful rally in silver mining stocks is overdue

No matter what silver prices do in the near-term, silver mining companies are making money hand over fist. One of these days, the stock market is going to catch on to that fact.

In a single week of trading between May 2 and May 6, 2011, silver spot prices collapsed more than 25 percent on weak economic data, new NYMEX margin requirements and a general sense that the silver market was overheating. On top of that, public SEC filings showed that several noted hedge fund managers and silver bulls had started trimming back their silver holdings as early as February.

Even after last week’s brutal sell-off in the silver market, though, analysts remain bullish on silver mining stocks. Here are three reasons why a powerful rally in silver mining stocks is overdue:

1) The cost of production is static. Even though silver lost more than 25 percent of its value in a single week of trading, the white metal’s still up nearly 20 percent since the start of the year. “The silver companies are making very good money at $35 an ounce,” Sprott Asset Management’s Charles Oliver told Reuters last week. “They’d be making very good money at $30 and most of them would be making very good money at $25.”

Indeed, the article points out that most of the world’s largest silver mining companies report production costs between $4 and $8 an ounce. If they can turn around and sell that silver for $35 an ounce, their profit margins are enormous – even after a drop in the price of silver.

2) Consolidation on the way. The one thing that’s been missing from the 10-year bull market in precious metals has been a wave of buyouts, takeovers and consolidation in the mining space. The world’s largest mining companies are sitting on war chests full of cash, and they’ll likely target junior mining companies to ensure a steady supply of silver in the years to come.

Silver Wheaton Corp.’s (NYSE:SLW) CEO Randy Smallwood went on the record last month predicting a wave of buyouts after silver prices stabilize. Smallwood argues that small cap silver mining stocks don’t want to sell when prices are rising rapidly. The fear, of course, is that they could have gotten more money for their company and operations if they’d held out for a few more months. This steep correction in silver prices could be just the opportunity Silver Wheaton and other silver mining giants have been waiting for.

3) The fundamental trend is up. Extreme market volatility can make anyone question their reasons for investing in silver, but the long-term trend remains intact. The Federal Reserve’s continuing its inflationary monetary easing program and interest rates remain near zero. The net effect is a dollar that’s headed down.

ShadowStats.com calculates the inflation rate at 10 percent using formulas our own government used just two decades ago (before they began stripping out costs for things like food and energy from the CPI). In such an environment, holding your cash in a low-interest bank account is akin to losing 10 percent of its purchasing power every year. By contrast, silver prices are still up nearly 20 percent this year, and they’ll likely head higher by 2012. No matter what the silver price does in the near-term, though, silver miners are still making money, and they’re doing it hand over fist. One of these days, the stock market is going to catch on to that fact.

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