Why Silver

Print Page

The historic silver/gold price ratio was 15 or 16:1, but in recent years, silver is relatively cheaper ranging from about 40:1 to 80:1. On Dec. 1st, 2009, with silver at $18.85 an ounce and gold at $1,192.00/oz., the ratio is 64:1. This means that silver is currently undervalued, and cheaper than historic norms, and thus it is a better investment than even gold if you want to "buy low and sell high".

The supply and demand fundamentals for silver are extraordinary. There has been an ongoing supply/demand deficit in silver for 12 years. More silver is consumed by industry than is produced by mining and recycling combined. Some say this deficit reaches back 60 years, and has consumed virtually all the known silver ever mined since the beginning of the world. The annual deficit has recently ranged from 100 million to 200 million ounces per year. Annual supply is about 650 million ounces, and annual demand is about 800 million ounces.

Considering refined and mined known silver reserves, there is far less silver in the world than gold. About 150 million ounces of silver vs. 4000 million ounces of gold.

Most silver, 70-80% brought to market, is mined as a by-product of copper mining, gold mining, or zinc and lead mining. There are very few silver mines in the world, since most are really copper or gold mines. Therefore, mild increases in the price of silver will not bring substantially more silver out of the ground. Much silver is consumed in photography; by Hollywood and medical photo imaging. There is so little silver used in each photograph, that price increases in silver will probably not reduce demand. With a relatively inelastic supply, and relatively inelastic demand, it will require a dramatic explosion in price to bring the supply and demand deficit back into balance.

Famous Billionaires have bought silver in recent years. In 1997, Warren Buffet bought 130 million ounces of real silver, due to the favorable "supply and demand fundamentals", and although he bought as much as they would let him legally buy, his purchase was with about 2% of the value of his portfolio. Another Billionaire who tried to follow in his lead would be unable to do so since there is less silver now available in the world to buy at the COMEX than what Buffet has, and less than that in known, reported silver reserves in the world. George Soros owns a large percentage of Apex Silver (SIL). Bill Gates owns over 10% of Pan American Silver (PAAS).

In the gold market, there has been a large increase in paper futures contracts which are used to suppress the price. In silver, the relative amount of paper contracts is much larger. In other words, there are more paper shorts who will be caught in an impossible situation when the price of silver really begins to rise due to the fundamental supply demand gap. They will be forced to buy silver or go bankrupt. Either action will cause a dramatic rise in the silver price. If they default on the silver contracts, that will signal to the world the severe shortage of silver, and signal a great investment opportunity.

One of the cheapest ways to buy silver: You can buy U.S. coins dated 1964 or earlier, $1000 face value (4000 quarters, or 2000 half dollars, or 10,000 dimes), in a "bag" of "junk silver", which contain 715-720 ounces of silver, depending on how worn the coins are.

You get so much silver for your money. A bag of junk silver weighs about 55 pounds, and is the size of a bowling ball. If you invested $100,000 into junk silver coins, at $3500/bag, that would give you 28.5 bags each weighing 55 pounds, or 57 bags weighing 27 pounds each, or about 1571 pounds total. Could you imagine moving that much around your house if you had to move? Silver is so cheap it creates physical problems for investors today!

You will sometimes find quarters in a bag dating back to the late 1800's. In the early 1900's, you could work ALL DAY for a wage of ONE SILVER QUARTER. Imagine being able to buy a day's wage of real money for less than a dollar of today's money! Today, in 2005, a day's wage is over $100. Another way to put it is that the dollar has lost over 99% of it's purchasing power over time, yet, due to silver being undervalued, you can get 100 times the value of your money and labor if you invest in silver. Imagine if they paid a day's wage today of $100 in silver quarters; they would have to give you about 100 silver quarters today. The implications are that if silver returns to its historic valuations, silver will need to go up in value about 100 times, to $450/oz. Silver is truly a bargain. 

THE MERITS OF BUYING $ILVER NOW

Here is most of the Silver "story" below with many web site references. It encompasses the use of logic and common sense to analyze the factors which help determine the value of $ilver.

1. Silver Supply/Demand imbalance: The #1 reason to buy Silver is because there has been consistently more user demand than producer supply for 16 years. During this time over 1500 M oz. (Million ounces) has been consumed from the world Silver stockpiles and used for industrial applications (mostly electronics), photography, jewelry & Silverware, and coins & medals. Last year 586 M oz. was mined from the Earth and 185 M oz. was recycled (mostly from photographical Silver applications) for a total supply of 771 M oz. Meanwhile the total demand was 838 M oz. Therefore last year 67 M oz. was consumed from world stockpiles of Silver. After 16 years of deficits the world stockpiles are extremely low. It is impossible for this deficit to continue much longer. Supply must soon come into equilibrium with demand. Either demand must fall substantially and/or supply must increase substantially. Silver is essential for our electronics rich world with new applications and uses for Silver consistently being discovered (as you can see at http://www.silverinstitute.org/newsdesk.html such as http://www.silverinstitute.org/news/pr10oct02.html and http://www.silverinstitute.org/news/pr11apr03.html ) with very little likelihood of a significant decline in industrial demand going forward. Therefore supply must increase to meet the demand. However, starting new mines to produce Silver costs $7-$10+ per ounce. Therefore the price of Silver MUST go up to encourage new mines to be tapped. It is smart to own something which has and will continue to have more demand than supply at a given price. This simple supply/demand disequilibrium analysis is mentioned by Warren Buffett as the main reason he bought a large chunk of the world stockpile of Silver http://www.berkshirehathaway.com/news/feb03981.html
   
   
2. Silver is scarce: There is very little physical Silver that can be purchased for less than $5/oz. possibly less than 10 Moz., definitely less than 100 Moz. which is small change in today's investment world. Even up to $10 there is most likely less than 500 Moz. available for new investment.
   Proof of scarcity:
   
   The U.S. govt. had 2500 Moz. of Silver left after it discontinued making 90% Silver dimes/quarters/half dollar coins over 30 years ago. As of the end of 2002 it had none left. In 2003 the U.S. govt. is making market purchases averaging almost 1 Moz. per month to mint it's now popular American Eagle 1 oz. coins. http://www.silverinstitute.org/news/pr06aug02.html
   
   The official Comex warehouses for investor Silver storage in the U.S. used to have over 300 Moz. 10 years ago http://www.silverinstitute.org/news/prsinv.htm
   Now the Comex has 107 Moz. http://www.nymex.com/jsp/markets/sil_fut_wareho.jsp
   
   European bullion bank vaults had over 550 Moz. in 1990 and less than 300Moz. at the end of 2001 (of which 129 Moz. is owned by Warren Buffett).
   
   
   Total world government stockpiles of Silver is estimated to be under 100 Moz. after 4 years of very heavy selling (mostly by China). I expect there will soon be publicized shortage of Silver. You definitely want to own Silver before any shortage is widely publicized.
   
   
3. Silver is cheap: Despite the scarcity of Silver that has developed from 20 years of supply deficits the price is dirt cheap in relative terms ($18.85). At its peak in 1980 Silver went over $50/oz. (equivalent to almost $150 in today's dollars) when a small group tried to corner the market in it. You can review price data charts for the last 20 years by going to http://www.kitco.com/charts/liveSilver.html
   
   Silver is especially cheap relative to gold. At various times in the last 30 years 20-100 ounces of Silver could buy you 1 oz. gold. Right now you need 80 oz. Silver to buy 1 oz. gold; thus making Silver relatively cheaper. http://www.cairns.net.au/~sharefin/Charts/AuAG1lt.gif
   
   One of the main reasons why Silver remained cheap in the 1990s despite big supply deficits is because most investors were selling their Silver holdings to buy into the popular stock market companies. This selling of Silver peaked in 2000 along with the stock market. From 1999 to now governments (mostly China) have helped fill the supply/demand gap by selling their holdings. Going forward, China should curtail its selling of Silver since it realizes it's rapidly growing economy will soon be needing more Silver that it can produce internally.
   
   Another important reason why Silver prices have remained low is because most mines that produce Silver produce it as a byproduct. Mining companies that primarily produce zinc, lead, copper, and gold often extract Silver as well. In fact 70-75% of the Silver mined around the world is a byproduct of mining other metals.
   http://www.silverinstitute.org/production.html
   
   This results in the supply of Silver being inelastic to the price of Silver. Whether the price of Silver goes up or down substantially its supply will not vary much. Effectively the supply of Silver is governed more by the prices of zinc, lead, copper, and gold. If the prices of those metals are lower, some mines will reduce mining activities and thereby mine less Silver as well; and vise versa. So, although some primary producing mines have closed operations over the last 13 years due to being unprofitable operations under $5/oz. the supply of Silver has not been significantly affected since primary Silver mines make up a minority of Silver production. A price of over $7 is needed to encourage new primary production of Silver. 
   
   
4. The smartest people own Silver now: At major turning points of asset prices the overwhelming majority of investors are always wrong. After a 23 year bear market in Silver, most investors have sold their holdings. Those that remain are disciplined savvy long-term investors like Warren Buffett that bought 129 Moz. in 1997 at $5.05/oz. http://www.berkshirehathaway.com/news/feb03981.html
   
   Other billionaires that are invested in Silver include George Soros, and Bill Gates who own shares in various Silver mining stocks and possibly Lawrence Tisch as well. So if we look at the 105 Moz. that is in storage at the Comex warehouses as mentioned above; it is likely that over 90 Moz. maybe 100+ Moz. is owned by people that will not sell anywhere near these prices. Most will not sell even if Silver goes to $10 next month. 
   
   
5. Major short positions in Silver: Another major reason for the incredibly low price in Silver is that there have been massive amounts of shorting of Silver in the last 15 years. There have been 2 major reasons for Silver short selling over the years.
   
   Silver producers enter into forward sale contracts to make delivery of future production at prearranged prices. For example, the biggest U.S. producer and shorter of Silver is Barrick Gold (ABX:NYSE). They produce 20 Moz. of Silver per year but were short almost 50 Moz. in Silver at the end of 2002. Effectively that's 2.5 years of pre-sold production which limits future supply. In February ABX made a press release that included the mention that they would start reducing their short position in various ways including making delivery on their forward contracts using current production. This means most of their 20 Moz. production will not be supplied to the market this year but will go to fulfill their previous delivery contracts. Thus adding to this year's supply deficit numbers.
   
   The leading independent Silver analyst Ted Butler (http://www.butlerresearch.com/archive_free.html) discovered Silver leasing around 7 years ago. With Silver leasing, an institution leases Silver from a major holder (mostly government central banks) and pays them a small interest rate of 1-2%. Seemed like easy money for the central bank that had the Silver collecting dust and storage fees so they loved the idea. For the institution that leases the Silver they simply sold the Silver into the marketplace and used the proceeds for investments yielding 6-10% thereby making a nice profit spread. A problem here is that most of these leases will never be repaid since the Silver has been sold and consumed and there is not enough Silver left out there to repay these leases back with Silver.
   
   Then we have a massive short position on the Comex futures exchange. Each Comex Silver futures contract represents 5000 oz. and there are around 80,000 open contracts. That's 400 Moz. which is more than what the world has today. The thing is most of these contracts are simply rolled over into the future when they come due. Few of them end up with the long side of the contract demanding delivery from the short side.
   The detailed analysis of short activity in the Silver market is very complicated but the result is that it has caused the price of Silver to stay at an artificially extremely low price. It also means that future supply will be curtailed due to these pre-sales.
   
   
6. Renewed investor demand: After a 20+ year bear market in Silver the average mainstream investor has had complete apathy for Silver as an investment since its been "dead money" for so long. Plus there have been no brokerage firms "pushing" Silver as an investment. Until about 10 years ago a portfolio allocation of 5-10% in gold and Silver was considered prudent by almost all financial advisors and brokerage firms. The 90's mega stock market bull wiped that allocation off everyone's sheets. However, since the pop of the stock market bubble investors have started moving back to gold and Silver as defensive investments. 2003 has shown an acceleration in investor demand for Silver.
   
   Some proof below:
   
   Data from the U.S. mint showing a big increase in demand for the American
   Silver Eagles:
   In 1999 sales doubled to 9 Moz. from an average of 4-5 Moz. in the 1990s due to the Y2K scare. But that increased pace stayed with us....
   2000 sales were 9.1 Moz
   2001 sales were 8.8 Moz.
   2002 sales were 10.5 Moz.
   2003 1st Quarter sales were 3.656 Moz. which is an annual rate of 14.6 Moz
   2003 American Eagle Bullion Sales Totals
   
   The most respected name in precious metals fabrication, Johnson Matthey, started producing 100 oz. bars for retail investors for the first time in 15 years to meet the renewed investor demand for Silver
   http://www.amark.com/newproducts/16.htm
   
   There is a closed-end mutual fund (CEF) that invests in physical gold and Silver. Closed-end mutual funds always trade at a discount or premium to the actual Net Asset Value of the fund. The degree to which a fund trades at a discount or premium is directly associated with the enthusiasm for that type of an investment by the public. During the precious metals major bear market from 1980 till 2001 CEF mostly traded at a discount. Since the end of 2001 CEF started trading at a premium and has remained that way. This shows us the renewed investor interest in Silver and that we are most likely at the beginning of a major bull market in Silver.
   ETFConnect - Central Fund of Canada Ticker
   
   Mexico (the largest Silver producing country) is considering adding Silver coins "Libertads" in mass to be used as money:
   http://www.gold-eagle.com/editorials_03/salinas061103.html
   http://www.plata.com.mx/plata/plata/silver.htm
   
   
7. Negative real interest rates: Historically, times of negative real interest rates (when inflation is higher than short-term interest rates) are very bullish for precious metal investments. There is simple logic behind this. Precious metals generally go up with inflation. Now investors are offered 1-2% short-term rates while inflation is 3-5%. So some investors recognize that they should own precious metals that should appreciate at least 3-5% to match inflation compared to only earning 1-2% interest. This investor appetite should increase greatly if capital gains on precious metals are taxed at 15% compared to interest income that is taxed at up to 35%.
   
   
8. SILVER IS MONEY: The 2nd best reason to own Silver is as protection against inflation. The benefit of owning Silver (as well as gold) during inflationary times is that it will hold its purchasing power. Silver (and gold) has been considered MONEY in most places for all of human civilization. In fact the word for money in many languages is the same as the word for Silver. While gold was used to settle large transactions (mostly between nations) Silver was used for everyday transactions. Silver is real money that cannot be inflated without the heavy costs of mining and refining it out of the Earth. This is in sharp contrast to the currencies around the world today, especially the U.S. dollar. It is very easy to "print" dollars out of thin air which is being done consistently. In fact here is the dictionary definition of inflation: "A persistent increase in the level of consumer prices or a persistent decline in the purchasing power of money, caused by an increase in available currency and credit beyond the proportion of available goods and services". Over 30 years ago the United States went off of the gold and Silver money standard and increased the printing of dollars. The money supply almost doubled from 1972 to 1978. Common sense tells us that the more dollars exist, the less the value per dollar. This is the basic meaning of inflation. During this period of unabashed increase in money supply the price of Silver went from under $2 in 1972 to over $6 in 1978. Then it defied a "normal" price of $7-$10 and continued to a high of $50/oz. when a group tried to corner the market on Silver. Of course this corner failed and the price crashed to more normal levels. Meanwhile our government (through the Federal Reserve Bank) woke up and decided to cease the massive expansion of the money supply. This was the beginning of the 20 year big bear market in Silver. The last time Silver traded over $10 was in 1987.
   
   We are at the very beginning of a renewed period of hard asset inflation. The Federal Reserve is conducting a highly inflationary policy of low interest rates and heavy new printing of dollars. This manipulation of dollars has already devalued our dollar by 30% against the Euro currency in 1 year. Gold is up 15% in 1 year. The average commodity is up 20% in 1 year as measured by the popular Goldman Sachs commodity index:
   http://tinyurl.com/nox7
   
   Meanwhile Silver is actually slightly down over the last year. This offers current buyers an extremely low price entry point.
   
   Inflation in our dollars is simply a hidden way to tax holders of dollars. The spending habits of our government are gluttonous and ever growing. The citizens of the U.S. are already very heavily taxed. Our government already has accumulated a colossal debt load by borrowing $trillions in the debt markets. Yet govt. spending is increasing while its revenues are decreasing. So what happens? Effectively the govt. is now printing dollars out of thin air to pay for the shortfall in revenues versus expenditures. This process will now be accelerated with the new tax cuts. This excessive printing of dollars is devaluating the dollar at a rapid pace. This is very appealing politically. The tax cuts make the citizens happier and shift the burden of the monstrous government budget deficit on all holders of U.S. dollars. Since almost half the holders of dollars (especially U.S. govt. bonds) are not U.S. citizens, the burden of the dollar devaluation is partially put on the backs of foreigners. As the dollar depreciates, it follows that the price of Silver (which is stated in dollar terms) must appreciate over time.
   
   The U.S. is now running a trade deficit of around $500 billion per year. This essentially means that we are importing more goods and services than we are exporting. The deficit is filled by exporting dollars (mostly in the form of debt) to other (mostly Asian) countries. We are literally exporting dollars at almost $1,000,000 per MINUTE. Thus far these Asian exporting countries (mostly China now) have been "suckered" into taking unbacked paper dollars to finance our consumption oriented culture. Now they are being suckered in even more by accepting extremely low interest rates on their dollar holdings. It is probable that these foreign countries awash with low yielding IOU's (dollars) will stop accepting dollars as payment by quickly selling dollars to buy hard assets as new dollars come in. This will accelerate the devaluation of the dollar, causing inflation.
   
   Additionally, it is politically easy to engineer inflation because the overwhelming majority of Americans are in debt (usually heavy debt). Holders of debt embrace inflation since their repayments will be easier to make. In the United States: consumers, corporations, and the govt. have racked up immense amounts of debt. This massive debt is increasing at a huge pace due to the (manipulative) low interest rate environment. In fact our culture strongly encourages debt. Everyone gets endless credit card promotions in the mail. The American net savings rate is near zero. It is almost unheard of to purchase a new car outright let alone a house. Debt has become a huge part of our society. The current American very high standard of living is financed by and very dependent on debt. How many people would be driving $40,000+ cars if they were not able to finance them? Who will cry foul as high inflation takes hold in the dollar? Most of the net creditors of dollar debt are foreigners. Why would the govt. politicians care what they think or how they get hurt? What are they going to do to the only super-power left in the world?
   
   As you can see, the path of least resistance is high inflation. Silver (and gold) is your best protection against this rapid devaluation of the dollar. In the 1970's real estate also protected investors from the inflation of the dollar. However, today's situation is very different. Today's real estate valuations are already inflated due to the credit/debt bubble. Today's real estate prices are very dependent on buyers getting credit at a low interest rate to fund the purchase. When strong inflation takes hold and interest rates are forced higher there will be a triple whammy for real estate (especially homes). First, most potential buyers will walk away from the market when faced with 8%+ rates compared to <6% rates. This will be a big decrease in demand. Second, banks will be more cautious on making low down payment loans. Third, banks will become more cautious about making any types of loans with long-term fixed interest rates since they will be getting repaid with rapidly depreciating dollars. If you imagine yourself in the shoes of a banking entity you will see how dangerous this is to the currently high housing prices that are completely based on debt.
   
   In the very long-run the whole basis behind having a currency without any hard asset backing it up is flawed and fraudulent. There is nothing stopping our govt. from printing unlimited amounts of dollars. In fact this printing power is necessary for a govt. that often buys votes through unmerited handouts. The extreme of this is a socialistic or worse a communistic govt. that takes money from productive individuals and gives it to unproductive "needy" individuals (minus taking a percentage for itself) without regard to merit. This is the opposite of capitalism based on freedom and liberty. Our paper dollars are now essentially worthless except for our faith in the govt. As our govt. moves more away from capitalism there will come a time when its motives are publicly put into question. You certainly do not want to own dollars at that time. Ironically, our popular Federal Reserve chairman Alan Greenspan understands the inherent fraud of dollars unbacked by Gold or Silver as you can see by the very interesting article he wrote 40 years ago that I strongly advise reading:
   http://www.gold-eagle.com/greenspan041998.html
   
   Most likely there will come a time when most of us will be billionaires but a gallon of milk will cost $25,000! A new currency will have to be issued that is backed by real gold and Silver. Since currently all world currencies are not backed by hard assets the same will happened worldwide. The biggest losers will be holders of fixed-income credit securities (mostly bonds) and cash.
   
   The inflationary risks all by themselves warrant Silver (and/or gold) ownership at 10% of your net worth if only as "insurance".
   
   
9. Silver going to $50+/oz.: I believe Silver's intrinsic value is worth around $35/oz. right now. As a value investor I love buying undervalued good assets then selling them out around what I think they are worth without regret when they go much higher. However, in the case of Silver I expect to sell much of my holdings at prices well above the intrinsic value. Below are the reasons why Silver should catapult well past its intrinsic value for a period of time. All are based on the development of a Silver shortage:
   
   Silver industrial demand and mining supply is inelastic. That means the amount demanded and supplied is barely affected by changes in the price of Silver. I explained the inelasticity of mining supply at the end of part III. Silver industrial demand is almost completely inelastic. Silver is an essential and irreplaceable part of many electronic devices such as computers. The amount of Silver used to make each electronics device is miniscule. A $2000 new Dell computer has nowhere near 1 ounce of Silver in it so it does not matter to Dell whether it costs $1 or $20 worth of Silver to produce 1 computer. Dell would even pay $100 for the tiny amount of Silver it needs for each computer since without that Silver it is impossible to build that computer. The same is try for Silver application in photography. Also most of the cost of Silver jewelry is based on the labor it takes to make it into various shapes so a price of $50/oz. may only result in a doubling of the price of Silver jewelry, which is inexpensive anyway. So the overall fabrication demand for Silver should hardly drop at all even with a tenfold increase in the price of Silver. While the mining supply of Silver will not increase greatly since 70% of the Silver mined is a small byproduct from mining other metals (assuming the prices of those metals do not rise substantially).
   
   Most users of Silver operate under Just In Time inventory management. JIT was an innovation by Japanese firms 25 years ago and made a standard in corporate culture in the 1980s to reduce capital expenditure costs. Companies no longer keep large amounts of raw materials that are needed to manufacture their products. They have efficient arrangements with suppliers to make delivery "just in time" for production thus freeing up capital that used to be just sitting around in the form of raw materials that would not get used for many months. The Silver shortage will be a serious problem for them since some will fail to receive all the Silver they need from their usual suppliers. For many companies a lack of Silver would result in a halt of production. This situation will probably encourage most Silver using companies to aggressively buy up as much Silver as they can for fear of delays in production. Most companies will pay ANY PRICE needed to obtain physical Silver right away. Wouldn't you do the same in their shoes?
   
   When a shortage of Silver becomes widely publicized and the price races over $10/oz. an immense group of momentum traders/investors whose strategy is to "buy high & sell higher" will be looking to buy into it. Tens (maybe hundreds) of Billions dollars will be chasing after less than $5 Billion of Silver.
   
   Most investors naturally do not quickly sell an asset that is quickly appreciating in value thus adding to the shortage.
   
   Recognizing the shortage, enough money will want to buy physical Silver by looking to take delivery on Comex Silver futures contracts to cause the failure of shorts to make delivery of Silver on their obligations against these contracts since they do not have enough Silver. The result will be that Silver futures contracts will trade at a substantial discount to physical Silver because no one will know when deliveries will actually be made.
   
   When Silver goes over $20 there will be a lot of new (and old) primary Silver mines that will be started. However, it takes 1-3 years from the time a decision is made to start a Silver mine till the first ounce of Silver is sold into the market. Therefore this future supply will not help the immediate Silver shortage situation.
   
   As prices approach and surpass $50/oz. there will be a flood of small coin holders looking to cash in their coins. They will look to sell them to local dealers who will then sell them to smelters that convert them into Silver suitable for industrial uses and/or to make delivery on the Comex. However, there will be a bottleneck since the few smelting operations that exist can only smelt a limited amount of Silver per month. Therefore the large quantities of Silver coins will not impede the price rise in Silver immediately.
   
   All these reasons combined make it quite possible that Silver will go to well over $100/oz. at its peak. It is impossible to say how high Silver can go.
   
   Now is the perfect time to buy Silver. Not only does it offer explosive potential due to scarcity and protection from inflation, but it is now so cheap that the downside risk in price is negligible. It is better to own Silver a year early than 1 week late. Silver will still be good buy at $20, $30, $35 per ounce; but the risk/reward ratio will never be this low again. Ownership of Silver does not offer you interest/dividends while you hold it but will protect you from the coming U.S. dollar devaluation.