10. Silver is a monetary metal, like gold, that is a hedge against a falling dollar.
Throughout history, silver coins have been used as money. Our Constitution states that only gold and silver can be money. The original US Dollar was officially defined as having a weight of 371 grains (roughly one ounce) of pure silver. While it no longer has the official designation of currency, silver still behaves as money in that people view it as a store of wealth and it can be readily traded for currencies and other goods.
Silver, like other currencies around the world, can gain or lose value against the US dollar. However, unlike other currencies, silver cannot just be conjured up out of thin air by a creative bank. Instead, a great deal of effort goes into creating new silver supplies. Lately, countries around the world are in a race to debase their currencies in the hopes of making their exports more competitive. As governments flood the world with new currency, stable money, such as silver, cannot help but go up in value.
The chart below shows the percent change in the value of silver vs. several world currencies for the last decade. The chart doesn’t include 2010 but so far this year, silver has gone up 70% vs. the US dollar.
9. Silver is undervalued relative to gold.
Gold and silver are highly correlated as investments vs. the dollar, but they can fluctuate in their relative value to each other. Gold is currently more useful as a store of wealth for nations, central banks and extremely wealthy investors because its higher price makes it easier to store. But here are some interesting tidbits about silver and gold you may not have heard.
The long-term historical price ratio of gold to silver is 16:1. That is, it would take 16 ounces of silver to buy one ounce of gold. Today, that ratio is 47:1 and has been steadily dropping for the last couple of years. If gold were to maintain its current price, the price of silver would need to triple to get to its historical 16:1 ratio.
Even better, the actual amount of silver in the earth’s crust is estimated to be only 7 to 16 times the amount of gold. According to calculations by industry insiders, the total amount of silver ever mined is around 46 bln oz. and total gold mined is 5 bln oz. This falls right in line with the ratio of gold to silver in the earth.
Even better than that, the amount of above ground silver available for investment today is actually less than the amount of gold! What? How can that be? Everyone knows that gold is more rare than silver. True, but while gold is hoarded in bullion, coins or jewelry, most of the silver has been used up by production or is in the form of jewelry, silverware or other goods. In bullion form there is about 2 bln oz of gold and only 1 bln oz of silver.
8. The supply and demand fundamentals of silver are favorable.
The price of all commodities, whether precious metals or corn or cotton, is ultimately driven by supply and demand. Silver has some interesting supply and demand characteristics to consider.
The supply of silver comes from three main areas:
1. New production from mines
New silver production from mines has increased slowly but steadily for the past decade from 591 million oz. in 2000 up to 710 million oz in 2009. However, the production of new silver from mines is highly inelastic for a number of reasons. That is, if the price of silver jumped up, there wouldn’t be an immediate boost in supply to meet the rising prices and bring them back down to earth.
For one, 70% of the silver mined today is simply a byproduct of the mining of some other metal, namely gold, copper, zinc and lead. With the exception of gold, the mine production of those other metals is driven primarily by industrial use requirements.If silver prices were to shoot up independently, copper miners wouldn’t start processing a bunch of more rock since silver is only a small percentage of their operation.
Even for the 30% of mines that are primary silver mines, the production can’t be ramped up at the flip of a switch. The production costs for silver has been higher that the price of silver for several years. Since silver has cost more to produce than to sell, many mines and production facilities closed their doors and stopped investment in new mine exploration. To ramp back up takes time and it takes financing and these days lenders are still skittish about lending to finance long-term projects.
A final factor in supply inelasticity is that as commodity prices rise due to inflation, the production costs for producing silver also rise. Mining is very energy and water intensive and as energy prices rise and water becomes a more scarce resource, the costs of production increase.
2. Recycling of scrap silver from jewelry, silverware, and other products
The recycling of goods such as jewelry and silverware also adds to the silver bullion supply. This is a bit of a wash though, because it is balanced by the new jewelry and silverware that is produced. In general, as the population grows, or as more poor people in emerging economies become richer, the demand for silver jewelry and goods will outpace the increase in supply from recycling these same items.
Another important factor on the supply side of the equation is that once the silver is used for industrial applications such as a camera or spray coating or film processing, it’s gone forever. It’s uneconomical to dig up and recycle the trace amounts of silver in a circuit board in a landfill at any price. These industrial applications account for over half of all silver mined each year.
3. Official Sector Sales
For the past 20 years, the demand for silver has outpaced the supply from mining operations. Since 2000, new mine production has only met 72% of total demand. To offset this imbalance, governments and other financial institutions have been selling off their stockpiles of silver. This had two effects; it kept the price of silver low and it depleted above ground reserves. Since 2006 the selling by governments has decreased by 80% from 78 million oz. in 2006 to 13.7 million oz. in 2009. There’s a reason for this; they’re basically tapped out. So if the supply shortfall can no longer meet demand there’s only one other variable that can balance the equation- price.
Demand for silver comes from three main areas:
Consumer demand which consists of jewelry and other silver products. I discussed above how consumer demand for silver products generally grows as the population of people who can afford these products grows. Consumer demand is currently about 25% of the market.
Industrial demand consists of the consumer products that contain silver. Industrial demand grows as world economies grow and new applications for silver are discovered. This is further discussed below in #7.
Investment demand consists of coins, bullion, and silver based paper assets. For many years investment demand has been a small fraction of total silver demand… but this is changing rapidly. Investment demand is discussed further in #6-3.
7. Silver is an industrial metal with unique properties and growing uses.
Silver is the most electrically conductive element and the best thermal conductor of all the metals. It is also one of the best reflectors of light in the visible spectrum. It is used in batteries, film photography (although this is phasing out due to digital cameras), air and water purification, musical instruments, specialty mirrors, reflective spray coatings, and the circuitry in every electronic device in your house. It has anti-microbial properties that make it useful in medical applications and disinfectants. It’s antibacterial properties can be used to fight oder in clothing. My freaking deodorant has silver in it. It can be used as a catalyst for many chemical reactions and the list goes on. Not to mention its use in jewelry and silverware.
For industrial applications, the demand side of the equation the price for silver is highly inelastic. In other words, a rising silver price doesn’t have much of an effect on the demand for silver in this sector. That is because in many applications, only a small amount of silver is used in the final product. If the price of silver went up to $100/oz manufacturers would continue to use silver in their circuit boards since alternatives have inferior performance and only a small amount of silver is needed relative to the overall cost of the final good, whether it’s a TV or a computer or my deodorant.
6. The silver market for investment is tiny.
The most important thing to realize is that the total world market for physical silver is tiny. Not just tiny, it’s minuscule. With a silver bullion inventory of 1.1 billion oz. at a price of $29 that means the entire worldwide silver inventory is $32 bln. That may sound like a lot to you and me, but it’s a drop in the bucket compared to the $82 trillion worldwide bond market, which for those of you too lazy to do the math is 2563 times bigger than the silver market. Of that 1.1 billion ounce, about half of it is accounted for by ETFs and other large holders which leaves about 600 million ounces for sale. If everyone in America bought 2 coins (about $60) that’s it; no more silver reserves. And that doesn’t even leave anything for Europe, China, Russia, India, Brazil, etc.
According to the Silver Institute and GFMS, in 2009, roughly 890 million oz. were added to the silver supply from mining, government sales, and melting down scrap silver. Of that, 730 million oz. were used up by fabrication and 22 million oz were for producer de-hedging, leaving only 137 million new oz for investment. In November alone the US Mint sold 4.2 million oz of silver coins and the silver ETF SLV bought 18 million ounces. Annualized that’s 266 million oz or twice the yearly production allotted for investment. And that’s only from those two sources!!!
5. The Chinese have joined the silver party.
Another important factor in the investment demand story for silver is that Chinese investors have joined the party. In the past, it was very difficult for Chinese citizens to buy gold and silver. About four years ago the Chinese government relaxed the rules regulating the sale of gold and silver, and about a year ago, the government began actively encouraging Chinese citizens to buy gold and silver. While Chinese citizens are not rich by American standards, they do have a high level of personal savings. And, oh yeah, there are a billion of them. China has traditionally been a net exporter of silver, but through October of 2010 they have been a net importer of 3000 metric tons.
And in case you were wondering, India’s silver imports for 2010 will increase by 20% to 1200 tons for the year.
4. Silver is a sleeping giant that’s just waking up.
The silver has risen considerably for the last eight years so it may seem high. Until you look at the big picture. The chart below shows the price of silver since 1970 adjusted for inflation (using the governments rigged CPI numbers I assume).
Whoa, that’s a crazy chart. What the heck happened? It the late 1970s, inflation was rising and many investors turned to silver to protect their wealth. The Hunt brothers tried to corner the silver market by buying physical silver and leveraging up to buy silver futures contracts on the COMEX. With a shortage of physical silver in the market, the price skyrocket to $50/oz. Then it all came crashing down when the COMEX changed it’s rules to shake out the Hunts’ leveraged positions and the Fed raised interest rates upwards of 20% to squash inflation. With inflation under control, beginning in 1980 through the dotcom crash of 2000, the stock market went on a tear and silver just kind of bumped along the bottom around $4/oz for three decades. People simply forgot about silver as an investment. Why on earth would someone invest in a dumb metal when you could get huge returns in the stock market?
When the Dotcom bubble burst, stocks were no longer seen as a sure thing, and investors began to look for alternative investments. As the Federal Reserve lowered interest rates to stave off a recession, savvy investors (I wish I had been one of them) began to move into precious metals as protection against inflation and because the supply/demand fundamentals had improved considerably due to the prolonged low prices. As the chart on the right shows, the silver price was hit hard by the financial crisis of 2008 as investors feared that a worldwide recession would reduce industrial demand for silver and deflationary pressures would hurt commodities. But as the chart demonstrates, the price of silver has since recovered and is going up at an increasing rate.
The conditions that caused silver to spike in 1980 are back today, only much greater. In the 1980s, silver reserves were higher and far fewer people had access to the market. And still, two rich brothers from Texas along with some wealthy Arabs were able to jack the silver price up to $50. In inflation adjusted terms, that equates to $136 today (or $447 if you use the “real” CPI numbers from Shadowstats.com). If a few rich investors jumped in to physical silver, they could by out the physical silver available for delivery without using leverage.
Consider that in 1980, the only buyers in the silver markets were wealthy Americans and Europeans who had access to the silver markets. Today, anyone can buy silver coins online, or trade ETFs or other silver related investments, and the markets have opened up to the whole world. Also consider that back then, countries around the world didn’t have massive sovereign debt problems and weren’t in a race to debase their currency. The spike in silver in 1980 happened independent of any currency crisis. At the rate we continue to print money today, it’s easy to see how silver could exceed its inflation adjusted high of $136 ($447).
3. The paper market for silver has suppressed the price.
Should the price of silver be much higher already? Many people who follow the gold and silver markets carefully think so. One of the problems with trying to get true price discovery for silver is that the spot price is determined not by physical silver trading, but by paper contracts and futures agreements in the silver market. These paper contracts are basically bets with two participants, one going short (or betting that the price will go down) and the other going long (or betting that the price will go up).
This is common for commodities, and has a legitimate purpose when producers sell future production to hedge against the price going down. But in the silver market today, the majority of the participants in the paper silver market are financial institutions. In most cases, when the contract expires, the participants settle up for cash or reinstitute new contracts. But the long positions also have the option to take physical delivery of the commodity. This is impractical for commodities such as oil or corn (who wants a bunch of barrels of oil sitting in their back yard?), but very doable in the case of precious metals.
According to the Commodity Futures Trading Commission, as of November 30th, 2010 there were 871 million ounces worth of open silver contracts. If the silver longs decided to take physical delivery, the shorts would need to give them physical silver which may require that they purchase physical silver on the open market to acquire it. As Eric Sprott points out, there is not enough physical silver available that is unaccounted for. In fact, if demand for physical silver keeps increasing, there may soon not even be enough production to handle spot silver demand, much less the futures market.
As the price of silver continues to rise, holders of leveraged short positions will be forced to cover their positions and could cause a massive “short squeeze” in the silver market causing prices to spike due to forced demand.
Many in the gold and silver industry believe that their has been an ongoing silver suppression scheme by JP Morgan and other large banks tied to the Fed. The theory is that JP Morgan and others would buy up large short positions to shake out leveraged long investors causing the price of silver to drop. Then they could slowly unwind their positions at lower prices for a profit. Once dismissed as pure conspiracy theory, this theory gained traction earlier this year when whistleblower Andrew MacGuire contacted the Commodities Futures Trading Commission to warn them exactly when, how and by how much JP Morgan would next manipulate the market. When the CFTC responded with a shrug, he went public with his story on King World News. Two days later, he and his wife were struck by a car in a hit and run “accident”. In October, Bart Chilton of the CFTC proclaimed that he believed that violations of the Commodities Exchange Act had taken place, and subsequently, several lawsuits have been filed against JP Morgan and HSBC. Stay tuned.
2. Physical silver is outside the matrix.
Physical silver is a tangible asset with intrinsic value that offers financial privacy without counterparty risk.
Physical silver and gold are some of the only investments you can make that aren’t simultaneously someone else’s liability. If you own a share of stock, that share is on the balance sheet of that company as a liability. If you own a bond that says company A owes you 10% upon maturity, if company A can’t pay, you’re SOL. As buyers of mortgage derivatives contracts and credit default swaps found out, your investment is only as good as the counterparty’s ability to pay. Even with silver futures contracts, if the party on the other end defaults, you’re SOL. Some experts believe that the paper silver market is leveraged up 45:1. Just as a bank only holds a fraction of the money it lends out in reserves, it is believed that banks may have lent out more silver than they hold on reserves, thus making them susceptible to a run on physical silver.
The stock market may provide good returns, but it’s rigged against the little guy. With high-speed trading, insider information, and the sweetheart deals going to the large investors, it’s an uphill battle for independent investors.
1. And the number one reason to own silver… Because we are in the early stages of the greatest transfer of wealth in the history of the world and those owning silver and gold and tangible goods will become exceptionally rich while those holding paper dollars or debt or derivatives will be wiped out.
Real wealth is not destroyed during a crash, it just changes hands. Phony “paper” wealth may be destroyed, such as when people saw their unrealized internet stock gains vanish into the ether in 2000, but those “gains” were never real to begin with. During the great depression, many people became extremely rich because they were on the right side of the trade. Those who pulled their money out before the crash or shorted the market, were able to buy up solid companies and property for pennies on the dollar.
This is especially true when a currency collapses. Throughout history, paper currencies have come and gone. They usually start out stable, but when a government realizes they can print up extra money to pay their bills the currency loses value, slowly at first, and then ramping up into an explosive climactic finish. If you don’t think this can happen in the United States, be advised that it already has. Twice. In fact, the one thing that all paper currencies have in common is that they eventually return to their intrinsic value of zero.
All currency collapses throughout history have something in common as well. When the currency collapsed, anyone holding gold and silver became very rich, while anyone holding assets based on the paper currency lost everything. The example of the hyperinflation in Germany after WWI provides us with a clear example. As the currency devaluation accelerated, people would pay any price to buy up any asset that would retain its value, particularly gold and silver. At the height of the hyperinflation, an entire city block in Berlin could be purchased for 25 ounces of gold ($35,000 at today’s prices).
As I pointed out in a paper I wrote in April 2010, there are a number of compelling reasons to suggest why our government will continue to print more paper dollars. In a follow-up paper I warned that this money printing was accelerating and that it could possibly end in a hyperinflationary scenario. If you haven’t read these papers yet please take the time to read them and I’m sure you will be convinced that it is imperative to own gold and silver.
A note about silver and silver ETFs
The first step to take for any silver investor is to buy some physical silver coins. I personally believe every American should own some and store them safely away in an accessible hiding place. Larger investments in silver require other means since storing a large amount of coins is impractical. Some other options include silver bars, bullion storage in an allocated storage facility, goldmoney.com (basically a bank that stores your money in metals), Gold and Silver mining companies, and metals Exchange Traded Funds (ETFs)
As I’ve discussed before, I’m not a big fan of silver and gold ETFs such as SLV and GLD. The whole point of owning silver is to get out of the “matrix” and have a tangible asset in your hand. There are some questions about SLV, which is managed by JP Morgan, one of the largest holders of silver short contracts. The SLV does own a lot of physical silver, but the question is, “Who is it promised to?”
However, there is a new silver ETF created by Eric Sprott with the ticker symbol PSLV (short for physical silver) that I like. Eric Sprott is a well-respected leader in the gold community who values owning the physical asset. PSLV (and its gold cousin PHYS) is a closed-end fund that owns physical silver that sits in its own vault, is audited, and is completely unencumbered of any lending or paper trading activities. Being a closed-end fund the price of PSLV can trade at a premium (or a discount) to the value of the actual assets in the vault, which many see as a negative. However, although you may be buying shares at a premium today, you also may be selling shares at a premium in the future so while timing is important, it’s a bit of a wash. PSLV has the advantage of being as liquid as a stock while still holding physical silver. But there is another major advantage to PSLV. Unlike other silver ETFs which are taxed at the “collectibles” rate of 28%, PSLV is taxed at the long-term capital gains rate of 15% if you hold it for longer than a year. Check it out here.
(Yeah, you heard that right. Silver, which is money according to the Constitution, is taxed at a “collectible” rate of 28%. So in other words, the government makes its currency decline in value and if you hold anything that maintains its value, you are taxed on the amount the dollar has dropped. Sweet, huh?)
Here are some silver dealers and resources to check out:
Disclaimer: Please note that I am not a financial adviser, and I’m not here to tell you what to do with your money. I’m just providing some research and giving my opinion on what I believe are good investments for myself. Any actions you take regarding your investments and financial future are entirely your responsibility.