The Silver Rocketship
A friend of The Real Asset Company has termed the silver investment opportunity “the silver rocketship“. We shine some light upon the fundamentals and in the process hope to understand this metaphor.
Investors may have heard plenty of commentary in the last year or so about silver. You may have also witnessed the silver price outperforming gold, but may be unsure what the silver analysts mean when they cite the “fundamentals” that are in place for moves to apparently new higher price discovery.
As a commodity one needs to understand the demand and supply equation that eventually set the price of silver. It is this demand/supply equation that analysts find conducive to higher prices, and that has lead a friend of The Real Asset Company to term this silver investment opportunity “the silver rocketship“.
We shine some light upon the fundamentals and in the process hope to do justice to this potentially apt metaphor.
For most of the last century, and since the abandonment of the bi-metallic and gold monetary standards, the gold/silver ratio has fluctuated significantly. This ratio has oscillated from lows of close to 15 to 1, to highs of 100 to 1 in the 1990s, and notably after the Credit Crunch of 2008 the ratio hit 80 to 1.
The gold/silver ratio has fallen close to 50 to 1 at the time of writing, and in our opinion is set to continue its downward trend if our assessment of the fundamentals is correct. To delve deeper into what these fundamentals are, let’s look first at demand for silver which can be fairly cleanly split into two parts:
To represent investment demand we will look at demand for physical silver and capital flows being serviced by coin and bullion dealers.
For reasons we cannot fully articulate here for lack of space, we do not believe an analysis of silver ETF holdings will provide a representative picture of true demand levels. In brief this is because ETF shares can be redeemed for physical bullion which then leaves the ETF.
The ETF holdings would thus show a decline but the investor’s demand and holding have not disappeared, he has merely changed how he chooses to hold his silver position. This does not even look into the suggestions that some ETFs do not represent good proxies for bullion investment.
We believe the buyers of coins and bars are good representations of demand and such fully funded investors represent some of the “strong hands” in a market for this precious commodity.
In their March 2001 research piece, “Follow The Money“, Sprott Asset Management found:
The US Mint, which is the world’s largest silver and gold coin manufacturer, recently reported that it had sold 13 million ounces of silver coins and 370 thousand ounces of gold coins on a year-to-date basis.
This means that the US Mint is now selling roughly equal amounts of silver and gold in dollars so far this year. Furthermore, bullion dealers like Sprott Money and GoldMoney have confirmed with us that they are now selling more silver than gold in dollar terms.
Eric Sprott and James Turk opined that this dynamic was still at play when they attended the GATA conference in September this August.
This trend is being evidenced elsewhere too; at The Real Asset Company we find client demand for silver challenging that of gold; whilst the sales of silver by other platforms and dealers such as goldsilver.com, Morgan Gold, and GoldCorp are extremely impressive, and seem not only to be growing at a faster rate than their gold sales, but can be greater in currency value terms than their sales of gold.
Google trends, meanwhile, show searches for silver related investments growing faster than those for gold.
Dollar for dollar, investors are allocating as much if not more money to silver than to gold. And why shouldn’t they? Silver is much more of a “precious” metal than the current ratio of 35-to-one (NB – written in March. Ratio is now 50 to 1) would suggest. – Eric Sprott
It seems that investment demand is strong and growing across the Western world and its established mints and bullion dealers, but what about Asia? Asian investors account for over 50% of gold investment demand according to The World Gold Council, so how is this participation affecting the silver market?
Data from Asia is less publicly available, but the Chinese government and other authorities are publicly encouraging their citizenry to invest in gold and silver.
Would you not encourage your citizens to diversify into hard assets, and monetary ones at that, if you held trillions of dollars of paper IOUs in your national currency reserves?
A telling fact is that according to Bloomberg, China used to export close to 100 million ounces of silver a year, but five years later now imports a little over 120 million ounces.
The Silver Institute reported in 2009 that the world silver market constitutes 889 million ounces a year, so China’s 200+ million ounce swing coupled with other growing Asian demand seems rather significant.
The other significant source of demand from Asia, India, is also consuming silver at an impressive rate and ZeroHedge shone light on UBS’s findings of “supply issues” in early October as India moves into a season of religious festivals and increased demand for bullion.
Although data from national mints and public brokerages in Asia is less publicly available, analysts on the ground in Asia report ravenous and growing demand. These reports, although sometimes more anecdotal, build an apparently compelling picture of demand growth.
Silver is about the most industrially useful metal known to man, and industrial demand, for our purposes “industrial” includes photographic and silverware demand, for physical silver has been growing for some years. Last year industrial demand accounted for over 60% of primary silver supply according to GFMS:
To better understand silver’s incredible industrial utility we refer to Wikipedia:
Silver is a very ductile, malleable… monovalent coinage metal… It has the highest electrical conductivity of all metals, even higher than copper, but its greater cost has prevented it from being widely used in place of copper for electrical purposes… An exception to this is in radio-frequency engineering, particularly at VHF and higher frequencies, where silver plating to improve electrical conductivity of parts, including wires, is widely employed.
Another notable exception is in high-end audio cables, where manufacturers claim that scaling copper conductors by 6% achieves slightly better results. Among metals, pure silver has the highest thermal conductivity… and extremely high optical reflectivity. Silver also has the lowest contact resistance of any metal.
Silver is essential to a number of medical, water filtration, anti-microbial applications, and has a range of growing industrial uses such as solar energy. One should especially note that within all these applications the amount of silver used is tiny and once the silver is consumed it is typically never recycled.
Many of its industrial applications require such small amounts that it is not economic to recover it from landfill. An example would be the production of fridges where silver can be used as an anti-microbial surface lining on shelves.
Such small amounts are used that the likes of fridge makers like Samsung are not concerned with a potential quadrupling of the silver price because their cost of silver per fridge produced will still be pennies. Critically a dramatic rise in the silver price does not threaten the manufacturer’s margin.
This fridge example can be extended across a great deal of silver’s uses, from medical dressings to water filters and photo-voltaic cells. Silver’s industrial demand, often cited as being dependent of consumption and economic growth, is in fact largely price inelastic.
Once this silver is consumed by industrial applications in tiny amounts it is almost never able to return to the market due to any recycling effort being unviable. Thus significant supply is leaving the market each year never to return.
With some analysis of the two components of silver demand we must turn to supply and its main constituents: above ground investible inventory, and mine supply and scrap.
One might believe that there should be more ounces of silver bullion than gold available to investors, but remember the level of industrial demand for silver that is often permanently removing this silver from the market.
To put this in context let’s lean on the oft cited Eric Sprott once more:
There are currently approximately two billion ounces of silver above ground in bullion form compared with the 5 billion ounces of gold mined throughout history.
So despite being more heavily mined over time, silver bullion is now the more scarce “precious” metal than gold bullion is from an investment supply perspective.
Two billion ounces might strike one as huge amount and inventory of silver, but at today’s spot price of $33/ounce it would take only $66 billion to buy up to potentially buy up all of the world’s silver bullion, should it all be available to the market.
This is not a significant sum of money in relative capital market terms.
Mine Supply and Scrap
Let’s look to annual mine supply to see how this inventory might be supplemented and replenished. According to statistics from The Silver Institute and The World Gold Council approximately 736 million ounces of silver and 85 million ounces of gold were mined globally in 2010.
The aforementioned industry bodies find that to supplement this mine supply another 215 million ounces of silver and 53 million ounces of gold entered the market from recycled scrap. These two sources thus contribute 951 million ounces of silver and 139 million ounces of gold supply.
How could a rise in the silver price affect these forms of supply? Whilst scrap supply to the market could increase as prices rise to acceptable levels of current holders of silverware and items, the supply of scrap is not currently that significant to the silver market.
The nature of the larger form of supply, from silver mining, is worth assessing. Analyst Jeff Neilsen urges that an abnormal situation has occurred due to silver’s relatively low price, but that in future more pure silver mines could become economically viable.
Until that time, according to Jeff:
The majority of silver currently mined each year is produced as a “by-product” of other mines,roughly 2/3 of all silver production.
In other words, contrary to the vast majority of other metals, silver is unique in relying upon this “incidental” production to satisfy the massive and growing demand for silver both as an “industrial metal“, and as an investment/insurance “good money“.
What these mining statistics really mean for silver is that its current mine supply is relatively unresponsive to potential rises in the silver price.
Until the silver price rises to an extent necessary for international miners to allocate capital to the pursuit of primary silver mines the mine supply of silver is unlikely increase in lock-step with rising silver prices.
The fundamentals for silver are starting to look encouraging for potential price rises:
– Industrial demand is rising with scientific discovery increasing silver’s already incredible utility due to almost irreplicable properties;
– This industrial demand displays a significant price inelasticity due to the typically tiny quantities of silver being used in its industrial applications;
– All the while investment demand is growing as investors remember silver’s monetary role and witness the purchasing power of “fiat” money and savings being eroded;
– This investment demand, although similar in currency value terms to gold, is seeking to access a relatively smaller inventory of investible physical bullion;
– This investment demand is global in its nature, but like gold demand is being driven by the faster growing creditor nations of the world, led by China, India, and other Asian economies who have a deep affiliation for precious metals;
– Mine supply is unable to react responsively to a rising silver price and deliver greater supply because over two thirds of silver production is a secondary product of other extraction;
– And, although 15 times more silver exists in the earth’s crust than gold, due to consistent industrial use and in contrast to the relatively useless gold, there are only a few billion ounces of investible silver available.
So why hasn’t this silver rocketship taken off? Am I too late to consider silver, you might ask?
Sometimes market prices can take time to reflect the true fundamentals. As one time silver investor, Warren Buffett, advises, “In the short run, the market is a voting machine but in the long run it is a weighing machine“.
Even if the fundamentals have more work to do on the silver price, significant gains have been achieved in the last year or so since the most far sighted silver analysts started really talking silver’s book.
The likes of Ben Davies of Hinde Capital and Robin Griffiths of JP Morgan Casanove touted silver in the summer and autumn of 2010. Since then we have moved from below $20/ounce to $35/ounce representing a 75% appreciation.
On route silver has touched $50/ounce and displayed its usual volatility; silver can indeed be a tricky madam and investors should be aware of this.
The great Austrian economist, Friederich Von Hayek advised that it was silver and not gold with the greatest role and history as a monetary metal, and we posit that investors are now buying silver, alongside gold, as protection from the ravages of fiat currency debasement.
If global investors continue to allocate their capital with a modern appreciation of the bimetallism of previous eras of sound money then silver looks to potentially reward investors more richly.
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Please Note: Information published here is provided to aid your thinking and investment decisions, not lead them. You should independently decide the best place for your money, and any investment decision you make is done so at your own risk. Data included here within may already be out of date.