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Silver Special Report


By John Lee             Printer Friendly Version

November 22, 2005

Silver Price from 1964-2005


Part 1. Investing in Silver


Silver has been the metal filled with mystique and fascination. It is irreplaceable in many industrial applications, and has long been stored as money for thousands of years.

Opportunists have kept silver on their investment radar screen.

In 1979 the sons of patriarch H.L. Hunt, Nelson Bunker and William Herbert, together with some wealthy Arabs, formed a silver pool. In a short period of time they had amassed more than 200 million ounces of silver, equivalent to half the world's deliverable supply.

Once the silver market was cornered, outsiders joined the chase, but a combination of changed trading rules on the New York Metals Market (COMEX), and the intervention of the Federal Reserve put an end to the game. The price began to slide, culminating in a 50% one-day decline on March 27, 1980 as the price plummeted from $21.62 to $10.80.

More recently in 1997, Warren Buffet purchased 130 million oz of silver secretly at below $5/oz. When he made such investment known , silver price immediately spiked up to $7/oz. from $4/oz. Granted, silver eventually came back down, as with all metal prices in the late 90s. Unquestionably though, a special place has been cemented in the hearts of speculators, and for good reasons.

Silver Fundamentals:

Fundamentally major sources of silver demand are as follows,

  1. Industrial: From Plasma TV and laptops, refrigerators to batteries.
  2. Photography and coating.
  3. Medical: disinfectant.
  4. Monetary: Named poor man’s gold, silver has been money for over a thousand years in many nations such as the UK, China, and Mexico. The British "pound sterling" originally signified a pound weight of silver.

Silver, money, and inflation

The curious might ask, why did various governments around the world abandon the silver-as -money standard in favor of a fiat money system* in the last 100 years?

Since president Nixon closed the gold window in 1972, currencies could no longer be exchanged for gold and silver at central banks around the world. The reasoning involved the idea that a new fiat money system whereby government controlled the money supply would offer more flexibility to modulate the economies through peaks and troughs. In other words, government would increase the money supply at times of recession and decrease the money supply at times when the economy was overheating. The timing of the removal of the gold window was not arbitrary as the United States was quickly depleting its gold reserve to the French and rest of European nations due to a burgeoning U.S. trade deficit.

The government perhaps initiated this system with good intentions, but a quick glance at the following chart shows such a fiat system could produce irreversible and potentially damaging rampant inflation.

The money supply (measured by M3) since1970 has increased 13 times from 800 billion to $10 trillion, while at the same time GDP had increased 6 times (assuming a 5% compounded annual growth over 35 years). Such is a system that guarantees inflation.

*Fiat money system – A paper money system that’s not backed by tangibles such as gold and silver.

Silver price from the past:

Adjusting for inflation with 1998 dollars, silver presents quite a compelling investment. Today, the ratio of oil over gold sits at near all time high, indicating gold is an overlooked investment. While considering gold, you could expect to hear silver bulls scream at you on the ratio of gold over silver, which today sits un-naturally high at 60+. Gold over silver ratio has been less than 20 for many centuries, the ratio of 60 shows silver today is under-priced relative to gold and vastly undervalued compared to oil.

Many silver speculators are puzzled by such comparisons. In order to analyze such anomalies, it’s important to fill in some more facts about the silver market.

Silver market size and supply/demand


Silver is a small market with $7 billion in global annual sales (900 million oz x $7.5/oz). This compares to the $37 billion annual gold sales (80 million oz x $460/oz), which in itself is considered small compared to the over-$1.9 trillion daily Forex transaction.

To put silver numbers in proper perspective – The U.S. hedge fund industry is now valued at over $1 trillion. Warren Buffet’s fund is valued at $130 billion. Google is valued at 100 billion.

World known above-ground stock is generously estimated at 200-500 million oz, or $1.5 billion to $4 billion. Small markets tend to be more volatile and prone to short term manipulation.

Supply and Demand of physical silver.

Please review the following annual supply and demand data from the silver institute.

One can see fabrication demand and mine production have dominated the silver picture. Those numbers have been fairly steady despite a volatile silver price. This shows both total fabrication demand and mine supply are price-inelastic. In other words, the silver quantity demanded and supplied are not affected much by price. Therefore silver price is likely sensitive to small changes such as reduction in government silver sales or increase in net investment demand.

Fabrication demand for the past decade has consistently exceeded mine production supply by 200 million oz per year.

Source: Silver Institute

Why is today’s silver price seemingly so low?

While no one knows for sure why silver prices are not rising with such a chronic deficit, we enlist the following as possible contributing factors:

1. Government sales

Global central banks perhaps have been more aggressive in dishorading silver than gold, which has
certainly been the case with the U.S. Treasury.
No longer deeming silver as money or a strategic metal, the United States Treasury dishoarded 3-4
billion oz. of silver in the last 3 decades. By 2003, it completely ran out of silver inventory.
Coincidently this is when silver began its ascent from $4.4/oz. to its present value of $7.7, (a 30%+
annualized increase).

2. Extraordinary short sales by COMEX commercials.

There are two distinctive markets that determine the global silver price. The physical trade that takes place globally and paper trade on the COMEX, the US commodity exchange.

Contrary to common sense and different from equity trading, traders on COMEX need not have evidence of physical silver (by means of warehouse receipts) to short* silver in the market. What this means is a COMEX trader can theoretically sell unlimited number of silver contracts to suppress the price.

The number of Comex silver short contracts has steadily grown 10% yearly to now nearly 130,000 contracts, or 600 million oz of silver. Of the total short silver position, 300 million oz of that is concentrated in 8 commercial banks.

*Short-Selling a COMEX contract would require the seller eventually deliver the physical silver or settle in cash before contract settlement date. The buyer of a COMEX silver contract can demand physical silver delivery or settle the trade in cash. Most investment funds choose not to take physical delivery due to regulatory tax penalty and storage concerns.

A 500 million oz. short position by commercial traders almost matches annual silver mine production of 580 million oz, and exceeds world known above ground inventory by as much as 50%. In equity analysis, this will be the equivalent of shorting 800 million shares of Amazon Inc. stock when Amazon Inc. has only 400 million shares floating. Through the internet era of the late 90’s we were able to see how short-covering could squeeze technology issues to irrational heights.

Judging by the size and the concentration of commercial short position, one can plausibly conclude there is a concerted effort to keep the silver price down. Possible reasons to suppress gold and silver prices are well documented at the non-profit and the prominent Canadian hedge fund And because the short position is so stunningly large, some silver analysts came out cautioning a default on silver COMEX should the short squeeze takes place.

Percent of Open Interest Held by the Indicated Number of the Largest Traders
: By Gross Position
: 4 or Less Traders 8 or Less Traders
: Long: Short Long Short:
All : 19.8 36.2 31.2 53.2

Gold vs Silver

Many gold investors also invest in silver, hence there has been much heated debate on the merits of silver vs gold as an investment.

Pro-gold camp pointed to 3 silver investment short-comings.

a. How much more silver is produced over gold

(500 million oz. vs 80 million oz). We refute such logic by pointing out that palladium, with no more than 8-million-oz. of annual production, should then be trading at a much higher price than gold (Palladium last traded at $250/oz.).

b. Silver is bulky.

The insured storage fee amounts to no more than 2% of the nominal silver value per year. In 1998, no mutual fund investors complained about the 5% front sales load in return for the double-digit gains. The 2% storage fractional cost should be weighted against the potential overall return.

c. Silver is an industrial metal, not a precious metal investment

We do not emphasize the industrial metal vs precious metal issue. In our opinion anything that goes up in price should be considered a good investment and silver has gone up 70% since the 2003 low of $4.4/oz.

Silver investors countered those arguments with pro-silver reasons.

a. Central Bank selling

While mine production supply couldn’t satisfy physical demand for either gold or silver, it’s worth noting that central banks have been more aggressive in dishoarding silver, thus silver supply from central banks is likely to be a lesser factor going forward

b. Commercial position

Total gold shorts on COMEX amounts to 20 million oz. vs 500million oz. for silver. The gold short position is very small compared to the silver short position, relative to nominal value, annual production, and above ground inventory. Every short contract must be covered.

c. Consumed vs. Stored

Above ground gold inventory is rated at around 150,000 tonnes, or $2 trillion. Above ground inventory for silver is rated at 200 – 500 million oz, or $1.4 billion – $4 billion. Silver has a better chance to repeat the palladium supply scare scenario of year 2000 (when it raced from $350/oz. to over $1,000/oz. in 12 months). Current silver known above-ground inventory couldn’t fill the gap

d. Speculative appeal

In today’s world where paper money far out-supplied any metal at current prices, fundamental supply and demand of the metal itself is less relevant to the direction of speculative money flow. Just like silver, which can be suppressed because of the small size of the silver market, prominent sizeable speculative capital can drive silver prices to unforeseen heights.

Since the gold to silver ratio peaked in 2003, silver has steadily outperformed gold, and therefore should be over-weighed for those who can withstand volatility.

Investing in Silver: Part I - Conclusion

Concurrent with the US dollar top in 2002, the mutli-decade bear market for silver appeared to be over in 2003 when it reached the inflation-adjusted historic low of US $4/oz. Again we point to the following factors for a higher silver price.

- Global central bank silver sales coming to an end
- Depleting global physical inventory
- Speculative investment demand with an appealing story and small market
- Rising industrial demand
- Silver miners unable to increase supply
- Potentially explosive commercial silver short covering.

We favor silver as an investment in the commodity complex to supplement a well-diversified portfolio. Assuming gold and silver returns to the historic average of 20 to 1, this would equate to a silver price of $22/oz with today’s gold price at 450/oz. Silver today trades at $7.5.


Click on the link to read part II of the report


John Lee