May 13, 2005
Silver bugs believe that, like gold, silver is
money. They also believe that the silver price is going to vastly
outperform the gold price because of silver’s supply shortage.
But silver is not money; it’s a commodity whose price is far
more dependent on industrial demand than on anything else. However,
because the silver market is so small, it is entirely possible for
silver investors to create their own self-fulfilling prophecy. You
need to be nimble, and remember to sell, to take advantage of such
an increase in the silver price.
Annual mine production of gold is about 80 million
ounces while annual mine production of silver is roughly 600 million
ounces, yet gold mining revenues are eight times more than revenues
from silver mining at current metal prices.
Why is gold expensive and silver less so? Because
gold is money and silver is primarily an industrial commodity. Even
though silver has, from time to time, been used as money, its chemical
and physical properties make it less desirable than gold as a monetary
asset. Among other things, silver oxidizes readily, and it is far
more abundant than gold.
Annual fabrication demand for silver is well in excess
of eight hundred million ounces a year, of which roughly forty percent
is used for industrial applications, just over twenty percent for
photography, thirty percent for jewelry, and the rest (less than
five percent) for coins and medals.
Because annual fabrication demand exceeds annual mine
supply, silver investors believe much higher prices are in store.
However, since industrial applications and photography account for
roughly two thirds of annual silver consumption, fabrication demand
plays a key role in the silver market. The silver price is thus
very dependent on changes in annual fabrication demand. As a result,
continued economic growth in North America and the rest of the world
should help the silver price remain strong and perhaps move up,
whereas an economic downturn could be quite detrimental to the silver
If we look at gold and silver in US dollars, then
the relative strength in the dollar since the early Nineties should
have had the same effect on both metals if they were priced as money,
and their charts should look the same. But they don’t.
Silver actually performed much better than gold during
the Nineties because demand for silver supported its price during
the high-tech boom in the latter part of the decade. When the tech
boom went bust, silver suffered, and its price barely budged from
2001 to 2003 while the gold price rallied strongly. Since 2003,
gold and silver prices have moved more or less in tandem, and that
is a result of the weakening US dollar. However, if we see a change
in the economic climate, the correlation between the two metals’
prices can easily break down again.
The amount of silver typically used in any given application
usually represents a very small component of the overall manufacturing
cost. Therefore the demand for silver from both industrial applications
and photography is very inelastic, meaning that if silver’s
price increases, demand does not decrease.
At the same time, because the silver market is such
a small market in dollar terms, a relatively small amount of investment
demand can cause the price to spike dramatically. And because fabrication
demand is inelastic, fabrication demand will not decline due to
the price increase.
So speculators buying silver in anticipation of a
move upwards can easily create a self-fulfilling prophecy, causing
the silver price to soar. But when they want to sell their metal
to take profits, the same lack of liquidity that drove the price
up will drive it right back down again.
This combination of a small illiquid market, inelastic
demand and feverishly bullish investors could cause the silver price
to outperform the gold price at some point. However, you must be
wary of an ensuing collapse and remember to sell. Silver’s
day in the sun might be very short-lived.
Still, there is no guarantee that the silver market
will enjoy the benefit of such a self-fulfilling prophecy. Judging
by the silver price since 1990 in relation to what we know was going
on in the world, it is entirely possible that silver will suffer
along with other base metals and commodities during an economic
As a side note, there will not be a commentary next
week. I will be in Reno for the Geological Society of Nevada symposium
and then in New York to speak at the Institutional Gold Conference
for details). Hope to see you there.
Paul van Eeden
Paul van Eeden works primarily to find investments for his
own portfolio and shares his investment ideas with subscribers to his weekly
investment publication. For more information please visit his website (www.paulvaneeden.com)
or contact his publisher at (800) 528-0559 or (602) 252-4477.
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