August 20, 2004
I’ve had so many questions about silver that I figured
I ought to get around to saying something about it.
Unlike gold, silver is not predominantly a monetary metal.
By that I’m not trying to imply that gold is used exclusively for
money, rather that its price is determined by its value as a monetary
asset. If gold was not valued as money, its current price would be but
a small fraction of what it currently is… much like silver.
While silver has from time to time been used as money, its
chemical and physical properties make it far less desirable than gold.
Among other things, silver oxidizes very easily, and it is also more abundant,
even though you might not think so given how tough it is to find a good
silver stock to buy. But more about silver stocks in a minute.
Annual mine production of gold is about eighty million ounces
while annual mine production of silver is roughly six hundred million
ounces. Silver production is more than seven times the annual gold production.
Yet, in dollar terms, the gold market is more than seven times as large
as the silver market.
Why is gold expensive and silver less so? Because gold is
money and silver is primarily an industrial commodity.
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.
As you can see, industrial applications and photography
account for about two thirds of annual silver consumption, and the rest
is used mainly for jewelry. Fabrication demand therefore plays a key role
in the silver market.
If we look at both gold and silver in US dollars, then whatever
effect the dollar had on gold, it would have had a similar effect on silver.
If both were priced as money, the charts would look the same. But they
Silver actually performed much better than gold during the
Nineties, rising more than twenty percent from early in the decade and
trading fairly consistently around $5.50 an ounce from 1994 to 1999. Gold,
on the other hand, increased by only seven percent from 1992 to 1994 and
stayed in that range only until 1996. From 1996 to 2001 the gold price
declined by more than thirty percent while the silver price held up until
1999 and then declined only slightly more than twenty percent until 2001.
Industrial demand for silver supported its price during
the latter part of the Nineties, which is why silver outperformed gold.
Industrial demand for silver increased by more than thirty
percent from 1994 to 2000, and has declined by more than six percent since
then. So while the “tech boom” was in full force, silver got
the benefit. When the tech boom went bust, silver suffered as well. And
that is why the silver price barely budged from 2001 to 2003, while the
gold price rallied strongly.
But the amount of silver typically used in any given application
usually represents a very small component of the overall manufacturing
cost. The demand for silver from both industrial applications and photography
is therefore very inelastic, meaning if the price increases the demand
does not decrease.
It is this inelastic demand for silver that could propel
its price much higher if investment demand for the metal picks up. And
that is precisely what has been happening since late last year.
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, it
doesn’t decline either.
So when speculators start buying silver in anticipation
of a move upwards, it very easily become a self-fulfilling prophesy, and
the silver price soars. But when they want to sell their metal to take
profits, the same illiquidity that drove the price up will drive it right
back down again.
The bottom line is that I fully expect silver to outperform
gold as the bull market unfolds but at some point, I also expect the silver
price to collapse again, at which point it could vastly under-perform
The biggest problem for silver speculators is the lack of
quality silver companies to chose from. Silver is primarily a by-product
of lead-zinc mines, with secondary production from some copper-gold, and
gold-silver mines. There are very few primary silver mines in the world
-- at least not many large ones.
Silver often accounts for a minor amount of the revenue
generated by large lead-zinc, and copper-gold mines. So even if the silver
price does increase, it has only a small impact on the value of the mines.
So unless you specifically want to be in the lead and/or zinc businesses,
you’re probably better off buying physical silver.
Fortunately, because of the volatile nature of the silver
price itself, one could stand to make a handsome profit just buying the
metal, although storage might become a problem.
But if you buy physical silver at least you don’t
have to worry about geo-political risk, management risk, geological risk,
or any of the other “risks” that far too often “happen”
to mining and exploration companies.
Even though the silver price was less volatile than the
gold price during the Nineties it will become much more volatile in the
future as speculators drive the price upwards. So if you like volatility,
silver’s for you.
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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