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
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 price.
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
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
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 downturn.
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 (see www.paulvaneeden.com
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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