At long last, an expert contributes an article on silver! Don Durrett was kind enough to allow me to paste in his chapter from his book (minor edit for clarity re his book title).
Much of this piece is historical in nature, when I mentioned that to him, he wrote back that nothing has really changed, the facts are still the same. I would still have liked to see comments on the price of silver having gotten so much higher than his 2010 numbers. On the other hand, since he wrote his Chapter, everything has come true (at least the rise in price),
so he called it right!
*** I seem to have lost his footnotes. ***
So, please consider this article as "Still Under Construction" until I can get this right...
Non-Expert Junior Blogger Robert is not capable of passing judgement on this article for accuracy nor conclusions. But, I am VERY INTERESTED in your comments about silver.
(Obnoxious cheer: Peru is No. 1!)
Another article soon, it may be a link because of all the graphics, but maybe I can squeeze it all in to an article here.
Below is courtesy of Mr. Durrett:
Here it is. You can post it. Just put a link to my book: How to Invest in Gold & Silver by Don Durrett
Chapter 1 – Why Invest in Silver?
Silver presents an amazing investment opportunity (although the entry price is very important). Why? Because there isn’t much left! In 1945, there were approximately 10 billion ounces (bullion and coins) of silver worldwide.[1] Today, there are approximately 1.5 billion ounces (bullion and coins). Where did it all go? Mostly into landfills. Silver is used in such small quantities in manufactured goods that most silver is not recycled. Thus, it is used and discarded.
Silver is used in thousands of products: appliances, TVs, computers, phones, radios, transportation (ships, trains, planes, and automobiles), jewelry, silverware, medical equipment, electrical connectors, mirrors, door handles, CD-ROMs, DVDs, film, batteries, solar power, water purification, anti-bacterial products, etc. It is the second most used ingredient for manufactured items after oil. Moreover, its usage is expanding. Every year, companies are finding new ways to use this versatile metal. For instance, they recently started putting silver in clothing to keep them smelling fresh.[2] In 2008, fabrication/product demand was 833 million ounces.[3] Most of this was used in the list of products cited above. And since most of these products will never be recycled, this silver is gone forever. This is where the billions of ounces of silver have gone. Total mine production in 2008 was only 681 million ounces.[4] Fortunately, a significant amount of silver is recycled every year (mostly from industrial waste, old jewelry, photography, and X-rays). Without this recycled silver, there would be a large shortage. However, even with recycled silver, there is an annual deficit. This deficit is overcome with government sales, from government inventory. In 2008, the deficit was 30 million ounces (see chart below).[5] Without these government sales, there would have been a shortage.
Supply 2008
Mine Production 680.9
Government Sales 30.9
Recycled Scrap 176.6
Total Supply 888.4
Demand 2008
Manufacturing 447.2
Imaging/Photography 104.8
Jewelry 158.3
Silverware 57.3
Coins & Medals 64.9
Total Fabrication 832.6
Investors 55.8
Total Demand 888.4
Notice that tiny amount in the Investors column: 55 million ounces. That is all the bullion that investors purchased. Less than $1 billion dollars! What happens if they want more? I’ll have more to say about that later.
Since 1945, there has been a consistent annual deficit of supply (mining plus recycled) versus demand (manufacturing, jewelry, investment, etc.). In 2008, silver demand was 888 million ounces, and supply was 858. This created a deficit of 30 million ounces. The deficit was made up by using existing government inventory. Thus, the global inventory continues to wither away, and it’s almost gone.
In 1945, the U.S. Government held 4 billion ounces of silver bullion.[6] Today, they have none. Where did it go? They sold it to manufacturers, because of production deficits. Without these sales, the economy would have suffered from a shortage and the price of silver would have soared. Today, China and India are the only two countries with a significant silver inventory.China has been selling it to their manufacturers, but this won’t last much longer. Soon, they, too, will be out.
The total dollar value of the 4 billion ounces of above ground gold is approximately $6 trillion (at $1,500/oz.). The estimated 1.5 billion ounces of above ground silver bullion has a value of $60 billion (at $40/oz.). Thus, there is more than 100 times more gold – in dollar terms – than silver.
In fact, the discrepancy is much worse than that. The silver supply available for delivery is actually only about 5% of the total, or about $2 billion. The rest of the silver is not for sale. Thus, the physical silver supply is a tiny market with huge potential for explosive price escalation.
For full disclosure, you should know that there are more than 15 billion ounces of silver in silverware, jewelry, and art works that can be recycled into bullion and coins.[7] Once silver reaches heady values, people will be exchanging their silver items for dollars. How much of an impact this will have on the price is unknown. Personally, I think if a recycling wave occurs, demand will likely soak it up and prices will still go higher. Annual investment demand for silver is approximately 15% of total silver demand (in 2008 it was 13.5%). That number could easily increase and soak up recycling.
The main difference between gold and silver is that you can never have a shortage in gold, because it is not industrially consumed in significant quantity. The price of gold can go higher, of course, but not because of a shortage (only demand can drive up the price). Silver, precisely because it is an industrial commodity (in addition to being money), will likely one day go into a shortage (considering the disappearing inventories and increasing demand).
In 1997, the precious metal palladium (used in automobile catalytic converters) was $100 an ounce. Then it suddenly started rising, and kept rising all the way to $1,100 by 2001. This breakout occurred when manufacturers began hoarding the metal from fear of a shortage. This scenario could happen again with silver. If you are a manufacturer, and silver inventories begin to shrink at the COMEX (New York Commodity Exchange), you are likely going to begin creating your own inventory. Manufacturers won’t have a choice. Without inventory, they will have to stop production. Note that this includes just about all of the large international manufacturing corporations.
The question I like to ask is, how high will the price of silver go if we have a shortage? Moreover, since there is no cheap alternative for silver, how desperate will manufacturers like Apple, Sony, Panasonic, Samsung, GE, Nokia, etc., become? Desperation plus shortages always mean rising prices.
As mentioned earlier, most of the silver bullion above ground is not for sale. Perhaps less than 25 million ounces are available for purchase globally for physical delivery on any given day. These 25 million ounces are spread out to retailers and wholesalers throughout the world. In 1997, Warren Buffett accumulated 130 million ounces at approximately $5 per ounce. (He sold at a nice profit, but regrets selling early.) It would be very difficult to accumulate that much silver today in a short period of time.
Of the approximate 1.5 billion ounces of silver bullion and coins in existence worldwide, one third exists in private holdings and another third is held by ETFs. This silver is not for sale.
In January 2010, estimates of the remaining distribution showed:
Silver Coins and Bullion
Private Holdings 500 million oz.
Silver ETFs 500 million oz.
Governments 200 million oz.
COMEX Silver Exchange 115 million oz.
Private Dealers 100 million oz.
Other 100 million oz.
As you can see, very little silver inventory is available for sale. Moreover, the exchanges that do have a silver inventory do not necessarily have any for purchase. For instance, the largest exchange – COMEX – has warned customers that they may have to take ETF shares instead of actual silver. Actual inventory available for purchase is quite limited.
These numbers are mind numbing. There simply is not that much silver available for physical delivery to investors. In dollar terms, we are talking about small amounts of money on a daily basis. In other words, it doesn’t matter if you have the money – and are willing to pay above market prices – the silver is just not available.
For this reason, hedge funds and large investors have been forced to focus on gold. If you have a billion dollars that you want to invest in physical silver by taking delivery, it’s not going to happen overnight. It could take months to find that much silver.
In addition to the low amounts of physical silver available for sale, inventories owned by ETFs are increasing quite rapidly. These are exchange traded funds, such as SLV, SIVR, and CEF, which trade as a stock on the major stock exchanges.
These ETFs are backed by physical silver, which are stored in warehouses. SLV has 300 million ounces, as of today, and it just keeps increasing. These ETFs are popping up all around the world: England, Canada, Switzerland, Australia, Dubai, etc. This will shrink inventory levels significantly. It is my opinion that these ETFs will consume the remaining inventory until a shortage emerges. This is very bullish for the silver price.
And if the ETFs do not force a shortage, then surely investors who are buying more and more bullion and coins will do so. (Ten million Silver Eagle 1 oz. coins were purchased from the U.S. Mint in the first quarter of 2010.)[9] Once this shortage emerges, the price is going to skyrocket. It’s not inconceivable for silver to reach $150 per ounce, and $100 is likely. I used to think that $150 silver was too high a long term target, but now I think it’s possible. If palladium can rise 10x from $100 to $1,000, then so can silver.
There is another factor that could drive prices substantially higher. Investors have purchased silver paper certificates to the tune of approximately 1 billion ounces of silver. Since banks do not have this much physical silver, they are exposed to huge losses – if silver continues to rise. The only thing they can do to hedge against additional losses is to purchase silver (either physical metal or an ETF) or silver futures contracts. If they begin to hedge, this will also drive prices up.
There are two types of silver paper certificates. One is backed by silver (and requires storage fees), and the other is paper only and is settled in cash. Most certificates backed by silver are in fact “naked” certificates that are not backed by real silver, but instead by promises made by banks and other financial institutions.
I call this a paper charade, because the banks and institutions do not have enough physical silver to back up their promises. Instead, they use “pooled” silver accounts that hold a small portion of silver inventory for physical settlements (a form of fractional banking). However, what happens if investors get nervous and begin requesting their physical silver? If that happens, we will see huge shortages and silver prices will explode.
If you’re wondering why banks would sell naked silver certificates, it was free money as long as silver remained cheap and no one redeemed their certificates. Investors gave banks billions of dollars, and all banks had to do was promise to pay them back at the current price of silver. This was a risky gambit that is about to be played out.
Originally, I started out as a gold investor, but I began adding silver investments in 2004 when I learned about the explosive upside potential of silver. I expect silver bullion to increase by a multiple of 20 or 30 before this bull market is finished (starting from $5 per ounce). That would result in a final price of $100 to $150 per ounce. This is not inconceivable. If we have a shortage, there should be a big move into silver by investors. Get ready for another bubble.
Another amazing thing about silver is that, even if we don’t encounter a shortage, the ratio of gold to silver is in our favor. Today the ratio is $1,500 / $35 = 43. The historical average is around 30. However, if you go back to the 18th and 19th centuries, when silver was considered money, the average ratio was 16! Thus, as silver is perceived more and more as money, the ratio will drop substantially. If gold goes to $2,000 and the ratio is squeezed to 25, then silver will rise to $80.
One last note: The true ratio of gold to silver in the ground is 10 to 1. Some people think that because of silver’s usefulness versus that of gold, that the ratio could go as high as 1 to 1. While I don’t expect that to happen, I do think that the ratio will shrink quite a bit. A ratio of 43 is incongruous with the rarity of the metal versus gold.
When you look at futures contracts, there is yet another built-in slingshot for the price of silver. Currently, there is a huge short position (i.e. future contracts betting that the price will drop) in silver equal to more than half of annual production. This is an occurrence that does not exist for any other commodity. This huge short position acts as pressure for an imminent explosion in prices.
Once the price rises past $50 per ounce, the huge shorts will be exposed to hundreds of millions of dollars in losses and will be forced to close out their short positions. If you monitor the COMEX short contracts as they recede from the current approximate 100,000 total (each representing 5,000 ounces of silver), this will correlate to an increase in price.
My estimate is that, when these contracts reduce to a normal level, the price of silver will double. Looking at it another way, if silver passes $50, can these companies really keep these contracts open with the upside in silver looking to go even higher?
This is called a short squeeze and I don’t see how it can be avoided.
Ted Butler, one of the leading silver analysts, believes that silver will be ten times more profitable than gold over the next few years. When you look at the supply/demand situation, this is entirely possible. He actually recommends selling your gold investments and purchasing silver bullion. I don’t have the confidence to do that, because I still consider gold as a safer investment – even though everything points to silver being the better investment.
Anyone who purchased silver bullion or silver coins when silver was below $10 (any time prior to 2005) is going to do very well on that long term investment. I respect people likeJason Hommel (http://silverstockreport.com/), who invested more than $1 million in silver bullion, back when silver was cheap. From 1995 to 2000, the silver price averaged just over $5 per ounce (see chart below).[10] Early investors are going to do incredibly well when this bull market reaches the mania phase over the next few years.
With such a low inventory of silver, it appears to me that investing in silver is a smart investment and a hedge against uncertanity. With the economy in turmoil, U.S. debt exploding, and Peak Oil[11] looming on the horizon, it seems inevitable that investors will seek out precious metals as a hedge. It won’t take much to create a silver shortage and make the price soar. Already it is becoming difficult to obtain physical silver. I see only two possible outcomes for long-term silver investors, both of which are positive:
1) The economy does not collapse and the above ground silver inventory withers down to nothing, creating severe shortages (although this will take several years).
2) The economy implodes and investors pour into silver as a hedge against uncertainty.
I expect high energy costs to impact our economy and our financial system, so the second outcome seems more likely. Our economy will also be facing pressures caused by our level of national debt, and a worldwide shortage of oil.
Whereas gold is mined all over the world in dozens of countries, silver is primarily mined in only ten countries. Here they are, listed in order of production:
Peru
Mexico
China
Australia
Chile
Poland
Russia
U.S.A.
Bolivia
Canada
These top ten countries produce approximately 85% of all silver.[12] To give you an idea of production, the top country – Peru – produces about 100 million ounces per year; whileCanada, the last entry, produces about 20 million ounces annually.
One of the things I like about silver is that there are not that many pure silver producers. Only about 20% of silver production comes from companies who are called silver miners. The rest of production comes from companies mining other minerals, such as copper, zinc, or gold. Silver, by and large, is mined as a byproduct.
What does this mean? Well, if the price of silver ever takes off and there is a mania, there are not that many stocks to choose from. All you have to do is own the good ones and you are going to do very well. Investors will have no choice but to bid up these stocks, and since this market is so tiny, the possibility for upside is tremendous.
There are a few risk factors to be aware of when investing in silver. If the economy collapses, the manufacturing sector could grind to a halt and industrial silver demand could crumble. Silver mining would continue due to high silver prices, thereby increasing supply dramatically and eventually depressing prices. On a positive note, if this happens, investor demand could very well exceed the lost industrial demand. Personally, I think silver prices are going to soar, and this supply risk does not bother me (although I will likely convert mostly to gold as a safer haven at some point in time). However, that is my personal opinion, and it does not reduce the risk of investing in silver.
Since silver is not necessarily a monetary metal, it is much more risky than investing in gold. Gold is simple to understand, since it is money and investors want it for that reason. End of story. Also, the gold inventory is very limited, with only about 2,500 tons mined each year. Thus, gold is a rare commodity that is very liquid, and the risk is simple to understand: if demand goes down, you lose money; and if demand goes up, you make money.
Silver isn’t so simple. This is both a curse and an opportunity. The upside can be substantial, as well as the downside. The volatility is not for the weak of heart. I have seen silver drop from $21 down to $9 in less than one year! Talk about a roller coaster.
If an excessive silver inventory builds, investors could drop this commodity like a rock. Mining shares could collapse very quickly under this scenario. So you have to have nerves of steel and believe in the long term trend.
When silver dropped to $9, I didn’t get upset. Instead, I kept buying. I treated it as an opportunity. This bull market is not going to end in the next year or two, so buy the dips. Be aware that no market goes up in a straight line, and there will be buying opportunities. Below is the price chart for silver from 2000 to 2010 (see chart below).[13]
One last caveat for full disclosure. There is a very small likelihood that governments could appropriate silver from the ETFs and force liquidation. For instance, if the silver price rises past $50 and there is a silver shortage – and investors are competing with manufacturers for physical silver – governments might be tempted to shut down an ETF, such as SLV. This could have the effect of creating a price collapse overnight. So, buyer beware. Silver is a risky investment.
