The Bullish Case for Silver 27 comments
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By Lara Crigger
After dropping almost 60% from its March 2008 peak of $21/ounce, silver appears to be on the rebound: Silver gained 24% back in the first quarter of 2009.
With a track record of strong performance during economic crises, silver seems particularly well poised to weather the current storm, especially the impending threat of inflation. Even our own Brad Zigler pointed out the potential staying power of the silver rally way back in February.
But if silver has so much potential, why is it still so hush-hush among investors?
"Frankly, I don't know," says David Morgan, founder of the Silver Investor and editor-in-chief of the monthly precious metals research guide, "The Morgan Report." As one of silver's most vocal bulls, Morgan has spent more than 30 years educating investors about this often-overlooked metal.
"Personally, I suspect people don't gravitate to silver because the market is so misunderstood," Morgan said in an interview last week. "They just don't understand the how, the where and the why."
Silver: The Green Metal
Unlike gold, says Morgan, which is useful predominately as a store of value, "silver has a dual personality, as both an industrial and monetary asset."
Silver's innate physical properties make it an ideal ingredient in several industrial applications. As nature's best electrical and thermal conductor, the metal is perfect for high-performance electronics or high-voltage circuits. Silver's high reflectivity makes it a must for fine-precision optics, and photosensitive silver compounds are the engine behind photographic film. The metal is even a natural biocide, which is handy in sterilization and treating wounds.
Given silver's valuable characteristics, it's not a big surprise that industrial demand for the metal has risen every year since 2001. The industrial sector now accounts for 54% of global silver usage. (The remainder breaks down into luxury demand - namely, the jewelry trade - and investment demand.)
"Not only is industry the fastest-growing segment of demand for silver, it's also the largest," says Morgan.
Demand could continue to grow long term, since silver is a component in many up-and-coming "green" technologies. Photovoltaic cells in solar arrays require silver coatings. Water purification plants use silver compounds to prevent bacteria and algae buildup. And super-efficient, eco-friendly silver-zinc batteries may soon supplant their lithium-ion cousins in the rapidly growing electric car market.
"Silver is a very clean metal, a very green metal," says Morgan. "And it's also inelastically priced: For some applications, no matter how you price it, you have to use silver."
Another growing demand comes from silver ETFs, which despite their relative newness, have attracted a significant following among individual investors and institutions, like pensions and insurance companies (which can't access the derivatives market). Combined, the silver ETFs added 63.5 million ounces to their stocks throughout the first three months of 2009, and the iShares Silver Trust ETF (NYSE Arca: SLV) now holds over 270 million ounces of fine silver - roughly three-fifths the total silver stocks, says Morgan.
Fig. 1: Historical Silver ETF Holdings
Source: "The Silver Investment Market Report," GMFS, April 2009
"Silver ETFs are far more of a dominant factor in the silver market than gold ETFs are in the gold market," he says. "Gold's just a much bigger market."
What Copper Has To Do With It
Approximately 70% of the silver mined each year is actually by-product, extracted from alloys and ores of gold, copper, nickel, lead and zinc. That means base metals miners and the big diversified natural resources companies often have great control over silver prices - for better or worse.
"If you're a copper miner, you don't care about the price of silver. You just pass it off to your bank for them to sell at any price they like. That puts a lot of pressure on silver prices," explains Morgan.
However, as the global recession has dampened industrial demand worldwide, there has been decreased activity among base metals producers. Less metal being mined means declining silver stocks; the COMEX Dealers Silver Inventory fell sharply between November 2008 and March 2009, dropping from almost 80 million ounces to roughly 70 million.
Additional disturbances in the base metals supply chain could benefit silver's prices further. For example, if the swine flu outbreak becomes a significant pandemic, it could cause supply disruptions from Mexico, which is the world's second-largest silver producer.
Silver, Gold And The Inflation Question
Historically, the fortunes of silver and gold have been inextricably linked, due to their shared use as stores of value. But even though the metals are almost 85% correlated, they're not interchangeable assets.
"Gold's monetary role is primarily in the doom-and-gloom market: If the financial system explodes, then gold will protect you," says Morgan. "Silver, on the other hand, is the best 'good-time' metal out there, because it's used in so many high-tech, high-end products."
Currently, the gold-silver ratio hovers around 70, although in the past few years it has ranged anywhere from 30 to 100. But in 1792, back when the metal was still used for money worldwide, U.S law fixed the ratio at 15.
The Founding Fathers may have been closer to the mark: To a large extent, the current high ratio is artificial - and only jumped after the demonetization of silver in the 1960s. "The natural gold/silver ratio, or the amount of silver coming out of the ground relative to gold, is closer to 8 to 1," says Morgan. "The current gold/silver ratio is just a function of how much people value one metal or the other."
When it comes to inflation, however, investors definitely know their preference: gold. It's nearly a matter of religious belief with many investors that investing in the yellow metal works as a hedge against inflation, but silver has historically performed just as well (and at a lower entry price point, too). "Silver has established itself as one of the best assets to have when dealing with inflationary pressures," says Morgan.
The problem with silver is that historically it's been a far more volatile market than gold, and subject to significant price movements based on the actions of a few big players. For example, in 1997, when Warren Buffett bought 130 million troy ounces of silver, prices leapt from $5 to $8 almost overnight. And in 1979, when the Hunt Brothers tried to corner the silver market, their willy-nilly metal grab sent prices skyrocketing from $11/ounce to $50/ounce in a matter of months. (After the Fed changed the rules on leverage in 1980, silver prices collapsed back below $11/ounces just two months later.)
"Silver's volatility does keep a lot of investors away, and that volatility will continue for at least the next few years," says Morgan. "But if you look at what's going on right now in our financial system and the destruction of the U.S. dollar, you wouldn't have a problem taking a position in gold and silver, because those are probably the two assets that will come out of this thing best."
Building A Silver Portfolio 101
Investors looking for access to physical silver have a range of available options: bars, coins, rounds, etc. (Given the current investor desire for safe havens, bullion demand has been especially strong recently; data for the top four silver bullion coins shows a combined 93% upswing in first quarter sales year over year.) If storage is a problem, U.S. investors can also access physical metal via the aforementioned iShares Silver Trust ETF.
Investors can also try silver futures, which trade on the COMEX, or a futures-tracking ETF like the PowerShares DB Silver Fund (NYSE Arca: DBS). But Morgan prefers top-tier mining companies over futures plays. "With mining companies, you can get leverage for both the upside and downside, just like a futures contract - but they carry far less risk," he says.
Although dozens of multi-metal miners provide access to silver, few pure-play silver mining companies exist. Some include:
* Pan American Silver (NASDAQ: PAAS), one of the world's largest primary silver miners, which operates eight mines in Mexico, Bolivia and Peru.
* Silver Wheaton Corporation (NYSE: SLW), another major silver mining company operating mines in Mexico, Sweden, Peru, Greece and the U.S.
* Silver Standard Resources (NASDAQ: SSRI), which doesn't itself mine for silver but rather owns stakes in the mine properties. Their holdings include projects in Argentina, Peru, Mexico, Canada, Chile, Australia and the U.S.
How High Is High? No One Knows
Morgan predicts that continuing financial instability will push silver higher throughout 2009. "I think silver will establish a wide trading range this summer," says Morgan. "But by early fall, we should start to see strength. By late 2009 into first quarter 2010, I'm looking for it to go beyond the $21 level it established in 2008."
The key, says Morgan, is the $25/ounce price point. "Once we get to that level and stay there for at least three or four consecutive trading days, I think you'll start to see a real acceleration in the silver market," he says.
"After that, how high is high? No one knows. There's no upside resistance once we break through that level, because anybody who owns silver is going to say, 'Well, I'm not going to sell now.' And that's when we'll see those markets really start to accelerate."
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This article has 27 comments:
Load of crap. The futures traders set the prices of everything and even the largest company's seem to have no control. Ever heard of Exxon saying, "Our price today is $75 a barrel?"
"The natural gold/silver ratio, or the amount of silver coming out of the ground relative to gold, is closer to 8 to 1," says Morgan.
I thought the prices of gold/silver were used to compute the ratio, not how many oz. are mined?
On Apr 30 11:39 AM ZZ wrote:
> "If you're a copper miner, you don't care about the price of silver.
> You just pass it off to your bank for them to sell at any price they
> like. That puts a lot of pressure on silver prices," explains Morgan.
>
>
> Load of crap. The futures traders set the prices of everything and
> even the largest company's seem to have no control. Ever heard of
> Exxon saying, "Our price today is $75 a barrel?"
The issue here is not that pure-play silver mining companies are unable to set their own commodities prices, because you're right--nobody gets to do that.
Rather, the issue is that silver is overwhelmingly an "incidental" commodity -- most of the companies who mine it out of the ground do so only to get to the other stuff, like copper and zinc. So they really couldn't care less what silver ends up ultimately being priced at; they send it off to someone else and tell 'em, "sell it at whatever price you like, we don't care". That sort of "whatever" attitude puts a real damper on silver's market value.
> "The natural gold/silver ratio, or the amount of silver coming out
> of the ground relative to gold, is closer to 8 to 1," says Morgan.
>
>
> I thought the prices of gold/silver were used to compute the ratio,
> not how many oz. are mined?
What Mr. Morgan was getting at was that there's a discrepancy between the ratio of actual physical gold mined each year to actual physical silver mined each year (which he calls the "natural" ratio) and what we as investors regard as the "gold/silver ratio" -- and that the former doesn't necessarily drive the latter.
Oil zoomed to $150 a barrel and then down to $40 a barrel in a few months. Was there a supply shortage at $150? No
Did demand fall off the roof on the way to $40? No
Political costs, permitting etc. are increasing as are the labor and associated social costs of mining. Mines are now expected to not only operate at a profit for shareholders but, increasingly, to provide benefits for nearby communities. With increased energy, demand and capital costs substantial increases in prices are inevitable.
Should silver regain some of its status as a monetary asset David Morgan's estimates could appear conservative.
I thought SLW only had one mine, which wasn't acquired until this year. Its primary business model takes advantage of silver being, as you call it, an "incidental" commodity. SLW buys silver in advance, from miners who produce it as a by-product. The purchase price is lower than the market price, so SLW earns the spread and takes on the risk/reward from moves in the silver price. The miners get a guaranteed price and don't have to bother marketing the silver.
Or could it be they have it covered with the bullion from the SLV ETF, which they are supposed to be the custodian of?
I haven't substantiated this stuff, so as far as I'm concerned it's all rumor. If it's true it would explain a great deal.
On Apr 30 03:27 PM TheWatchers wrote:
> The lack of interest is from the investors that have been doing their
> homework and know that J.P. Morgan Bank has been manipulating the
> Silver market with their large short positon.
From what I've read they could never really cover (unless they could buy/sell enough call/put options on Silver or miners to make up for it), so why'd they do it? Why didn't they cover in October '08?
Can anyone enlighten me or point me in the right dee-rection?
Look at what happened to the Hunt Brothers. The money changers stepped in and changed the rules, lest they be successful and others follow in their footsteps. And Warren Buffet? Even he was only allowed to hold his silver for a few short years. No, the big names know that silver is an off-limits special metal, that due to its nature, is used to control the price of gold (and thus paper money).
For all we know, silver could not only be the most indispensable metal on Earth, but throughout the whole Universe as well.
But the price still, although moves up [sort of], for the last 20 years it Has not even kept up with inflation, where a 3% CD compounded annually, would have been better. (than silver, but not with inflation.)
Look, I bought silver about 18 years ago, it was about $4.50 Maybe a little lower. So, if it has gone to it's [now] level, (not gonna worry about where it was, will be or any other thing except present day spot price, which is the real price whether you like it or not.
Now Silver is 12.60 as I type 5/1/09 12:45 PM and lessee, divide 12.60 by $4.50 and you get 2.8 (or 280% ) in 18 years. Divide 2.8 into 18 years. That equals 6% a year. Am I correct. Go compare the price of a gallon of fuel, back then ($.84 Cents), a gallon of milk, a loaf of bread etc and etc again. Compare the % rates you could have locked in out there ( I JUST got a 3 year annuity from Met life guaranteeing me 7.25% and no risk of capital, worst I can do is 7.25... Go check back, silver has done nothing comparitively and if I had a grain of one cow dropping for every guru that has said, "silver will explode" in the last 18 years, I could go into the dirt business and resurface every farm in the world with nice new fertilizer. Go dispute that fact! (well, it is no better than [or worse] than the gurus selling silver)
So what am I saying, silver will continue on up, but for my money, unless you are totally convinced, PM's are a tradable commodity, and not for storing in closets. Closets are for shoes.
Buy something that pays you a return. More money has been lost chasing dividends than any other circus ring.
The younger you are, the more you should look into annuities.
BTW, used to have a series three lic and series 7 too for that matter. So I am speaking from some knowledge and expirence.
Capt Brian
Happy Navigation.
On Apr 30 11:09 AM GMiki1 wrote:
> I hold a lot (for me) of physical silver, but also a lot of shares
> in silver miners and in SLW. If you want to know about the coming
> silver squeeze, see Ted Butler's columns--do a search. This week
> he says there has been a shift, with the trapped COMEX silver shorts
> struggling to get out because they know that the silver push is coming
> to shove. As for where else to hold money, in addition to silver
> and gold and mining shares, there's platinum, there's oil and there's
> nat gas, and water, and grains... cotton. Lots of choices.
As far as the Captain's comment about about his 18 year investment observations, he chose the wrong time frame. During the late 1970's and early 1980s when we had the silver price blow off (up from under $1.29/oz up to the $50/oz mentioned) there were several billion ounces of "junk" silver put into the inventory. That enormous stockpile was worked off until 2001 when it appeared to be substantially used up. For the last eight years the silver price increase has substantially out preformed the Capt's money markets. He chose the wrong time period for an honest comparison. Starting right now he would get it right if he bailed out of those "safe" investments and got himself a batch of the shinny metal.
As far as commentary on silver miners goes, I refer you to Mr. Morgan's site, Silver-Investor.com, which is an excellent resource on all things silver (including which miners he likes and why).
You either misunderstand the investment product you purchased or are misrepresenting it. While indeed the benefit base SEEMS to compound at a guaranteed 7.25%, this doesn't mean that you've earned 23.4% interest (after annual compounding of 7.25%) at the end of 3 years. Let's see the things that can get in the way. I assume you chose the Lifetime WIthdrawal Benefit policy.
www.annuityfyi.com/lif...
Metlife Lifetime Withdrawal Guarantee II (LWG II)
Maximum Annual Withdrawal Amount:
5% if withdrawals begin at ages 59 1/2 through 75
6% if withdrawals begin at age 76 or older
Guaranteed Withdrawals Based on Greater of:
7.25% compounded annually until earlier of 10-year anniversary or 2nd withdrawal
or
annual step-ups until 91st birthday
or
account value
Annual Cost (single/joint):
1.25% / 1.50%
1) There is an annual cost JUST FOR THIS RIDER of 1.25%. If the market does worse, year to year, for your period base (as annuity years are based on when you write the contract and not on a Jan 1 to Dec 31 year) than 7.25% for each of those 3 years, you are only now earning 6% interest.
2) Annutities can have additional fees, such as:
* Mortality fees of 1 to 1.35% of your account (protection for the insurer in case you live a long time),
* Maintenance fees of $20 to $30 per year, and
* Investment advisory fees of 0.3% to 1% of the assets in the annuity’s portfolios.
Any of these, if present, will reduce your expected return.
Let's assume you pay an advisory fee of 0.5% (if I'm wrong correct me). That reduces your 6% interest to 5.5%.
Let's say you deposited 1 million dollars into this annuity and will begin withdrawals in 3 years. Your benefit base increases to
$ 1,174,241.
3) Now, this is a variable and NOT a fixed income product, so you will be paying ORDINARY INCOME TAX (which, for most marginal tax brackets is higher than capital gains tax) on your withdrawals, which will further reduce your earned interest. Lets say you'll pay 25% tax on these withdrawals.
Assuming you are older than 59.5 but younger than 75,
that means you can only withdraw 5% per year, which means that you are receiving payouts only after 20 years will you receive more than your benefit base (ignoring your possible death before that, and various riders that protect for that possibility).
You will withdraw 5% of $ 1,174,241, or $58,712 per year. You will be taxed 25% on that, which nets you $44,034 per year. If any of this brings your taxable income above $82,250, you might be paying 28% or 33% or 35% on the excess. Now, Obama has indicated he wants to raise the two top brackets to 36% and 39.6%, respectively, which would make this even worse (answers.yahoo.com/ques...). OTOH, his capital gains tax would be a maximum of 20%.
4) Inflation reduces the *real* value of your withdrawals.
M3 is growing far faster than the U.S. government's purported figures for inflation (seekingalpha.com/artic...). The U.S. govt. would have us believe that the rate of inflation is currently hovering around 0% (www.usinflationcalcula.../). This is a blatant lie.
5) Annuities have all kinds of tricks to minimize your returns from a strong market. Let's entertaining the notion that, instead of the U.S. entering a financial apocalypse of a hyper-inflating US dollar within the next 10 years, that we will see a light out of this Depression (yes, I use the "D" word). If the stock market eventually rebounds, much of that upside will NOT be seen in your annuity, as your annuity gives you guaranteed income which is compensated bylower returns.
For the purpose of supposed "guaranteed income", you are losing the flexibility of cashing out your account and converting it to Euros, gold, silver, stocks, bonds, moon rocks, whatever. If the dollar hyperinflates, you are S.O.L. Since we don't know what actions future administrations are taking, and what will happen with the economy, you giving far too much trust to Metlife and this product.
If your investment horizon is at least 23 years (3 years now + 20 year pay period to reach your benefit base), you will do far better investing in a low fee ETF and withdrawing when YOU want to, even though you will pay a 20% tax on dividends. In this annuity you're only investing for 3 years, and withdrawing after that and paying income tax on those withdrawals for every year. Since you only have 3 tax free years, your taxed years on the annuity will likely be higher than capital gains taxes for an EFT.
The only reason I see to purchase such an annuity is
a) You expect to live at least 23 more years
b) You think the economy will be garbage not for the next 3 years, but for the next 23 years or more (you could be invested in an EFT the entire time you're withdrawing from your annuity, which is NOT gaining interest).
This is a lose-lose proposition. If you're wrong, you will have made more money in an EFT. If you're right, this annuity will not suffice as a hedge against inflation.
www.smartmoney.com/per.../
It's always good to hear from David Morgan too. He continues to be insightful and one of the best promoters of the metal that I love best.
One thing not addressed though that has become a concern of mine is the possibility of silver seizures by government in a time of crisis. For all the reason mentioned about silvers useful qualities we should never forget that it is an incredibly important metal from a "military industrial" perspective.
My concern arises mainly because of the know and growing silver shortages worldwide and because so much of what is consumed is never recovered. I have said this before, but I will repeat my assertion that Silver will be the new Gold in the future.
It is because of it's usefulness and as a strategic resource that it is the likeliest of precious metals to be seized if a real crisis arrives, especially war (real war). It is because of it's relative scarcity that it should be priced well above the current market value.
If I had read that the Chinese were hoarding Silver instead of Gold I would have had a lot of sleepless nights and made quick plans to buy as much of the metal "off the books" as I could lay my hands on.
Cam