Silver In A Weak Economy

 |  Includes: COT, DBS, SIVR, SLV, SLW, USV, ZSL
by: Gary Bourgeault

Silver in general is standing at a very interesting position, as it's poised to break out in the short term, while at the same time a weakening economy will play havoc with the precious metal over time.

We'll look at some myths surrounding silver in this article, as well as some of the realities inherent in silver as an investment option.

Along with that the performance of silver in a weak economy and recession will be examined, as it appears that's where we're headed yet again. The recent CPI numbers point to that as a probability.

Finally, we'll look at the effects and importance of the demonetization of silver, the silver/gold ratio as a metric, silver bull chatter, and silver and taxes.

Demonetizing Silver

To understand silver an investor must understand the consequences of when it was demonetized in 1963.

For our use, demonetization is a reference to when the government ended the legal relationship between paper money - silver certificates - and silver. Others point to the Fourth Coinage Act in 1873 as the time when silver was demonetized.

Here's how one economist describes why silver demonetization is defined by 1963 (Also see good debate between gold bug and silver bull there.):

What was the meaning of the demonetization of silver? It was the legislative revocation of what had been a legal relationship between paper money -- silver certificates -- and silver. You could legally demand silver with a silver certificate. You could not legally demand it with a Federal Reserve note. Silver was effectively demonetized by law on June 4, 1963, when silver certificates were abolished. Only for as long as they did not wear out -- a few months -- would people exchange them for silver coins. But you could do that without them, as I did. Why? Because silver coins were all there were above the nickel. You could write a check and get silver. But the fact was, after June 4, 1963, Congress could legally replace America's silver coinage with clad coins, with no threat of redemptions for silver by millions of holders of silver certificates.

The importance of silver demonetization is it is now largely an industrial or jewelry metal, rather than legal tender. That means large investors like central banks aren't buying up silver as they do with gold. Some ETFs buy silver, but that has had a negligible effect at this time. It could make a difference when the economy is growing, but that is far from the case, and has been for quite a while now.

Silver Demand

Since silver prices are and will be mostly moved by industrial and jewelry demand, it's important to continue to watch data reflecting those areas.

In 2012, Silver fabrication fell to 846.8 Moz. Industrial silver fabrication dropped to 465.9 Moz, a decline of 4 percent. The bright spot in 2012 was China and India, with China experiencing a slight gain in industrial silver demand, while India had a jump of 4 percent.

Global silver demand for jewelry in 2012 remained about the same as 2011, with 185.6 Moz used there. Depending on how you look at it, this could be considered a negative because the high price of gold has resulted in consumers changing to silver as an alternative jewelry source. If the migration of a larger number of consumers to silver didn't cause demand to rise, it points to a weak market. Gold demand for jewelry dropped 4 percent in 2012.

Now that gold has corrected, consumers are going back into that market for jewelry, which will cause silver demand for jewelry to fall, at least in the short term. That could easily change if gold prices fall significantly again.

As expected, demand for silver for use in photography continued to plunge in 2012, dropping to 57.8 Moz. Silverware demand was also lower, down to 44.9 Moz.

Another major factor going forward is the proposed idea by a number of states to lower or get rid of renewable energy standards. That could have a big impact on silver demand in the solar industry.

The chart below gives a look at silver demand since 2003. As you can see, demand has remained somewhat level during that time. Part of that is from the plunge in demand in photography, while new uses struggle to make up for that loss. Don't be fooled by the last three years, as much of that has the appearance of being higher overall based upon implied net investments.

Another 41.5 Moz of silver was added to the demand side in 2012 from de-hedging by producers.

Silver Supply

Silver supply in 2012 was down by 7.5 percent to 261.3 Moz. The major reasons for that are net producers weren't hedging, lower scrap supply, and a drop in sales of government stock.

The sales of government stock plummeted an extraordinary 39 percent to 7.4 Moz, a 15-year low. China and India were the countries largely contributing to those results, with Russia adding to it by its fall in disposals.

Silver scrap was also down on the year because of a decline in recycled silverware, jewelry and photography items. Silver scrap supply dropped to 253.9 Moz, 1.6 percent lower than 2011.

Controversial Silver Supply/Demand Assertions

One thing anyone investing in silver must take into account, is the seemingly endless assertion there is a shortage of silver. That has been the narrative by a number of silver bulls for decades, and deserves a close look by those unaware of the story.

Take into consideration the year silver reached its all-time high of about $50 an ounce in 1980. In just 11 years - 1991 - the price collapsed to an anemic $3.60 an ounce. That's about a 93 percent plunge in price.

Twelve years later in January, 2003, the price of silver was $4.67. Throughout those many years a number of silver bulls continued to assert there was a large gap between silver production and consumption; an assertion that has never stopped being made to this day.

So silver investors were continually told to buy silver over those 23 years, based upon the "fact" there was an alleged shortage of silver, which would cause the price of silver to soar, or at minimum to find support.

While the silver bulls were selling silver coinage, it still had a dramatic effect on the outlook for silver stocks, which were sure to go up if a silver shortage was imminent. An endless, imminent, silver shortage can keep investors in the game far past when it would have been prudent to sell. Picture the imminent narrative being shouted out all the while silver investments got crushed by a loss of over 90 percent during that time. That's the worst-case scenario of course, but the plummet in silver prices would have crushed the majority of investors throughout those 23 years.

Can Silver Supply/Demand Assertions be Trusted?

All of this leads to the question of whether or not investors can trust the assertions being thrown out there concerning silver demand and supply. I don't think we should.

The major case is the one already presented. If there was a shortage of silver from 1980 to 2003, how could the price have continued to drop to such precipitous levels?

What needs to be taken into account to counter these assertions is that silver over the years continues to have supply and demand of 770 million ounces to 900 million ounces.

In other words, how could silver continue to be consumed from some unidentifiable storehouse or storehouses and still fall in price during that period of time? Where were these alleged above-ground silver supplies coming from?

What those putting forth these statistics must do is provide evidence that can be confirmed and verified concerning the exact origin of the above-ground silver supply. That means about 200 million ounces a year over a 25-year period must be accounted for. What's the explanation? Real explanations. Not theories, but provable data.

You have my permission to not believe any of those silver bulls making wild claims about silver shortages. Why trust current statistics when past forecasts based upon similar assertions have been proven to be false? Don't make silver investing decisions from asserted silver shortages until verifiable data are confirmed to be true.

CPI and Weak Economy

Now let's look at the U.S. economy. Recently the Federal Reserve Bank of Cleveland released its Median CPI figures.

Here's what the release said:

According to the Federal Reserve Bank of Cleveland, the median Consumer Price Index rose 0.1% (1.1% annualized rate) in March. The 16% trimmed-mean Consumer Price Index rose 0.1% (0.7% annualized rate) during the month. The median CPI and 16% trimmed-mean CPI are measures of core inflation calculated by the Federal Reserve Bank of Cleveland based on data released in the Bureau of Labor Statistics' monthly CPI report.

Earlier today, the BLS reported that the seasonally adjusted CPI for all urban consumers fell 0.2% (-2.2% annualized rate) in March. The CPI less food and energy increased 0.1% (1.3% annualized rate) on a seasonally adjusted basis. Over the last 12 months, the median CPI rose 2.1%, the trimmed-mean CPI rose 1.7%, the CPI rose 1.5%, and the CPI less food and energy rose 1.9%
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What this confirms is the U.S. economy continues to falter, as consumers aren't out there buying much, as was confirmed by the drop in durable goods orders, which were down by 5.7 percent in March. That means consumers are buying what they need and not what they want, suggesting a survival mode rather than confidence the economy is growing and everything is economically healthy.

The so-called economic recovery is on life support, and will continue to tumble even more.

Even though the $1 trillion being spent annually by the Fed to jumpstart the economy is a complete failure, it isn't going to stop the Fed from continuing to stimulate far into the future.

What silver investors need to look at is if that will push the price of silver up, or if the drop in industrial demand will offset it. In other words, will silver investors put more weight on protection from inflation or on industrial and jewelry demand. The answer to that question will determine the price movement of silver over time.

There is no doubt the U.S. and global economy is contracting, and that must be taken into account by silver investors, and all investors for that matter.

Historically, silver gets crushed in a recession, so bear that in mind as the data come out. Also, be aware that the way the GDP is being determined has changed, with the purpose of making the U.S. economy look stronger than it really is.

Silver/Gold Ratio

When you hear talk of the importance of the silver/gold ratio, the majority of investors don't know the history of that ratio, especially when the ubiquitous ratio of 15-to-one is assumed.

It is thought that is the normal performance of gold and silver in relationship to one another, when in fact it's based upon historical Federal law. That's another way of saying it was a price control. The longevity of that law makes it appear gold and silver moved that way in a free market. They didn't.

So the idea silver will move close to its historical ratio with gold is a misguided one, as now it is trading more freely and the circumstances of that time are long gone.

Many investors consider the 15-to-one ratio as one based upon market forces, rather than the government interference that produced it. Consequently, the assumption is made that if silver moves closer to gold in it past performance, it means the white metal is almost guaranteed to reach astronomical price levels.

Whether or not silver does reach extraordinary levels, it won't be projected or understood by using the gold/silver ratio as a forecasting tool. That would be fool's gold for sure.

If the price ratio between gold and silver failed miserably from 1980 to 2003, I wouldn't suggest using it as a factor in determining how to allocate your capital in precious metals.

To figure out the current ratio, divide the price of gold by the price of silver. It remains far above a 15-to-one ratio, that's for sure.

Silver and Cycles

Silver is extremely volatile and its price moves in cycles. The cycles are dependent largely on macro-economic realities. It recently dropped into the low twenties an ounce, to as high as $44.00 an ounce. That has happened a couple of times over the last year, and those patient enough to wait for a good entry point and sell at the right time have made a lot of money.

The problem is those not familiar with the movements of silver can get clobbered in the markets because they buy high and then sell low, taking big losses. Some that don't know how quickly and deep silver prices can change, don't even put stop-losses on their investments, not understanding how fast things can move.

While this can happen in the best and worst of markets, the price movement of silver in a weak economy can be painfully downward for those going long. Of course those shorting silver during those times can make a lot of money.

Is it Time to Invest in Silver?

After reading this so far you may think I'm a silver bear when it comes to investing. That couldn't be further from the truth, as silver has been a significant part of my investment strategy over the last couple of years, with a lot of short- and long-term success.

Much of this was written to help you understand how silver prices will respond in a weak economy, and some of the fallacies floating around out there that are used by many to make silver allocation and investment decisions.

On the positive side, right now we're sitting on a golden opportunity for silver, as historically under these conditions silver prices have soared after experiencing a similar type of correction.

After the recent beating silver prices took, it's time to look at silver as a contrarian play, based upon the fears stoked up by the amazing plunge in prices.

To do that we need to look at what is called the Commitment of Traders [COT] report. It measures how interested investors are concerning silver.

When you look at the chart below, note the purple dips, which is where investor sentiment for silver is lowest. The purple line represents net bets (long bets minus short bets) of silver futures traders. Then look at the black line above it, which shows how the price of silver has responded during those periods of time over the years.

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Under these conditions, silver prices have historically moved up in a range of 20 percent to 30 percent, usually moving on average between the two at about 25 percent.

That's usually been the price movement over a period of a couple of months. It can be a little less or a little more, but has typically been close to that range.

Below is the performance of silver the last four times similar conditions were in place.

After the plunge in price and associated wariness of silver investors, the thing to look for now is whether or not silver has in fact hit a bottom, or there are still some reverberations to come. It's possible there could be one more dive in the price of silver before it reverses direction. Either way money will be made, but if you get in too early the upside will probably be more in the 10 percent to 15 percent range, as prices could drop another 10 percent or so. It's a win/win, with gains from the 10 percent to 25 percent range very probable.

In the near-term silver should move upward nicely, so we need to be diligent and ready for it. Is this guaranteed? Of course not. But based upon historical evidence, the probabilities are very high.

Where to Invest

When investing in silver, I prefer ETFs, ETNs, or streaming companies like Silver Wheaton (NYSE:SLW). They're easy to understand in an already complex silver market. The ETFs or ETNs are focused on a very specific part of the silver market, and have low costs.

I've invested in ProShares UltraShort Silver (NYSEARCA:ZSL) with good results when I've believed the price of silver will drop. Below is a one-year chart showing how quickly the unit price can move up when silver drops. I've used ZSL with Silver Wheaton at times to take advantage of the volatile price movements of silver, making money when the price goes up or down.

One-year ZSL Performance

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iShares Silver Trust (NYSEARCA:SLV)

iShares Silver Trust is a good proxy for the price of silver. Minus expenses and liabilities, the goal of the fund is to mirror the price of silver. You can see from the chart below that has been how it has performed.

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ETFS Physical Silver Shares ETF (NYSEARCA:SIVR)

For those wanting to invest in the price of silver bullion, the ETFS Physical Silver Shares ETF could be just what you are looking for. The shares of the fund are backed by physical allocated silver bullion, which is held by a custodian.


Silver futures contracts are the focus of the E-TRACS CMCI Silver ETN. Here's how the company describes its purpose:

The investment seeks to track the price and performance yield, before fees and expenses, of the UBS Bloomberg CMCI Silver Total Return index. The fund is designed to be representative of the entire liquid forward curve of the silver contracts. The index measures the collateralized returns from a basket of silver futures contracts.

It is comprised of the silver futures contracts included in the CMCI with five target maturities.

Other options are the PowerShares DB Silver Fund (NYSEARCA:DBS) and ProShares Ultra Silver (NYSEARCA:AGQ). The PowerShares DB Silver Fund tracks the Deutsche Bank Liquid Commodity Index - Optimum Yield Silver Excess Return, and the PowerShares DB Silver Fund's goal is to provide daily investment results that correspond to double the daily performance of silver bullion as measured by the U.S. Dollar fixing price for delivery in London.

I'm not interested in silver miners at this time because of the uncertainty surrounding the weak global economy, which will pressure earnings if silver prices continue to fall over the long term. There are simply too many variables when combined with what was mentioned earlier in the article to make a accurate assessment of the future performance of the silver miners. Things like debt loads, geo-political concerns, radical union demands, and quality of management in place, among other elements.

Silver Investing and Taxes

Since silver investing many times includes moving in and out of the market over a short period of time, silver investors need to keep their exposure to a tax event in mind each time they buy and sell quickly.

In those cases we're taxed at individual rates rather than long-term investment rates.


Silver investing is not for the faint of heart, and only a small portion of your capital should be allocated to the volatile precious metal. That's especially true if you only have a basic understanding of the sector. I've had at times large percentages of my investment capital in silver, but I've been studying it for a long time and understand it very well.

The most important aspect of silver investing is understanding the cycle it's in and the economic environment it's operating under.

Since we're in a weak economy, even though silver prices could jump by 20 percent or more in the near term, and possibly will, over time we'll most likely see the price of silver under pressure unless something in the global economy changes.

The problem with silver for the investor is it can be exhilarating because of the quick price movements and perceived ability to make big money. It's not called poor man's gold for nothing, as it can turn on you very quickly and devastate your portfolio.

The key for successful silver investing is to patiently wait until the price drops to levels where there isn't much more room to go but up, yet also putting a stop-loss in place to cover yourself in case there is still more room to drop.

If you want to hold silver for the long term, it's imperative to buy on big dips, as that cycle will repeat itself over and over again, and those major dips must be considered buying opportunities which should be taken advantage of. That could only happen once or twice a year.

That may seem very obvious, but when it comes to silver, the volatility of the price movements can cause many otherwise logical investors to buy or sell on emotion and impulse, rather than on a strategy that has been put in place.

If silver does go up in price soon, and if history is a fairly accurate barometer, we could make a fairly quick 15 percent to 25 percent in gains. We shouldn't attempt to squeeze everything out of the price, as it will fall back once the gains are made.

Just keep on putting stop-losses in place as the price goes up and let that price dictate your exit. Be sure to leave enough room with your stop-loss for the volatile silver price, or you'll find yourself moved from the playing field as the price of silver is rising, because of the daily swings in silver prices, which could trigger a stop-loss that is too conservative.

Disclosure: I am long SLW. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.