Thursday's Action Suggests Silver Is Worthless But Is It?

| About: iShares Silver (SLV)

Silver (NYSEARCA:SLV) and Gold (NYSEARCA:GLD) must be worthless. That's what the market is telling us. Get rid of it as fast as you can, for any price. Today (6/27/13) gold dipped below $1200 an oz for the first time in three years. Silver trickled a bit lower to touch $18.34. So, was there a cause to selling today? Well, for most of trading today the metals were flat. Not so unexpected considering they are down 28.5% and 39.1% on the year. Then Atlanta Federal Reserve President Dennis Lockhart spoke. As soon as his comments were publicized, the metals plummeted. The kicker? He didn't say anything new.

Mr. Lockhart said that the Fed will eventually reduce its balance sheet. Well yeah obviously. What does it mean? It means slowing its quantitative easing and monthly bond buying, pretty much exactly what Ben Bernanke said after the FOMC meeting last week, which sent metals down like a block of lead tossed in a pond. Maybe it was when he said there aren't really inflationary problems on the horizon. I guess when Bernanke said there would only be a few percentage points inflation at most over the next few years, the selloff on that news wasn't enough, so it needed repeating. Repeated news must be novel news to the weak hands getting rid of their worthless gold and silver. Enough about all this talk that gold, but especially silver is running out. Supply and demand have no place here. It's all about sentiment.

Perhaps Lockhart tried to boost confidence when he said nothing has changed in the Fed's overall monetary policy. He also said that the Fed wouldn't consider raising interest rates until 2015. Nope, nothing novel here, and this is actually good news for the metals, usually anyway. This time? Nope, time to sell more! Now the initial selling likely triggered further stop loss orders compounding the issue, though one could argue some of it was rooted in fundamentals. Gold and silver investors likely have noted the liquidation of physical holdings from the exchange traded funds.

That might raise concern. Record physical demand globally was also partially offset by the recent reports of less demand for physical gold and silver in India and China. Well, with gold sitting at $1,200 and silver at $18.50, I guess there is no reason they shouldn't both head to zero. I contend that there is value in the metals, particularly silver. I further believe there is demand for silver, and it may not be today or tomorrow, but eventually the laws of supply and demand will catch up to the price action in silver.

Supply Issues With Silver

Unlike gold, silver is consumed in industrial processes, and is eventually discarded into landfills, never to be recovered. This is the result of silver having been intentionally underpriced for many decades, and even today, is still not economic to recycle at current prices. Industrial processes have been intentionally designed not to consume gold, and at the high prices gold has commanded for decades, it is nearly all recycled. It is said that 99% of all gold ever mined is still in existence above ground. Accordingly, we find the silver stockpiles as a percentage of all silver ever mined to be much smaller than gold stockpiles as a percentage of all gold ever mined. This older Seeking Alpha analysis is an eloquent piece detailing the decreasing supply of silver in the world while demand increases. In the article, Ted Butler is quoted as saying this, 15 years ago:

"at the end of World War II, total known stocks of silver amounted to ten billion ounces (with the US government holding 4 billion ounces of that total amount). At that time, we were just entering an era of unprecedented global economic expansion that has lasted to the present. In this era, silver was consumed in a variety of vital modern applications at a phenomenal rate. Today, known stocks of silver have shrunk over 95%, to maybe a half a billion ounces. The nine and a half billion ounce draw down in total silver inventory, was the result of the persistent shortfall between supply and demand, which continues to this day. Not coincidentally, the current 200 million-ounce annual deficit in silver mirrors the long-term trend line average. This continuing deficit is remarkable in that there has been decent growth in world production of silver over the past 50 years, but obviously not enough to satisfy the surge in industrial demand."

I will further discuss reasons silver may have slightly more value than thin air.

Gold-to-Silver Price Ratio Has Widened And a Contraction Is in Order

At the time of this writing, silver is priced around $18.50 an ounce, approximately 70% off its all-time highs set in April of 2011. Gold is currently priced at about $1,200 an ounce. That represents a 65 to 1 gold-to-silver price ratio, whereas the historical ratio was always 16 to 1. In my investing career, that range has been historically wider, from 30 to 1 up to 90 to 1. The respective prices of gold and silver have not approached this historical ratio in many years, and I believe a reversion is long overdue. To achieve this reversion, gold would have to fall over $900 while silver remains stable, or an ounce of silver will have to rise at a greater rate than gold in value in the coming years. I believe the latter is far more likely than the former, especially in a climate of endless monetary easing, which so far has not been inflationary and may cause temporary deflation. However, more money supply often leads to less buying power and higher prices. That's one reason for owning silver as a precious metal, if you subscribe to the idea. Combine this with the rising demand in the technology sector and the fact that industrial demand will return in full force once we have moved completely out of the recession and we have a strong case for an investment in silver. While the ratio is now at 65 to 1, it has generally been in the 50 range for some time in last few years.

The Demand for Silver is At An All Time High

You may be aware that this year we have seen a shortage of both American Silver Eagles from the US Mint as well as junk silver available (that is, pre-1965 US dimes, quarters and half dollars). Further, silver ETFs, including some that will be mentioned in this article, have continued buying silver coins and bullion at a record pace while simultaneously dealing with redemptions. Demand in China and India remains high as well. Thus, demand for the metal is there, but this physical demand has been unable to quell the decline in prices. Where the bulk of demand lies and continues to grow is in industrial and technological applications. Therefore, there will always be some level of demand, but such demand should pick up significantly when the global economy comes fully out of recession. When the economy fully rebounds, there will be a spike in demand in many areas. The demand will not be just in coin and bullion form as silver is used in the following areas as well:

  1. Currency; coins and bullion
  2. Jewelry
  3. Silverware; utensils, cutlery
  4. Dentistry
  5. Photography
  6. Electronics
  7. Mirrors and optics
  8. Musical instruments
  9. Medical devices and instruments
  10. Textiles
  11. Nanotechnology

I want to highlight the technology front. This is where demand continues to rise. While there has been a push to recycle electronics and silver can be salvaged from tech devices, it is rarely done and silver gets destroyed/wasted. We are in a generation dominated by cell phones, laptops, tablets etc. Millions of smart phones are being made and sold, which has created massive industrial demand for silver. As its sales are strong this demand will continue. I point to one example that illustrates this point. There is an average 20 cents of silver now used in each cell phone. While that is not much for a single phone, considering there were nearly six billion mobile subscribers worldwide in 2011-2012, a number that's growing here in 2013, it becomes clear that new phones will always be in demand. Using the average of 20 cents a phone, we generate demand for over $1 billion worth of silver in just new mobile devices alone. Now think about all of the other industries using silver. It is in finite supply. There is also a lot of silver in old cell phones, photography chemicals or medical devices that already have been taken out of the market. Although there is a push to recycle electronics and reclaim costly elements like silver within them, in situations where silver is used in very small portions (such as new smartphones), it is not cost-effective or even practical to recover the silver. Thus, new silver will be utilized in these devices.

If You Don't Believe Silver Is Worthless…

There are three ways investors can get exposure to silver. My top approach for silver exposure is purchasing physical silver bullion and coins, followed by purchasing shares of ETFs that track silver prices, and finally through the stock of the individual silver companies/miners.

Physical Assets

I firmly believe the best way to invest in silver is through physical bullion or coins. There are dealers in most cities and merchants on the Internet where you can buy silver bullion bars and/or coins. I not only consider physical silver as a wise investment given government stimulus, but I also consider it to be a form of insurance in case of a total breakdown of the fiat currencies and modern financial systems we have in the world today. If you decide to invest in physical silver assets, do so by only buying from a reputable dealer. The only downside from Internet purchases is high shipping and insurance costs as well as the possibility of a required minimum purchase. Whenever possible, buy locally to avoid such excessive shipping and handling fees.

Silver ETFs Track Physical Prices

Sprott Physical Silver Trust (PSLV): I am currently only recommending this ETF. There are others which you can consider, but this is my favorite. The PSLV is an ETF that is backed entirely by physical silver bullion. The fund's goal is to provide a secure, convenient and exchange-traded investment alternative for investors who want to hold physical bullion. The Trust offers a number of compelling advantages over traditional exchange-traded bullion funds, including bullion storage in Canada, which is not held with a bank-owned custodian. Further, the fund allows investors to redeem units of the ETF for delivery of an equivalent amount of physical bullion. In this regard, the fund is unique relative to its competitors' ETF products. Currently PSLV trades at $7.20 a share on average daily volume of 1,200,000. The 52-week range of PSLV is $7.16 to $14.47.

Silver Companies

Finally there are the silver companies/miners to consider for exposure to silver. There are plenty of individual companies that I really like. See my other articles for which are my favorites and why. Right now, the only company I am recommending in this article is Silver Wheaton (NYSE:SLW). SLW is a worldwide silver streaming company. Streaming is a very unique and long-term solvent business approach in the gold and silver space. The company offers a superior alternative to traditional precious metal mining stocks because in general the approach SLW takes offers a stronger opportunity for revenue growth with lower long-term overhead than mining companies, many of which are in unstable jurisdictions. Rather than mine for metals directly, SLW generates its profits by providing upfront financing for other companies in the mining space looking to expand and drill for precious metals. In exchange for the up-front financing of these companies, SLW acquires the right to purchase a portion of production generated from the mines at a fixed cost. SLW has contracts with companies around the world to purchase silver production in bulk at prices well below market value. Once SLW acquires the silver at the predetermined upfront investment cost, it then proceeds to sell the silver at higher prices.

At the time of this writing, SLW currently trades at $18.30 and has a 52-week trading range of $17.75 to $41.30. The stock is down almost 50% since the start of the year and represents a good opportunity to initiate or add to a position. On average, about 5.8 million shares exchange hands daily, and most trading session volume has been around this number. The company trades at a 11.4 P/E multiple but only a 0.61 PEG ratio and currently yields 2.6%. SLW's earnings per share are estimated to grow at a rate of 36% in the next five years, though recent lower silver prices have been a short-term impediment to revenues. The company also has a strong balance sheet with a debt-to-equity ratio that is decreasing. SLW also has more proven and probable reserves of silver in its portfolio than other major silver companies as discussed in this recent piece.


So, there are a few ways to invest in silver should you think it has value. I think you are best off just owning the physical metal, but if you must, you can buy a silver ETF or stock. After all of this selling, it's probably time to start a position. If you have held on this long, no sense in selling now. Nearly all the weak hands are out. Short sellers may apply more pressure, but eventually, they will be all that's left, while real buyers accumulate physical. When you really consider the supply and demand issue, it begs the question, if the world has consumed 90-95% of total known inventory of silver over the past 50 years, what will the future hold when the last practical inventory of silver is depleted at current prices, and supply from current production must satisfy current demand?

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. 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.

Additional disclosure: I own physical gold and silver, and several precious metals companies. Approximately 7% of my portfolio is in this sector.