Investing In Silver

Like Rodney Dangerfield, silver gets no respect. It trades at a fraction of its distant cousin gold. It lacks the ornamental cachet of platinum. Widely used in photography, technology, defense, and electronic industries, as the "poor man's gold", silver seems more "industrial" than "precious." And with just under 80% of new silver production a byproduct of gold, copper, lead and zinc mining, silver seems to be the unwanted stepchild of the metals world.

Silver does have its unique characteristics. Of the 92 naturally occurring elements, it's the best conductor of both heat and electricity, as well as the most reflective and the second-most ductile and malleable. Unlike gold -- where virtually all of the metal ever mined still exists -- most of the silver used in industry is consumed. Despite its widespread uses, the silver market is surprisingly small. There are only a few hundred million ounces of silver actively traded around the world. By contrast, gold trades at 2.5 billion ounces. Trading mere 1 million ounces of silver can move the entire market.

But this unwanted stepchild has its Cinderella moments. Most notable was the ill-fated attempt the Hunt brothers made to corner the silver market during the late 1970s, causing the price to spike in 1980 to $49.45 per ounce. Then in 1997, Warren Buffett purchased 130 million ounces of silver at $4.40 per ounce. His rationale was simple as it was compelling: silver demand had been covered by drawdowns from the existing stockpiles and supply was simply not catching up. The price of silver soared 50% on the back of the endorsement by the Oracle of Omaha. But Buffett exited the position within a few years and today Berkshire Hathaway has no positions in silver.

Silver again made headlines last year with the launch of the silver ETF (SLV). Despite predictions that this would send silver prices to the moon, it's been more of a roller coaster than a rocket.

Investing in Silver: The Bullish Case

Jim Rogers is fond of noting that no one can repeal the law of supply and demand. It's on this front that silver really shines.

On the supply side, silver seems like it's a one-way bet. According to research consultancy CPM, in 1900 there were 12 billion ounces of silver on the planet. Today this number has fallen to 300 million ounces -- a drop of 97.5%. During the long bear market from 1980 to 2003 -- when silver traded mostly in the $3.50-$5 per ounce range -- silver was more valuable when it was left in the ground. As a result, over the course of the 1990s, the gap between silver supply and silver demand began to widen. The Silver Institute notes that mine production of new silver rose only 4% from 1990–1999, while demand increased by 22% during the same period. By 2002, mine production totaled 585.9 million ounces, while total demand hit 863 million ounces. Even when you combine newly mined silver with recovered silver from scrap, the gap between supply and demand has been widening. Two years ago, the Chinese government announced that it had depleted its stocks of silver. The above-ground silver supply is projected to shrink to a critically low level by 2010.

On the demand side, the picture is more mixed. Improved technology has reduced demand for silver in both jewelry and photography. But industrial demand in the electronics sector and metal and coin fabrication businesses -- has taken up the slack. New industrial uses for silver are consistently being developed, including uses as divergent as a catalyst in fuel cells for electric motor cars, high-temperature superconductor wires, and an anti-microbial agent.

Investing in Silver: The Bearish Case

Conventional wisdom dictates that the primary reason for silver's doldrums has to do with excess supply due to the drawdown of accumulated stockpiles. These stockpiles include old scrap and coin melt, as well as those held by various governments selling reserves. Now that this selling has dried up, argue the bulls, silver's price can head only in one direction.

Bears argue that the Silver Institute's own studies conclude that over the past 10 years or so all demand was met by several plentiful means of supply. The bogeyman of governmental sales on stockpiles never exceeded 4% of total supply. And with the bulk of silver mined as a byproduct of mining copper, zinc, and lead -- there are suspicions that there is a lot more silver in the ground than official statistics indicate.

Certainly there is some big money betting on silver's decline. According to the CFTC's weekly Commitment of Traders Report, four large traders are holding 90% of all short contracts. That's a total of 245 million ounces and equivalent to 140 days of production. That's a Hunt brothers style bet -- and is unprecedented in any commodity. And this time it's all a huge bet against silver.

How to Invest in Silver

One area where silver has outshined gold over the past few years is in terms of investment returns. While gold has doubled in price since 2001, silver has done even better. At $12.40 an ounce, the metal is up more than 224% since 2002. More importantly, bulls argue it's got a way to go. Trading at barely 20% of its previous record level of $49.50, silver is one of the most oversold assets around. Finally, the current price of gold is roughly 50x that of silver. If silver returns to the historic average of 15x -- you will have made about 3.5x your money. And that assumes that the gold price stays at its current level. Silver bulls predict the metal will rise 10x from its current levels between now and the end of the commodities supercycle around 2015.

The easiest way to invest in silver is to buy the iShares Silver Trust (SLV). Silver mining companies offer the greatest leveraged play on the price of silver. These include companies like Silver Wheaton (SLW), Sterling Mining (SRLM) and Mines Management (MGN). Silver Coins are an old favorite. And several new products offer exposure to the price of silver including Perth Mint Certificates Program [PMCP] or an EverBank Metals Select Account. The details of these structures vary and you should consult their respective websites.

Comments

[Al Lackey:]

Silver Wheaton is NOT a mining company. Read Value Line.

2007 Jul 03 11:16 PM

[VVV:]

"Silver Wheaton Corp., a mining company, engages in the silver production. It purchases silver from Luismin mines in Mexico and the Zinkgruvan mine in Sweden, as well as purchases silver from the Yauliyacu Mine in Peru. The company was incorporated in 1994. It was formerly known as Chap Mercantile, Inc. and changed its name to Silver Wheaton Corp. in 2004. Silver Wheaton is headquartered in Vancouver, Canada."

2007 Aug 01 04:29 AM