Is Silver Finally Starting to Catch Up with Gold?

Includes: DBP, DBS, SLV
by: Lee Thomas

Gold prices have hit an all time high; as a result, many investors are starting to take notice of silver and its low trailing price as compared to gold. Depending on the source of data, it is hard not to get excited after reading articles by experts giving out historical price data of how silver at one point reached a high of $50USD in 1980. Compared to today’s price of $16.89/oz, silver is just plain cheap if adjusted for inflation, but before you start loading up silver, let’s take a step back in time.

There is one piece of information that many of these writers seem to leave out when they talk about the highest price ever of silver that was touched briefly in 1980. The real story behind it will also explain the quick tumble soon after.

Do the Hunt Brothers attempting to corner the silver market ring a bell? Nelson and William Hunt were the heirs of H.L. Hunt, the oil tycoon and were one of the wealthiest families in America at the time. They started buying silver as a hedge against inflation in the early 1970s and continued for nearly a decade.

Silver was floating around a low of $6/oz in early 1979, but in the fall of 1979, the Hunt Brothers along with some wealthy Arabs formed a silver buying partnership and purchased 200 million ounces of silver. This was equivalent to half of the world’s deliverable supply of silver at the time. As you can imagine, by early 1980 the price of silver had skyrocketed.

COMEX, a division of the New York Mercantile Exchange was not going to let the silver cornering take place and raised the margin requirements. Because they were highly leveraged, the Hunt Brothers could not meet the margin calls and were forced to sell. The price of silver took a nose dive, falling as much as 50% in one day on March 27th 1980 from $21.62 to $10.80.

As a result, the Hunt Brothers declared bankruptcy while the Bache Group who handled the brothers’ trades was financially ruined. Silver prices remained above $15 for a brief time in 1980 and then declined for more than two decades; however, since 2001 silver prices have reached higher highs at the end of each year.

Another Perspective

There are differing opinions as to where the true value of silver should be at. The average price of silver fluctuates mainly because of supply and demand caused by its many uses. The largest consumption of silver after jewelry and silverware had been in the photographic industry. However, as a direct result of the wide spread acceptance of digital photography, there has been a steady decline in silver usage from this industry.

According to The Silver Book report released last week by the VM Group/Fortis, there was a surplus of 6171 tons of silver in 2007. The demand for silver from the photography industry fell faster than they had projected in their last report. The supply of silver will increase as traditional photography is replaced with digital and demand from other areas decline. The digital takeover is not limited to just retail consumers, but also in the large segment of medical and movie industry. Will there be any other industrial uses of silver that will replace the demand displaced by the photography industry?

There is a potential for the demand for silver to increase over the next decade because of new industrial or technological uses and thus reduce the supply and increase silver prices. Two of the uses of silver that will have a large impact on the supply are its use as a lumber preservative and in RFID devices.

How much silver is demanded by the RFID technology is dependent on if its use is widely accepted. Additional technological consumption may come into play, like its use as an antibacterial agent, so its medical uses may increase as well. The demand is unknown at this time, but if supply remains steady as it had been for the past 5 years and demands from the aforementioned industry starts rising, so will silver prices.

Another huge demand that will affect the supply that should not be dismissed is the silver held by Exchange Traded Funds. Currently, there are 3 silver ETFs available that has placed a sizeable demand on the silver supply. The Silver Book report shows that there was a 0 demand from ETFs in 2005, but the following year saw 3,768 tons.

The Silver/Gold Ratio

An interesting fact to look at is the ratio of the silver and gold prices. In the past 100 years, this ratio has widely fluctuated. The lowest being 22.93 in 1970 and the highest of 101.63 in 1990 when silver was $4.17 and gold at $423.80. Taking the average of the lowest and highest you get a 55.69 ratio. At today’s silver and gold prices, the ratio is 53.88. Does this mean the current price of silver or $16.84 is as high as it gets today?

Maybe not, some speculators feel the possibility of the ratio falling to around 25 which would translate to silver being at a price of $36.59 per ounce. This is interesting because the nominal silver price in 1980 was $15.20/oz and if adjusted for inflation in 2007, the price of silver would be around $36.40 per ounce.

The Silver Lining

So what is the moral of the story besides not trying to corner the silver market? There might still be some legs left in silver’s rise depending on who you listen to. Be it the abstract idea of silver/gold ratios, or the balance of supply and demand from actual silver consumption.

When reading investment articles and newsletters that throw predictions and numbers at you, take it with a grain of salt, do your due diligence and try to see things from different perspectives.