Friday, April 1, 2011


So the way I currently understand it, if gold is an interesting investment alternative, then silver is utterly fascinating. Gold and silver have often been used in tandem as units of money, silver being the "poor man's gold" mainly due to it being more abundant. Silver shares all the same properties of money as gold. If gold is worth something as a store of wealth, how do you value silver?

Throughout most of history, the gold-silver ratio has been around 15. This would imply that there is about 15 times more silver than gold. Apparently, silver is about 16 times more abundant in the earth's crust, so I guess the historical ratio is pretty close. If we know approximately how much gold and how much silver there is in the world, we should be able to do a rough calculation to see if this makes sense. I think it's important to know how much of each metal has been mined and is lying around somewhere on earth, and how much is being added to that cumulative total each year. And how much is being used up.

Most commodities have a somewhat predictable relationship of supply to price, although the time lags can be several years. For example, if people decide they need more zinc, demand goes up, meaning the price will go up, which now makes it more profitable to open a new zinc mine, which (eventually, after all the environmental assessments, permits, geology, building infrastructure, etc.) will result in more zinc on the market, and prices will adjust down. But silver, unlike most other metals, is usually mined as a byproduct of another mine like gold or lead; there aren't too many primary silver mines in the world. Which means it's that much harder for silver to respond to the supply-demand laws of economics. If the demand for silver goes way up, the price will rise but it will be very difficult for the market to create new supply as there just aren't the massive silver deposits sitting in the ground waiting to be mined. So the price of silver might stay high.

An extension to this is the scrap market. There are a couple of reasons why reusing silver is problematic. First of all, when silver is used industrially it is generally in minute quantities, which makes recovery expensive. How much time and effort does it take to recycle a few milligrams of silver from a circuit board? (It's these tiny amounts that also make silver relatively price-inelastic for industry.) And second, much "scrap" silver is in the form of silverware and other heirlooms that generally aren't for sale. For instance, the amount of silver scrap increased only about 50% in the late 1970s while the price of silver was going up 1000%.

As most people know, silver used to be used mainly in photographic film, and digital cameras have basically become the entire market. However, while photographic use of silver drops to zero, countless other industries are finding that silver is unique and irreplaceable. The main uses of silver these days is in electronics (silver being the single best electrical conductor) and also increasingly as an antibacterial agent. It is used in microscopic quantities, meaning (a) it is hard to recycle, and (b) it is fairly inelastic. A recent Kitco article projects industrial demand for silver to increase by 35% over the next five years. This would bring the demand from industry pretty close to the annual mining supply - which doesn't leave a lot of room for investment demand.

According to the World Gold Council, about 150,000 tonnes of gold have ever been mined, give or take. A few ounces have been lost or buried in dead people's dental work, but basically most of it is still around. (That sort of confirms its constant value over time: gold has never been so worthless that it gets lost.) This works out to a little more than 4 billion ounces, and mining can only increase the supply about 2-3% a year.

Data on silver is for some reason harder to nail down. My best guess for all the silver ever mined in history is a little over 40 billion ounces, or roughly ten times the historical figure for gold. Annual mining produces about 700 million new ounces a year, and like gold this supply does not change much regardless of price or other factors. So at best, there is ten times as much gold as silver, and the supply of both is quite consistent. But: while upwards of 95% of all gold ever mined is still around, a much lower percentage of silver still exists. One estimate is about 50%, meaning the other half has been consumed by industry, or is in landfills. And only a small fraction of this is in bullion form; the rest is jewelry and other artifacts that make is more difficult to obtain for investment.

So these admittedly rough estimates indicate that the ratio of silver to gold (the actual, tangible metals, not their prices) is a high of 10:1, and could be 5:1 or possibly lower.

The gold-silver price ratio has usually been around 15 or so for most of history due to the geologic availability of the two metals. It currently sits at 37.8. If the ratio were simply to revert to the average, the price of silver would go up to around $95 from $38 today (assuming the price of gold does not change). If the ratio hits 10:1 or even 5:1, then silver would be worth $143 or $287 respectively. If the dollar bears are right and gold continues to go up, you can double or triple all these prices.

Even if this whole fiat money/gold thesis is wrong and gold goes down, there's an excellent chance that silver will hold its own, due to the gold-silver ratio correction and to its own unique industrial demand. The only way I can see silver going down (apart from paper manipulation, but that's another story and should be unwinding soon anyway) is if a massive silver deposit was suddenly discovered, far bigger than anything ever found. It would have to be the silver equivalent of three or four new Saudi Arabias flooding the oil market. Apart from that, the downside risks are so low and the upside is so high.

Some very logical and sane people have been calling this a once-in-a-generation opportunity for while now. And it should continue, at least until we get either 1) a gold-backed currency, 2) double-digit interest rates to combat inflation, or 3) your cab driver starts asking you how much silver you own.

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