Reflecting on Silver
the "ah" in ag
by David Morgan
November 22, 2002

It’s a fact. Gold investors believe in gold under any economic condition, but they aren’t so sure about silver. Gold, they insist, is valuable and in fact undervalued. Their argument is basically that gold did well during the last Depression and silver only sold at twenty-five cents an ounce. This truth and their bias is only partially accurate as we investigate which of these two metals truly is the most undervalued.

If you relate silver to gold, the first thing that you note is the value ratio. For thousands of years, the ratio was generally 16:1 or lower. That assumption was the low for silver, not the high. In the year 200, you could buy an ounce of gold with only 10 ounces of silver.  In 3500 B.C., three ounces of silver were equal to one ounce of gold.

For 5000 years, before it was discovered that silver had material and industrial uses, it held a consistently high value in relation to gold. This relationship was upset by the development of the phenomenal Comstock load in the late 1800’s. Silver also dropped briefly during the Depression where it took 70 ounces of silver to buy an ounce of gold. I state this briefly to maintain factual integrity due to government intervention in revaluing gold and silver. The quick rise of silver to gold ratio of 27:1 occurred when the United States Treasury fixed silver at $1.29 per ounce and gold was fixed at $35 per ounce. Gold’s increase in value is widely known among precious metals investors. The fact remains that silver was also revalued a few years after gold.

After the government removed the official backing of silver certificates in 1965, two years later, the U.S. Treasury lost control of silver and its price rose to $2.50 per ounce. This placed silver once again near the historic ratio of 15:1. During the turbulent times since 1971 when the international gold window was closed, both gold and silver had been seeking their corresponding level, in a world of an ever-depreciating dollar.

The Facts About Silver

More recently, silver has been moving in the area around 40:1 to over 70:1 with gold. There are some very strong reasons why this ratio is seriously out of whack, and why it will be increasingly out of whack, until the price of silver rises. The facts weigh heavily in favor of the smaller ratio and that's a higher silver price. Here are some of the facts.

1. When the U.S. Treasury sold off a half-million ounces of silver at less than $2 dollars per ounce, the price of gold was $35. The silver to gold ratio was about 17:1.

2.  The U. S. treasury has no silver – nada, zilch, zero – as in NONE.  There is no official stockpile anywhere in the world. I am aware that the latest GFMS report gives government holdings of 200 million ounces. This is unofficial at best and loaned at worst. [See The Smartest Money]

3.  While gold rose from $35 to $320 since closure of the Gold Cover Clause (a 900% increase), silver rose from a $1.29 per ounce to the present $4.55 per ounce – a little over a 300% increase.

4.  Global stocks and the rate of usage also seem to favor silver. There may be as much as a billion ounces a silver in the world. That's probably the maximum. This is according to the CPM Group and includes coinage. I refer you to my previous work. [See The Smartest Money] There are about 2 billion ounces of gold in the world, or a little more, and a good portion is still it in the central banks. There is half as much silver as there is gold.

Additionally, the silver is being used – actually consumed – while gold, for the most part, mainly changes its form. For example, the main industrial use for gold is jewelry, where it still exists as gold. Here, then, is the difference. Gold is used. Silver is mainly consumed.

The net result is that we face declining availability of silver; while in the long-term, we do not face declining availability of gold, at least not nearly to the same extent.  The exhaustion of supplies of silver is foreseeable, whereas the exhaustion of supplies of gold, apart from monetary usage, is not foreseeable. 

5.  The world shortfall production of more than 100 million ounces a year for ten years has been narrowing the ratio of physical metal. The ratio of physical supply in 1990 stood at roughly one to one. For each ounce of gold, there was one ounce of silver. Again, according to CPM, the ratio has fallen to a 2:1 ratio. That is correct. For every ounce of silver, there are two ounces of gold. If that does not make you think about the price ratio being over 70:1 as I write this, then you had better put on your thinking cap.

The shortfall has been met by the drawdown of silver stockpiles. Whether this has been through sales or leasing is not the debate here. (See Previous) The point is the deficit has been met and the price is still low. The question remains will silver catch the attention of the investment community or not?

The immense popularity of silver, when it first broke loose from Treasury control, resulted in massive speculator purchases.  These were later liquidated as a result of the fall prize from above $6 per ounce below $4 per ounce.

Will there be some type of official event, which would increase the popularity of silver as an investment? Frankly, I see some significance in the Treasury announcement that silver needed to be purchased in the open market to continue the silver eagle program. This announcement was seen as a non-event in the investment community.

These are the principal arguments favoring silver. They have not fundamentally changed for very long time. I have speculated that because of the strategic uses of silver, and because of its shortage, the price ratio would fall sometime to at least 10:1. I think we are approaching the point where the discrepancy between these two metals will begin to exert itself. And as usual, it will probably go too far in favor of silver. I don't know how far this will be, but it's a long way up from here. 

Technical Trends – Will It Move?

From the technical standpoint, we must observe that silver has been below $5 and has remained near $5 for a very long time. There have been a few exceptions. The announcement of Buffett’s purchase briefly sent silver over $7 an ounce.

I would like to divert slightly here and remind the reader that when silver was starting to show good price action, there was an immediate threat of a lawsuit against the “longs” for what else – manipulating the price of silver. Anyone that reads my work and that of others on silver is very aware of the short position, without any threat of legal action. This simple fact may go a long way in answering the question I so often receive, why hasn’t a big player bought up the remaining amount of silver on the Comex. Silver is probably the only commodity in the world where you may need an act of Congress to take delivery of your purchase. (Joking of course!)

If silver breaks above $5 and holds, the next strong resistance point is $5.50. In my view, this level will take some work to penetrate and corresponds to the $330 level in gold so often written about. Once silver penetrates $5.50 and remains, there's very little overhead supply above the $5.50 level.  I believe that the next time silver goes crazy, it will pass the $7 mark established during the Buffett purchase. Every time in the past when silver has broken up through the long-term channel formation near the $5 level, it has gone up very fast.  It is just as fast a performer on the downside. I don't think you would be unreasonable to expect silver to hit $7 in 2003.

Two influences could work against the silver bulls. First, if the price of gold were to drop materially, expect weakness in silver. Secondly, a severe world depression would cut down the usage. However, remember when that happens, there will be a big decline in mining of copper, zinc and lead, which relate to silver materials. So the production of silver should fall accordingly. The shortfall in usage against production would still be very large.

Supply & Demand Issues Favor Silver

Remember this always and everywhere: the stocks of silver are not inexhaustible. We tend to forget that. We tend to forget how near the point we may be when we arrive at the silver crisis. A silver corner developed in late 1979 and it did not hold. This was because it was largely manmade. The big silver corner will come when the supplies, regardless of anyone, are just not meeting demand. When that time arrives, $10 will be low for silver.

Pricing Affordability in Wealth Preservation

Another element that may well aid the silver situation is that gold is so high-priced that ordinary people can only buy tiny quantities of it. There may be a growing tendency for people to save silver as money-of-last-resort. On the level of the common man, silver may be the metal of choice; whereas the rich save gold. At any rate, the potential of silver would appear to be considerably greater than the potential for gold. Silver has been riding in a fairly stable area between $4.50 and $5 and heaven knows how long it has stayed there. This is certainly not a large percentage fluctuation, relative to what other asset classes have witnessed over the past several years. Overall it would appear to me, that this area, around $4.50, is highly favorable for the purchase of silver. What applies to silver must applies to the best silver stocks.

The Shine in Silver; Solid & Tangible

It can be taken for granted that metals are safer than other commodities, but are not necessarily a good investment at any given time. They are safer than other commodities for the simple reason that they not will spoil. Only gold and silver stand apart from other metals and have done so for thousands of years. That's not likely to change. The other precious metals will be priced according to the conditions. For example, platinum will remain rare, but if its usage fails to meet expectations, the price may decline. Of course if war requires more raw materials, then almost all metals would be in higher demand. Gold and silver, however, are the metals for those who wish to preserve their wealth.

Production Factors

Working strongly in favor of silver is the relative decline in production from a very long-term perspective. Silver stockpiles have declined dramatically during the past 13 years.  Going back in history to 1650, the world was producing 44 times as much silver as gold.  But now the world only produces about seven times as much silver as gold.

In all this time, consumption of silver has far outstripped consumption of gold. While the supply of gold as the monetary metal can remain adequate for at least a generation, this is not true for silver. The shortfall production of the consumption continues, even under recessionary conditions. It is very important to remember that during an economic downturn, silver production from copper, lead, and zinc, would be seriously curtailed. This fact was mentioned in a recent special Hightower report on silver.

This drop in mining other metals would mean an automatic curtailment of 75% of the source material silver of production, because nearly 75% of silver is mined in conjunction with copper and zinc and other metals. To increase silver production substantially, production of those other metals would have to be increased.

I concede that a depression would cut down the consumption of silver. However, the shortfall would remain intact. This has been evident the last couple of years. So every month, month after month, year after year, we are eating away at the remaining stores silver. In mathematical terms, it is a very interesting curve, because as a function of time, less is available. Thus, a larger amount in percentage terms is used as the months roll by.

Increased Merit in Silver Usage

As the world’s technology advances, the consumption of silver advances. Today photography consumes most of the silver, tomorrow it will be electronics and other new technologies that may rival photography in their demand. Two areas that have recently been reported are superconductivity and the use of silver as a replacement for arsenic as a wood preservative.

Silver is Money

At the same time, silver is still money, regardless of what the central banks say. We know this, because we know that are several hundred million dollars in silver holdings. It plainly states on the face of those silver coins that they are money. These coins are accepted without question as money. In this manner, I think silver has a monetary role to play.

Silver is Affordable to All

How many average people can buy 20 ounces of gold? How many can afford a 10 oz. bar of gold? How many of the world’s population can afford to buy even one ounce of gold at $320 per ounce? There are millions of working-class people that are not likely to be satisfied to hold as little as one gold coin. They would find it hard to negotiate for their needs. The sum is too large to negotiate for most daily needs. Gold is the monetary metal for the larger sums of money and for the rich. I believe that silver still has a role to play as money for the millions who cannot spend very much for total security, but still can spend something. Silver provides that security. They will have some money that will always work for them. So I repeat, it is not unreasonable to think that in the not-too-distant future, instead of selling a ratio of over 70:1, silver may well sell at a ratio of 10:1.

The Future for Silver

As the uses for silver continue to increase and the shortfall is accentuated, I believe when the right day comes, the correction in silver price will be even more dramatic than it was in gold after the signing of the Washington agreement. I believe the rising curve in silver will be breathtaking.

When this will happen exactly we do not know. I do believe it could begin in 2003.  Stocks of silver are dwindling and it is beginning to show. Probably the largest supply of silver is in India, but they are selling only tiny amounts relative to their total holdings. Millions of peasants hold silver for a last ditch emergency. This was verified in part by the latest GFMS study, which indicated silver movement within India due to natural disasters within the country.

All in all, the future for silver is subject to more influences than probably any other commodity, and certainly to more factors than gold. Whether this happens over the short-term or not, one must not lose sight of three major factors as far as silver is concerned. I like to call it the ABC’s of silver investing.

A. The shortfall is about 100 million ounces per year.

B. Silver is being consumed and not stored like gold.

C. Sooner or later we will run out of silver stockpiles. We're not too far from that day.  When that day comes, there could be a panic to buy silver. A ratio of 10:1 is a fairly reasonable expectation.
As I reflect on the merit and value of silver, both historically and in present-day terms, I wait in expectation for that “Day of Ah!” will surely come for AG.

© 2002 David Morgan
November 22, 2002