Gold and Silver

Silver is a screaming buy

It is always difficult to assess if something is a buy or a sell. However, current market conditions and recent silver price make the task very easy for silver. I believe that this is one of the rarest opportunities to buy silver at such a discount. I also believe that price could go much higher from here for a short period of time – kind of the same or even bigger spike than that of 2009-2011 when silver price went up 5 times for 2 years. Let’s take a look what makes me think so.

As every asset, the price in a free market is set by demand and supply.

Supply-side:

  • Silver is relatively small market. Just to give you an idea – every year are sold and bought around 1 bln Oz of physical silver which at current prices is around $15 bln per year. This is extremely small market compared to others. For example yearly silver market in dollar volume is equal to three days of oil demand dollar volume. So the market can go up or down with an astonishing pace. That’s why silver is known as gold on steroids.
  • Silver supply comes from three sources – mine supply being the biggest, scrap and government sales. For some time government sales are virtually zero so the sources of supply remain 2.
  • Scrap silver is when people sell back their jewelry for money or when silver is being extracted from electrical appliances for reuse. Scrap supply is going down for the last 2-3 years and in 2014 was 168 mln Oz which is about 17% from total supply. And it will probably remain this way or even go down as at current prices people don’t seem to see an incentive to sell back their jewelry or silverware.
  • A lot of silver is used for the production of electrical appliances. But in each appliance, very little silver is being used – something like a gram or two. So most of the silver that is being used in electrical appliances will never be retrieved from there as it is not worth the effort at current price levels. Every year tens of thousand of Oz’s are lost forever from the silver market, without a chance to be retrieved again.
  • Mine supply is  the biggest source of silver – +80% of total supply. To get out silver out of a mine is a very long and risky process. Sometimes decades can pass from starting to explore a property to the first ounce being sold from that property. Very few things can compare in terms of complexity to the decision to open up a mine. So mine supply is a very sticky source. They can withstand bad economic conditions for quite a long as closing a mine is much worse that being 2-3 years in the red. But when mines start closing due to bad economic conditions, silver supply from these mines is lost for years and years to come.  That’s what is happening now – not many mines have closed since price of silver tumbled from almost 50$ 3 years ago to 14.50$ now. But not for long – some mines are are starting to get out of business due to low silver price. Remember, that supply is not going to recover any time soon.
  • Every mine has an area with higher concentrations and lower concentrations of metals in the rock. In normal times you mine from both so that you average out concentrations. Many miners however, due to low silver price are forced to mine only the high grade concentrations currently just to be able to survive. That in the long run is very detrimental however. It is like choosing to lose your two legs in order to survive now. When higher concentrations run out and miners are left out with areas of poor metal grades, miners will need much higher prices to mine the lower grades – or they will go out of business.
  • A lot of silver is mined as a by product of other materials – zinc, lead, copper and gold. All the commodities are being hit very hard in recent years so zinc, lead, copper and gold miners suffer just like silver miners, this putting further pressure on supply. This year for example two of the largest zinc mines are about to close without being replaced.

Demand-side:

  • Most of the silver is being used in industry – as i wrote before it has some astonishing characteristics which make silver invaluable in electronics, medicine and insulation. Industry takes up 60% of silver, jewelry – 20%, silverware – around 5% and the rest is investment demand in terms of coins and bars.
  • Industry is kind of steady consumer of silver. While some applications go down as silver in photography, others are on the rise – medicine, insulation and solar panels. Silverware and jewelry are also kind of steady. The only thing that fluctuates in big way on the demand side is the investment demand.
  • In contrast to stocks and other financial assets, silver demand goes through the roof when price goes down. Silver investment demand is set for a 29 year record this year. US mint is expected to sell around 45-50 mln 1Oz silver eagle coins this year. So 5% of the overall market goes in a single silver coin – i don’t know how that sounds to you but by all means that is huge number. Sales of maple leafs, philharmonics etc are also on the rise too. US mint is selling coins with two months delivery time as they just can’t make that many coins. If things don’t settle down, physical shortage is almost guaranteed next year.

But what about the price?

  • Everything is good so far but why price falls and does not soar? Valid question. Silver price is not set on the physical market but on the derivatives market. Every day, more silver is being traded than being produced in a year!!! So the pricing mechanism is not in the hands of miners and customers but in the hands of financial speculators. And in times of cheap money, resource is ample to manipulate price. However, when things reach a point when shortages of physical silver appear and you will be able to buy only silver derivatives, price will explode and wipe out unprepared speculators. No matter how long the rigging, the physical market is the king at the end of the game.
  • Official silver price is one thing but real price is something else. For example the price of silver now is listed as 14.5-15 dollars but 1 OZ american eagle coins sell at +30% premiums over market due to supply squeeze. So it is the kind of situation that you enter a shop with a sign “1 cent for a loaf of bread” but they have none left.
  • Silver miners sell silver at cost – Pan american silver, Coeur, First majestic etc all have all in sustaining costs around 15$ for Q2 2015 which is what the silver price is, so you can rarely have an opportunity to buy silver at cost.
  • Silver market sentiment is at multiple years lows which by itself is a very bullish sign. Remember what Buffet said – “Be greedy when others are fearful and be fearful when others are greedy”.
  • Big investor names are aligning for a bull run in the  resource industry as Carl Icahn, Soros, Stanley Druckenmiller and Mrc Faber.

 

Investing in silver is not for the faint-hearted as it goes down or up in high magnitude in short periods of time. However, if you get on board in the right moment the returns are compared to nothing else. I think that it is just that kind of a moment now. Of course you should be thinking only physical silver and not paper derivatives over silver.

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