Milton Friedman, Nobel Laureate in Economics
Gold is good but is silver better? We think so and in this article we explain why. Silver has been right there with gold as a currency. In fact silver has been around for centuries and has been used as money in different places, for longer periods of time of time compared to gold. Although these days, silver is generally regarded as more of a commodity, being widely used in industrial application such as photography, electric conductors and others, it is making a comeback as a precious metal that has great value potential. During the height of the global financial crisis in 2008/09, the amount of silver coins minted showed a massive resurgence indicating the flight to safety from paper currencies.
As an industrial metal, silver is well sought after for its unique characteristics:
• It is by far the best electrical conductor of all metals, precious or otherwise, often used for making of electric switches, conductors and others,
• It is strong, reliable and ductile, hence, a good ingredient in making batteries, medical appliances, and solar panels,
• Silver’s reflective nature and sensitivity to light makes it suitable for making quality jewelry and silverware. However, this sector accounts for only 1/3 of the silver industry. About 50% of its fabrication use comes from industrial demand while photography accounts for about 12% of total demand.
Use of Silver
Source: The Silver Institute, 2009
Silver can be considered a genuine form of money. It is different from gold but it has the 6 aspects of money in the classical sense. It is divisible, durable, convenient, consistent, has utility value and cannot be created by government. As such it is a good store of value, often used in the past as a medium of exchange, and a profitable precious metal to have in your portfolio.
There are three good reasons to buy silver today.
1. It is cheap relative to gold
One of the ways to determine whether the price of silver is cheap or not, is to compare it to another precious metal, namely gold. In the past, gold and silver had been side by side as currencies in circulation. The exchange ratio was fixed at around 15: 1 i.e. 15 ounces of silver for one ounce of the yellow metal. In the 1980s’ it was around 17: 1 which is close to the long-term average. By end of 2007, the average was 54 times down from the all time high of 96 times. Today, the price of gold is at $1200/oz and the ratio is now around 65:1. We know that when gold prices in USD start to fall, the ratio of silver/gold tends to rise. That is, silver tend to fall even faster than gold as the monetary part of its demand evaporates. But the reverse is also true: as the price of gold starts to rise, the impact on silver will be more pronounced. Hence, silver will likely to outperform gold in a precious metals bull market.
If gold price goes from $1200/oz now to say, $2000/oz, which may happen in a short time, then the ratio of silver/gold may fall to say 30:1 which is still quite high. That means 30 ounces of silver for each ounce of gold – implying a silver price of roughly $60/oz which gives us an upside of a staggering 350%!
2. It is cheap relative to stocks
Another relative measure would be to compare the price of silver to stocks. The question asked would be: how many ounces of silver would buy you one share of the Dow Jones Industrial Average (DJIA)? Note: DJIA is the oldest stock indices available and dates back to the 1930s.
From the chart below, the ratio of DJIA to Silver from 1 Jan 1996 to 1 Aug 2010, we can observe that the ratio was as high as 2500 times in 2001. In other words, you needed 2500 ounces of silver to buy one share of the DJIA. The ratio in 1996 was almost 1000, and today, it stands around 500, with price of silver at around $19 per oz. In 1980s’ the ratio bottomed at only 18 times. So, we can observe that the current ratio is around 20% of its peak ratio, and it can be argued that the stock market is probably just in recovery phase, post the 2008/09 global financial crisis. The DJIA is likely to move up further in years to come, as the prospects of US companies’ earnings improve, implying that prices of silver will likely to increase: even to just maintain its current ratio of DJIA/silver of 500 times.
Silver is cheaper compared to stocks
Source: www.finance.yahoo.com, The Silver Institute
3. Silver prices to move up as demand exceeds supply
It is interesting to note, that price of silver today at around $19/oz is 65% below its 1980 average of $54.63/oz (in real terms, i.e. 2009 inflation adjusted). Thus, it provides an excellent entry point to precious metals versus gold.
Although in 2009, we see a slight surplus in terms of supply over demand, this situation is likely to reverse. The increase in demand would come from: 1) an increase in demand from investments, namely in exchange traded funds (ETFs) and private investors. And 2) an improvement in industrial demand for silver as the global economies hit by the 2008 financial crisis, resume its growth path in next few years.
i) Over last 10 years there has been a significant increase in the fabrication of coins and medals by 145%. The other sectors (namely, jewelry, and silverware, photography, and industrial) have all shown declines over the same period. Most of the increase in demand has been driven by the uncertainty in global financial markets, diverting much of the money previously in currencies, and financial assets into physical assets such as silver and gold.
Silver demand to be driven by investments/ETFs
ii) Meanwhile silver production from mines is expected to be limited. This source of new silver showed a growth of only 20% from 2000 to 2009 which is very insignificant. Supply from mines in 2009 grew only marginally by only 4% to 709m oz (and derived mainly from primary silver mining sources and from gold mining). Scrap supply continues to fall and supply from government sector also fell in 2009: they have very little stock left (estimated at 61m oz as at end 2009) hence limiting its supply to the market.
Supply of silver increasing only at moderate pace
Given this imbalance scenario, it appears that the price of silver will likely to move up as demand outstrips the limited supply coming on-stream in near future.
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Chris Gan
29 August 2010
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