It can’t get no respect. But there’s nothing funny about this investment. The case for silver, says the world’s most famous precious metal analyst, is now stronger than it’s ever been before…
I have said it many times: mining is an innately risky business. Worse, it’s an impossible business if metals’ prices are too low. In the case of silver, during the long bear market from 1980 to 2003, when silver traded mostly in the $3.50-$5 per ounce range, there were no major, public, pure silver mining companies that generated free cash flow. None.
The end result was that very few pure silver producers remained in business. With the exception of a smattering of mines in Mexico, Peru and very few other locations, it has simply been uneconomic to produce silver (other than as a by-product).
That is not to say that there haven’t been profitable silver mines, but very large mining companies, such as BHP Billiton, generally own these. These are not stocks you would buy strictly for the silver exposure, however, because silver is a minute portion of the overall value of the company.
Which points to one of the fundamental caveats about silver: namely that around 80% of new production is a byproduct of gold, copper, lead and zinc. So silver is produced almost regardless of its price. That makes primary production of silver even more volatile and risky than mining in general.
Of the primary silver producers (defined as companies in which at least 50% of their revenue is silver), the value of the silver they produce represents only about 3% of total supply brought to market. It’s a tiny sub-sector of mining.
Silver Stocks: Supply and Demand
But, understanding the risks, I think silver stocks could provide some of the best, if not the very best, contrarian returns in the years ahead. There are several reasons I say that, but the main one is the ongoing silver supply/demand equation.
At first glance, one of the more remarkable aspects about the silver bear market was that, beginning in 1990, it occurred against the backdrop of a supply deficit. In those years when the global economy could be considered in a positive light, annual silver deficits ran as high as 200 million ounces. When the economy was in recession, the silver shortfall still came in at 40-50 million ounces.
More recently, in 2002, a down year for the U.S. economy, mine production totaled 585.9 million ounces, while total demand hit 863 million ounces. So production has not kept up with demand for a very long time.
For a brief period back in 1997-98, it looked as if the supply/demand imbalance had finally caught the attention of the market when Warren Buffet purchased 129.7 million ounces. Prices moved all the way to the $7.50 level before institutional short sellers and forward selling by base metals producers beat the price back to the $4 range. Once again, silver could get no respect.
Despite the supply deficits, and overlooking the relatively short-lived rally that took it to $8.29 in early April, the price of silver has been remarkably stable in the $4 to $6 per ounce range. Why no sustained recovery?
Ignoring the conspiracy theories making the rounds, the primary reason for silver’s doldrums has to do with the drawdown of accumulated stockpiles. These stockpiles include old scrap and coin melt, as well as those held by various governments who used to think that backing a currency with something other than cheap talk was the right thing to do.
Speaking of cheap talk, in 1959, the U.S. Treasury held 2.06 billion ounces, the majority of which was sold in the 1960s in a futile attempt to keep the price at $1.29, where they’d arbitrarily fixed it. The balance was used in the minting of Silver Eagles coins from 1986 through 2002. As a consequence, except for a few bars forgotten in some dark corner, the U.S. stockpile is gone. As the government uses 12.5 million ounces a year in coinage, it is (or soon will be) a net buyer.
Silver Stocks: India and China Holdings
The largest remaining known government silver inventories are in India, which was reported to be holding around 87 million ounces as recently as 2002.
The largest unknown government inventory is likely held by China, whose currency was the last in the world to be backed by silver. In its usual inscrutable way, the Chinese government has not revealed the extent of its holdings, but we know that it has been a big seller over the past few years, almost certainly helping to keep a lid on the price. Last year, of a total of 82.6 million net ounces of silver that came onto the market through government sales, 35 million ounces came from China. That on top of over 50 million ounces they sold into the market the year prior. Some of the most credible silver observers believe that these sales cannot continue for long at the same pace before the Chinese stockpile, too, is depleted…which the fall-off in year-over-year sales may already be indicating.
I would add that the Chinese may very well decide it is better to hang on to what they have left in their stockpile, rather than continue to trade it for increasingly worthless dollars. We should have additional clarity on the Chinese stockpiles later this year once The Silver Institute releases its new comprehensive study on the topic. Regardless, the odds are good that we are nearing the end of the period where government silver sales are much of a factor.
Institutionally held inventories (Comex, CBT, etc), have likewise fallen dramatically. After reaching 245.8 million ounces in 1996, these inventories have dropped by 41.3% to 144.4 million in 2002.
All told, according to the CPM Group, global non-coin inventory is now in the area of 419 million ounces, with an additional estimated coin inventory of about 487.5 million ounces, but one shouldn’t put too much stock in these figures because much of the world’s silver is now stashed in the lock boxes, drawers, and closets of individual holders.
Silver Stocks: Sellers Vanish
Speaking of individuals, as is often the case after a long bear market, sellers begin to dry up. Case in point, sales of silver by individual holders fell to 43.5 million ounces on a net basis in 2003, down from 81 million ounces in 2002…and well off the peak hit in 1997 when individuals dumped 221 million ounces back onto the market.
Jewelry demand, silver’s second largest use, was higher at 276.7 million ounces in 2003, compared to 265.9 million ounces in 2002, a rise of 4.06%. Driving growth is demand from Asia, including a 22% increase in jewelry demand from China and a 13% increase in Thailand. The fact remains that, while silver’s fundamentals are very much affected by industrial demand, it is still viewed as poor man’s gold by much of the world undefined an alternative to the colored toilet paper governments pass off as currency.
For some years now, silver bears have warned that the move to digital photography will dry up that important use of silver. In the long run, that may be true. Yet, the correlation with sales of digital cameras and available silver supplies is not a 1:1 ratio because photographic demand also influences silver supply. As much of the secondary scrap supply is refined from photographic film and chemicals, a decline in photographic demand also impacts secondary scrap supply.
According to the GFMS World Silver Survey 2004, photography, which accounts for the third-largest silver off-take, was down to 196.1 million ounces compared to 205.7 million ounces the year before. But even that relatively modest decline may not accurately reflect the trend because the Iraq war, fear of terrorism, and the SARS hysteria dramatically curtailed tourism and hence picture taking.
Silver Stocks: Industrial Usage
That same survey shows that a 2-year decline in global fabrication demand for silver ended in 2003, with demand increasing to 859.2 million ounces, 13.3 million ounces over 2002’s level.
Industrial usage, which is reflected in the fabrication figures, is the largest source of silver demand. It was up 2.87% to 351.2 million ounces. It is always worth noting that unlike gold, where virtually all the metal ever mined still exists, in the case of silver, most of that used in industry is consumed. I’m quite optimistic about silver industrial demand outpacing overall economic growth for the indefinite future simply because, of the 92 naturally occurring elements, it’s the best conductor of both heat and electricity, as well as the most reflective and the second-most ductile and malleable.
As a result, there are new industrial uses for silver consistently being developed, some with the potential to add significantly to demand, including uses as divergent as a catalyst in fuel cells for electric motor cars, high- temperature superconductor wires, and as an anti-microbial agent.
Unless the reported numbers are wildly askew, there’s no question silver is going much higher in price. And that’s not counting the possibility of a monetary, crisis-driven mania, like the mania that took silver to $50 in 1980. I have no reason to believe the numbers aren’t more or less accurate and plenty of reason to expect a mania.
for The Daily Reckoning
June 30, 2004
Editor’s note: Doug Casey, author of bestseller Crisis Investing, has been seeking and finding incredible opportunities around the world for over 25 years. He has lived in seven countries and visited over one hundred more, actively – and successfully – speculating in international stock, bond, commodity and real estate markets.
It’s Wednesday, the big day. And the world doesn’t hold its breath.
Nothing is going to happen to nobody, people believe. Today, the Great Enabler is supposed to announce a historic change in Fed direction. Henceforth, instead of making money easier to get, it will be harder to get – by, most likely, one quarter of one percent.
Alan "Bubbles" Greenspan has made money easier to get than any Fed chairman who ever lived. It was so easy to get for so long that a lot of people got a lot of it. Consumers had more (borrowed) money to spend than ever. That they spent it on cheap, imported goods was a wrinkle the Feds hadn’t counted on. Instead of inspiring jobs and capital spending in the U.S., the EZ money merely encouraged Americans to ruin themselves – while the jobs and factories sprouted in Asia!
Now, Greenspan’s reputation…and his economy…count on the recklessness continuing. Which is too bad for everybody because inflation rates are edging up. Interest rates are beginning to anticipate even higher inflation. The bond vigilantes, aslumber longer than Rip Van Winkle, now stir. Last quarter, they woke up and began to sell…it was the worse for bonds in 24 years.
The Fed can’t take this sitting down. It has to at least appear to protest. Its honor is at stake; which is to say, it doesn’t have much to lose. So it intends to raise interest rates by .25% – enough to show its heart is in the right place, but not enough to trouble anyone’s wallet.
If the announcement comes as expected, we will take off our reading glasses and pause for a moment of silence, here at the Daily Reckoning office in London. The present trend has lasted longer than most marriages. A person could have bought a house in 1980 and refinanced almost every year – knocking almost a full percentage point off each time. Each year, he would have had more money to spend…as his mortgage payments declined.
Larry Kudlow, a neo-economist, has written a remarkable article explaining why "this Bush Boom is a lot like the Reagan Boom 20 Years Ago." They are similar, we reply, but only in the same way that, say, Uma Thurman, stark naked, is a lot like Dick Cheney in a negligee.
Both may have a certain appeal. It depends on your tastes. In every particular – especially the essential ones – the two are quite different.
Bush is not Reagan. And America 2004 is not America 1980. Back then, stocks were cheap and gold was dear. Interest rates were high and bonds were low. It was, after all, before the boom began. If anyone knows how it can be compared to the period after the boom ends he doesn’t work here in the building with golden balls (explanation below).
1980, we have explained, was contrary to 2004 in almost every way. America was still the world’s biggest creditor – now, it is the world’s biggest debtor. America still had a positive trade balance – now it has the biggest trade negative imbalance ever achieved by any nation. Americans were still, relatively, unburdened by debt. Now, they carry such heavy loads, they may collapse at any moment.
Most important, the Reagan Boom and the Clinton boom that followed were largely, if not completely, driven by falling interest rates and EZ credit. Rising rates – which is what the Fed announces today – will have the exact opposite effect.
A Bush boom? Don’t count on it, dear reader. [Ed. Note: Safety is underrated. So it’s also cheap. Now it’s time to
take advantage of this complacency and protect our hard-earned assets. Dan Ferris has found the perfect vehicle.
More news from Addison:
Addison Wiggin, from Baltimore, Maryland…
– A new era starts today at 2.15 p.m. EDT, we think. Today, the FOMC will issue a press release with its latest decision on the official lending rate. Everybody seems to think that the base rate will rise by a quarter of 1%, and frankly, considering how scared the Fed is of the market, we tend to agree. The appeasement will continue.
– There is much lethargy in the markets at the moment. We see the S&P trapped in a narrow trading range between 1,130 and 1,135. Yesterday, it escaped…by one point, to close at 1,136. Likewise, volatility, as measured by the VIX, is extremely low. It currently hovers near the all-time lows set back in 1996. We keep reading that this market is difficult for both investors and traders alike and that everyone but the pros on Wall Street should be holding cash. People are bored; today, the boredom is expected to continue. "The rate rise has already been priced in to the markets," they say.
– We’re not so sure, dear reader. Low volatility doesn’t stay low volatility; it becomes high volatility. Boredom never remains. Just when you least expect it, boredom turns to excitement and complacency turns to panic. We don’t know what Mr. Market will feel like this afternoon, or tomorrow, or even next month, but we remind readers – the strangest things happen when no one is expecting them. ‘Nothing’ cannot happen forever.
– Yesterday, gold plunged back below the $400 mark. We can find only one explanation: buy the rumor, sell the news. With the Fed expected to raise rates for the first time in 4 years, all the recent rumor has focused on the ‘tightening’ cycle. Gold has struggled, but struggled well it has. At the beginning of April, gold was within a rounding error of $430. Then the jobs came, and the inflation and the earnings and Greenspan. The ‘relic’ was knocked down to the mid-$370’s by early May. But despite yesterday’s anxiety-attack, gold is still nudging $400. Who would have thought it? And just as Big Al embarks on a new era of inflation-quashing?
– And what about bonds? Treasurys are heading for their worst quarterly loss since 1980. The 10-year note started April at 3.84%. Yields had risen as high as 4.90% on the 14th June, although yesterday they closed at 4.70%, down marginally on the day. Bond traders actually listen to Greenspan and they believe him. In 1980, they didn’t. Whatever the Fed said, the markets did the opposite. They doubted the Fed would ever beat inflation. "It couldn’t be done," they said, "the U.S. is structurally prone to inflation." 10-year yields were pushed to 15.84% in September 1981.
– But do readers and bond traders really believe that Greenspan is serious in his threat to beat inflation at all costs? Could he realistically say anything else? From our humble perch, we don’t see an anti-inflationary policy for miles, or even the intent to impose one. We see the lowest interest rates for 5 decades coupled with a rapidly growing economy. We see an administration that will do anything to keep the credit bubble expanding and keep the consumer spending. They may talk the talk, but they will never walk the walk.
– Last quarter, the markets should have struggled, and for a while, they did. They hate rising interest rates, especially because such a huge proportion of America’s corporations are so directly dependent on low interest rates. But in actuality, the market has held itself with great aplomb. The S&P opened the quarter at 1,128; yesterday it closed at 1,136, up 3 points on the day. The Dow moved from 10,357 on April1 to 10,413 yesterday, a 57- point gain or 0.5%. Tech stocks, as measured by the Nasdaq Composite, moved up from 1,996 to 2,034 over the last three months, a 2% gain. Yesterday alone, they gained 0.75%. We admire the confidence of the lumpeninvestoriat. They should have been selling on this rumor and today they should buy the news.
– We may be on the cusp of a brave new world, dear reader, and it might start at 2.15 this afternoon. But then again, we’ve been saying that for ages…
Bill Bonner, back in London:
*** Gold plunged $8 yesterday. Inflation? Don’t count on that either, dear reader. Oil, of the Brent crude variety, dropped below $33 a barrel yesterday. Chain store sales were reported as ‘sluggish’ for last week. And Wal-Mart cut its sales forecast in half.
Autos are beginning to back up on inventory lots. Retail stocks are falling. These are not signs of ‘heating up’ or inflation.
*** American capitalism has become as degenerate as American democracy. The greedy scoundrels who run Fortune 500 companies increased their own pay 26% last year. Neither capitalism nor democracy work the way the textbooks tell you. Capitalist corporations are not run for the benefit of shareholders…and government is not run for the benefit of voters. Instead, both institutions have been captured by their managers…the smooth-talking hacks who make careers out of spending other people’s money. Year after year, the managers find new ways to get more of the money for themselves – stock options, pensions, health care, golden handcuffs…golden parachutes. Why not? The little guys never read the fine print. Politicians do the same – rigging the system so challengers scarcely have a chance. U.S. Term Limits, a group with an obvious purpose, estimates that the odds of a member of Congress getting reelected are something like 99 to 1. The only way to get rid of the leech undefined other than when the occasional lawmaker is caught in bed with either a live boy or a dead girl – is to wait for him to swell up and drop off. Otherwise, the lumpeninvestors and the lumpen voters are too busy refinancing their houses to notice.
*** The Queen’s Walkway, along the south bank of the Thames, was so crowded this morning your editor was practically knocked down by a reckless runner.
He tried to give the fellow a good Baltimore salute but he was off in pursuit of some other pedestrian before we could say anything.
What put the crowds on two feet this morning is a subway strike. Unionized ‘Tube’ workers say they are concerned that modernization will mean fewer jobs. What nincompoops.
*** Until this week, our new Daily Reckoning headquarters was in the Centre Point building…a protruding edifice so ugly that many Londoners were hoping terrorists would make it their next target. But it was not fear of death that lead us to move – it was fear of elevators. A high-tech system had been installed, such that once inside, you had no control over where you were going. This led to many pointless rides…as well as a longing to move. So, we found a graceless building with huge golden balls, on the bank of the Thames, a short walk from Waterloo Station. It is perfect.
*** Little Edward was delighted yesterday. The poor boy worked so hard at his schoolwork. Or, more accurately, his mother and a group of tutors worked so hard on him. But it seemed to pay off. He improved so much his teacher gave him "compliments."