What's Next for Silver?

The Daily Reckoning PRESENTS: The performance of silver has outshone even gold: silver was up almost 31% in 2005, compared to gold’s gain of almost 18%. Now some investors are asking: “Was that it?” And if we aren’t near the top for silver, then how high will it go? To answer those questions, Doug Casey looks at what’s driving the market today…


There are important differences between silver and gold. The demand for gold is almost entirely a demand for holding the stuff for financial purposes (protection and profit) and for uses, such as jewelry. Very little gold is actually consumed. In this respect, gold is the polar opposite of a base metal, such as iron, that people buy exclusively for purposes that use it up. Silver has a foot in both worlds; some is bought for uses that will consume it; other ounces are held for financial protection or profit.

Most of the gold ever mined (including the metal in Baal, Cleopatra’s necklace and what Alexander looted from the ancient cities of West Asia) remains above ground in various easy-to-melt forms. The reasons for gold’s physical persistence are chemical – it is nearly inert, so it doesn’t corrode – and economic; because of its great value, very little gets lost or discarded as waste. Annual mine production is small compared to the existing stockpiles – on the same order as the small amount of gold that is lost or consumed each year. So, the size of the existing stockpile doesn’t change much. Fluctuations in the price of gold come almost exclusively from fluctuations in the demand to hold the stuff.

Ounces of silver, on the other hand, come and go – not as quickly as tons of iron, but as inevitably. Silver, unlike gold, is chemically active. When silver is used, much of it gets used up – consumed beyond practical recovery. And because silver is so much less rare than gold, less effort goes into salvaging and protecting it. Annual mine production and consumption are large compared to existing stockpiles, so fluctuations in price come from changes in both those factors and also from changes in the demand to hold silver for financial purposes.

The uses for silver in modern industry are growing. It is the best conductor of both heat and electricity, the most reflective, and (after gold) the second-most ductile and malleable element. It is used in photography and for many electrical applications, particularly in conductors, switches, contacts and fuses. Silver alloys are used in batteries as cathodes. As a bactericide, silver is used in water purification and air-handling systems – we recently came across an ad for a silver-lined washing machine that claims to need no detergent to produce clean laundry.

The uses for silver are so numerous that, despite the dwindling role in photography, you can expect demand to remain strong as long as industrial economies remain strong. And they have been so for some time now – with China and India leading the charge.

But since the Hunt brothers’ ill-fated attempt to corner the silver market back in 1980, there has been little investment demand for silver from the public in developed countries. This has clearly and unequivocally changed, as evidenced by the new silver exchange-traded fund (ETF) from Barclays.

Most silver mines are really lead-zinc-silver mines or copper-silver mines or gold-silver mines, from which silver is a byproduct. In fact, 70% to 80% of all silver comes as a byproduct of copper, lead and zinc mining. Because the byproduct element is so large in the supply of new silver, production doesn’t respond much to price. This puts the few mines that do produce primarily silver in an extremely risky position. Over the last two decades, with silver being dug out by copper, lead and zinc miners regardless of how low the price went, most pure silver mines consistently lost money, and none were especially profitable. For more than 20 years preceding 2003, no pure silver mining company generated free cash.

However, there are many known silver deposits and proven reserves poised for production as soon as silver crosses whatever price line makes them economically viable. Furthermore, low silver prices don’t necessarily halt exploration; it’s the prices of copper, lead and zinc that drive exploration.

So, with silver hitting record highs and base metals doing the same (increasing the flow of silver as a byproduct), hundreds of millions more ounces of silver will be heading for the market. According to the latest projections in the CPM Group’s CPM Silver Yearbook 2006, there may even be a production-consumption surplus of 48.4 million ounces of silver in 2006, the first such surplus since 1989. However, those figures don’t include investment demand. The production-consumption surplus means that inventory will increase, but that still doesn’t tell us where the price is headed. If financial demand (to hold silver for protection or profit) increases faster than the accumulating physical inventory, the price will keep going up. But will it?

For one thing, consumption has been eating into above-ground stocks of silver at a phenomenal rate for decades, eroding total world bullion inventories from an estimated 2.1 billion ounces in 1990 to around 400 million ounces today – a drop of 1.7 billion ounces. A large chunk of the drop, about 240 million ounces, came from government sales. But that source is almost gone, with governments holding only about 87 million ounces at the end of 2005.

For another, silver is like uranium as an industrial metal, in that it is hard to replace and it is used in such small relative quantities, that the price could double or triple without having a major impact on industrial usage. But the main reason, as mentioned above, silver is being rediscovered as an investment vehicle, most notably in Barclays’ new silver ETF (SLV).

The advent of Barclays’ silver ETF has been a big factor in the price of silver lately, if only through the expectations of speculators. The popularity of the streetTRACKS Gold Shares ETF (GLD), which has raised $8.13 billion since it began trading in November 2004, suggests that Barclays’ silver ETF will pull a lot of silver off the market. As of this writing, August 7, 2006, it has already sucked up 92.4 million ounces of silver. There goes the supposed surplus.

And as silver gets back on trend, and gets noticed by an increasing number of investors, the ETFs will make it easier for those investors to participate.  That is also true for certain institutions – most of which are barred from owning physical metals – so they will, in essence, uncork a latent source of investment demand. And Barclays’ silver ETF may be even more important than GLD. In Europe you have to pay a VAT (17.5% in the UK) on the purchase of silver bullion bars, as the metal is used in manufacturing. This is a blight on active trading – a market niche the new ETF accommodates free of VAT.

Throw in well-deserved concerns about the U.S. dollar and about the at-least-it’s-not-the-dollar euro, and increased financial demand will almost certainly outstrip any increase in global silver production for the next couple of years. And, of course, if there’s a major economic crisis, the production-consumption surplus will be utterly swamped in the mad dash to get out of paper and into precious metals – a transition the ETFs will facilitate greatly.

There is another potential source of silver – the tons of it that people hold in the form of old junk. If a high price for silver starts getting people excited, won’t the masses send their broken candlesticks and seldom used spoons and trays to scrap dealers? Will that source of supply turn into a flood, as it did so dramatically during the 1980 price spike? At some price, yes – but probably not for a while.

Stable higher prices will encourage people to sell. But rising prices and the reasons for the growing financial demand will encourage people to put off selling even their unloved, broken candlesticks. Even as the incentive to melt down Grandma’s tea set increases, the “silver is money” factor pushes the other way.

In 1974, silver was at $6.70, about twice today’s price in constant dollars, but supply from all secondary sources was less than 170 million ounces. And in 1980, when silver reached its peak at $48.70 per ounce, secondary sources provided just 302 million ounces – a big number, but nothing like 20 billion ounces. Furthermore, the great bull market in silver that ended in 1980 came after a hundred years in which the public accumulated relatively cheap silver. A lot of that was cleared out – melted down – in the early 1980s, and there hasn’t been as much time to replace it. Not only that, we suspect that relatively few people have bought much made of pure silver since 1980; if you can’t afford gold, why pay for solid silver when you can get something electroplated that looks just as good for a fraction of the cost?

Will silver hit its previous 1980 high? It was $48.70 then, but that’s $120 in today’s dollars – almost 10 times the current price. Given that just below the surface, the threats to the U.S. economy are even greater today than in the late 1970s, we can easily envision silver closing in on its previous high and even going way beyond it.


Doug Casey
for The Daily Reckoning
August 22, 2006

P.S. When will this come to pass? No telling. But, periodic and inevitable corrections aside, it’s going to happen, of that we are confident. And, more to the point of our service, when it does, the silver stocks we follow on behalf of our readers won’t just go to the moon, they’ll leave the solar system. To be sure you don’t miss this profitable ride on the resource bull market rocket, subscribe to the International Speculator now.

Editor’s Note: Doug Casey is the author of Crisis Investing, which was #1 on the New York Times Best Seller list for 26 weeks. He is also editor and publisher of the International Speculator, one of the nation’s most established and highly respected publications on gold, silver and other natural resource investments.

“Inflation is a crowd phenomenon in the strictest and most concrete sense of the word. The confusion it wreaks on the population of whole countries is by no means confined to the actual period of the inflation. One may say that, apart from wars and revolutions, there is nothing in our modern civilizations which compares in importance to it,” wrote Elias Canetti in “Crowds and Power.” “The upheavals caused by inflations are so profound that people prefer to hush them up and conceal them.”

Last night, before going to bed, we read an essay by Paul Cantor about hyperinflation in Germany in the 1920s and how it affected the writings of Thomas Mann, particularly his short story, “Disorder and Early Sorrow.” Cantor deconstructs the story from the perspective of Austrian economics, showing how hyperinflation provides not merely a background, but also a means of understanding it.

This is how Mann describes one of his characters, a housewife, coping with skyrocketing prices:

“The floor is always swaying under her feet, and everything seems upside down. She speaks of what is uppermost in her mind: the eggs, they simply must be bought today.  Six thousand marks a piece they are, and just so many are to be had on this one day of the week at one single shop fifteen minutes’ journey away.”

We find we do our best thinking when we are asleep. While we were dozing, our brain must have gone to work on the theme of the article like a Pakistani policeman on a “jihadi.” We awoke in the middle of the night to find it reduced to a bloody pulp, and blabbing about one simple and horrible crime:  the destruction of the American middle class.

But, the culprit is no pawn of jihad. No splinter faction or 5th columnist…no mole, no collaborator…no revolutionary cell skulking in basements. No, in the United States in the early 21st century, as in the Weimar Republic, the saboteurs are the financial chiefs ensconced in the capital itself. They are the nibs whose faces grace magazine covers, who give speeches, win honorary degrees, and chivvy consumers  – can you believe it? All to avail themselves of every latest innovation from the financial industry…such as adjustable rate mortgages.

Remember that although the value of the dollar was whittled in half during his tenure at the Fed, Alan Greenspan enjoys his retirement today like a portly bishop…basking in a job done well. And, was it not the same Alan Greenspan who was knighted by Queen Elizabeth II, shortly after he won the prestigious Enron Prize?

The inflation of the mark in Germany led to disorder. It then led to sorrow. The inflation of the dollar, over the last quarter of a century, leads in the same direction…winding through bubbles, busts, ARMs and Neg Am mortgages. In the last four years alone, debt in the United States has gone up by an amount equal to 100% of the GDP. There are now an estimated $300 trillion worth of derivative contracts outstanding – in a world economy only worth $55 trillion. And, it takes five to six dollars of additional debt to create one single dollar of additional GDP. The typical ratio is usually about two dollars of debt to one dollar of GDP.

But it is the bust in residential real estate that creates the most disorder and the most sorrow, because it has got the middle and lower classes caught in a steel trap from which they cannot escape.

“No Money Down Disaster,” reads a headline in this week’s Barron’s. The author notices what we have been saying for months that adjustable rate mortgages are on the verge of ruining the marginal borrower and dragging down the entire economy, too.

For, now, says Barron’s, residential real estate is threatening to revert to the mean, which may indicate a 30% drop in prices that will wipe out the equity of millions of homeowners.

Either they will end up paying more than they can afford (why did they go for “no money down” in the first place?), for something worth less than they paid for it (that is what happens in a bear market). Or, they will lose their houses. When that happens, the world they thought they understood, will give way beneath their feet.
As Dr. Cantor writes about the 1920s, “A society composed of embittered people…is soon going to face major political problems, as the rise of fascism in Germany was to show.”

More on this later in the week…

First, more news from our currency expert…


Chuck Butler, reporting from EverBank:

“German investor confidence really took a hit this month as measured and reported by the German think-tank ZEW. Investors are beginning to show concern about the higher interest rates and the upcoming higher taxes that begin in 2007.”

Read today’s Daily Pfennig here.


And, in the meantime, more thoughts…

*** The latest from Addison and his perambulation with the good doctor:

“My thinking on these issues has never been clearer,” Dr. Richebächer asserts. “You must think about cause and effect. And place the stones in a row…stone for stone…to understand consequences. Americans no longer consider consequences. They see that everything is going well today. They assume every thing will always go well.

“But what can the U.S. consumer do? Overly indebted consumers must pay back their debts somehow. There are two ways to do s through rising income or by selling assets. Therein lies the problem. The United States today has its lowest level of income growth since the Great Depression. And asset prices have either stagnated or started to fall – especially housing.

“Consumer borrowing is fine for a young couple who can reasonably expect their incomes to rise over their lifetime. But today, you have credit expansion that is completely out of control. Even since the Federal Reserve began raising rates in 2004, bank credit expansion has continued unabated.”

[Addison’s note: One way for the Federal Reserve to aid in bank credit expansion is through “open market operations” – purchases of securities and other assets on the market. From a low of $550 billion in 2000, when the stock market began to crash, the Federal Reserve has continued to add assets through the “open market,” even while publicly claiming they are “tightening” monetary policy.

In 2004, when the rate hikes began, the Fed had already amassed $750 billion in assets. Today it has nearly $850 billion. A chart of bank credit expansion during a period of public credit tightening reveals the exact opposite. To quote the good doctor: “There has been no monetary tightening. Period.”]

“What will happen next, we suspect,” Dr. Richebächer continues, “is that asset prices will decline precipitously and the consumer will be left with a pile of debts. With what resources will he repay them? Ja, it is consequence that matter…not assumptions.

“Still there is not a single critical word from the economic establishment in America.”

*** “A fool and his money are soon parted,” goes the old saying. What has always puzzled us is how the two of them got together in the first place. The world is full of dunces and dimwits…many of them with money. But, where and how did they get it?

We are not sure of the answer to that, but we are dead certain we know how the two go their separate ways.

The other day, for instance, we were sitting down with a young friend of ours.

“Yes, I’ve decided to set up my own business,” he said.

“Doing what?” we wanted to know.

“Managing money,” he explained. “It’s just much better to be on your own. You don’t have all that overhead and employees to bother with. And here in Europe, there’s not a lot of regulation, as long as you stick to rich clients. You know, high net worth individuals.

“I only invest in value plays. Remember, I used to try technical trading and other forms of speculation. But what I learned from you was that what really works is following a ‘Warren Buffett’ approach. And so far, I’m up 40% this year. And, I made a 38% gain last year. Really, I’m just in two areas now: gold stocks (I guess I learned that from you too) and Chinese stocks.

“And, I charge clients just like everyone else, a 20% performance fee…”

Thus is a hedge-fund manager born.

And thus, does a whole industry of clever folk get to work to try to take a fool’s dough away from him. They offer to protect it, to manage it, to invest it, to coddle it, caress it, clip its nails and dye its hair. And when they’re done, so is the dough.

Our young friend knows nothing about investing – or rather, not much. How do we know? Because we taught him everything he knows. Yet, here he is now providing financial services to hundreds of wealthy clients – one of thousands, maybe millions, of people in the world’s most profitable sector.

*** The Italian Rivieria is far more dramatic – and inhospitable – than the French one.

‘Riviera’ technically means a location in which the mountains drop directly into the sea. On the Italian side, this is definitely true. The beaches are beds of sea-worn rocks roughly 10 meters wide. Stepping into the sea is more like diving into the deep end of a swimming pool than wading softly off a sandy beach into sun-warmed seawater. The bathers are still topless from time to time. And the atmosphere still relaxed, if not more so. But there’s less space between the cliffs and the sea.

This weekend we slipped away to the Italian coastal ville San Remo. We’d heard of an enormous flea market in the center of town, which turned out to be true. But the old salt that the journey is often worth more than the destination proved itself true. On the way back, we ended up making a pit stop at a restaurant that couldn’t have been built on more than 20 meters of land. High class. Civilized. And empty, but for a few well-dressed diners in the middle of a hot day.

We entered and immediately caused a commotion. Our two boys were sporting soccer shirts we’d purchased at the flea market. One wore a French national team shirt with Zidane written across the back…the other, Italy, and the name Meterazzi. (If you don’t follow le football, France and Italy were in the finals of the World Cup this year. Zidane, the French national star, was thrown out of the game with 10 minutes remaining after head-butting Meterazzi, an Italian player, in the chest. The fact that our kids were wearing both shirts earned them free entrees in the restaurant. Heh.)

Above the French border town of Menton, a few kilometers later, we discovered the little village of St. Agnes, which claims to be the highest coastal village in Europe. We don’t dispute the claim; it rests on top of an 800-meter mountain with cliffs on three sides. There have been people living in the area since before the Romans conquered Gaul. The ruins of a ninth-century chateau rest at the very crest of the mountain.

The high mountain village of St. Agnes is also the site of the second fort inland, of those that made up the Maginot line. A deep bunker with gun turrets and enough room to house nearly 400 men, the fort is a testament to the adage that generals always strive to fight the last war. It was opened in 1932, but closed in 1938 before the real hostilities between France and Italy began.

This area had formerly been in dispute for centuries. Not far from the village, in a hamlet known as La Turbie, lies an enormous Roman ruin known as La Trophee des Alpes. It sits high on a mountain overlooking the tiny principality of Monaco. In fact, directly below the edge of the park in which the ruins lie, you can see the palace of the Grimaldi family, and the many casinos of Monte Carlo. The Senate in Rome dedicated the Trophee des Alpes to commemorate the Emperor Augustus’ dominion over the tribes of Gaul. The site also served as the starting point on a coastal highway known as the Via Julia that connected Italy with Spain and opened the whole of the western part of the Empire to trade.

Today, on both sides of the border, residents are equally fluent in French and Italian. It’s as if the Trophee des Alpes and the forts of the Maginot Line never existed. “In Europe,” Dr. Richebächer explains, “the people have taken over. Our politicians talk and try to do things. But nobody listens to them anymore. We know that nothing good can come of it.”

The Daily Reckoning