Silver Investing: Re-Monetization Ahead?

Silver Investment points to the early stages of re-monetization for this truly "monetary metal"...

how silver had been systematically de-monetized by governments worldwide over the past 150 years or so, writes Greg Canavan of Sound Money, Sound Investments.

(You can read Part I of Greg's in-depth analysis here...)

These actions have seen the Gold/Silver Ratio move from its long term historical average of around 15:1 to 66:1 today. In other words, one ounce of gold is now equivalent to 66 ounces of silver.

So here, we'll show you why silver could potentially be one of the cheapest assets in the world right now. The silver market is not at all analyzed by mainstream investors. For this reason, Silver Investment remains very much overlooked as an opportunity.

As proponents of sound money, we believe precious metals, most notably Gold Bullion, will have an increasing role to play as the current unsustainable system evolves to a more stable footing. But if gold's role as money becomes increasingly recognized, then Silver Investment will also come into the picture. Because as economist Milton Friedman noted, "The major monetary metal in history is silver, not gold." This fact hasn't been forgotten.

Investment demand for silver is beginning to grow very strongly and conditions are primed for this growth to continue. If this occurs, silver will effectively be 're-monetized'. As such we expect to see the gold/silver ratio to move heavily back in silver's favor in the years ahead. To understand why this may be the case you first need to consider the fundamentals of the silver market. That is, the supply and demand factors.

Let's look at supply first...

In 2009, 80%, of the world's supply of silver, or 709.6 million ounces, came from mine production. Peru was the largest producer of silver with 123.9m ounces, followed by Mexico (104.7m) China (89.1m) and Australia (52.6m). (Nearly all of Australia's silver production comes from BHP's Cannington Mine in North West Queensland. Cannington is one of the world's largest silver/lead mines. Pure silver mines are rare in Australia – most of the output is as a by-product of gold or base metal production.)

Supplies of scrap silver accounted for 19% of global supply in 2009, or 165.7 million ounces, while government sales represented just 1%. Notably, supplies from both of these sources fell heavily in 2009 compared to 2008.

Silver demand is a more interesting and complex story. The chart below, taken from the Silver Institute, shows the various sources of demand for silver.

By far the largest source of demand is 'Industrial Applications'. A funny thing happened to silver soon after its demonetization process got underway; new technologies resulted in a massive increase in its usefulness for industry.

As a conductor of heat and electricity, silver's qualities are unrivalled. Because it doesn't corrode or overheat (and therefore cause fires) it is used for switches, contacts and fuses in nearly all electrical appliances, from households to industry. In addition, silver is used in computers, mobile phones and cars.

Silver also has anti-bacterial qualities. Thousands of years ago, water and wine were transported in silver vessels to ward off contamination. Now, the medical industry uses silver in a range of applications to speed healing and avoid infections.

Silver has many other industrial uses, including advanced technology, however we think you get the gist. Silver plays a critically important role in the modern economy.

As you can see from the chart, industrial applications account for a large portion of silver demand. In 2009, it represented 48% of total demand, or 352.2 million ounces. This represented a sharp fall from 2008 as the global recession took its toll. But as you can see, this didn't really impact overall demand. We'll look at the reason for that in a moment.

Other major areas of demand include jewelry, which is fairly constant (22% of 2009 total demand) and photography (11%). Silver nitrate was first used in the photographic industry in the 1800s and it became a major user of the metal throughout the 1900s. However, with the advent of digital photography demand from this field has waned over the past decade.

Silverware demand (as in, plates, cutlery etc) has been fairly steady over the past few years while demand for coins (representing 11% of 2009 total demand) has increased strongly. In 2006 coin demand soaked up 39.8m ounces of supply. In 2009 coins accounted for 78.7m ounces – a near doubling in 3 years.

Which brings us to one of the increasingly important aspects silver demand – Silver Investment demand. (Note that investment demand and coin demand are counted separately). Here's where things get interesting. The Silver Institute tracks global silver supply and demand and you can find this data (going back to 2000) on their website. GFMS compiles the data. And as you have seen, mine production and scrap sales dominate the supply side, while 'fabrication' (which includes the uses discussed above) dominates the demand side of the equation.

But these two sources do not equal out. GFMS have therefore created a category, 'implied' investment, to balance out global supply and demand. From 2008 to 2009 this implied investment demand increased by a whopping 184%, from 48.2m ounces to 136.9m ounces. The creation of silver ETFs in 2006 is considered the primary reason behind the increase in Silver Investment demand.

But even a cursory glance at the numbers compiled by GFMS leads you to think that these numbers may be understated, perhaps significantly.


Well, the GMFS 2010 World Silver Survey shows that the total holdings of the world's three largest silver ETFs were 385.8m ounces in April 2010. The first ETF, the US based ishares Silver Trust, trading under the symbol of SLV, started in 2006 while the other two kicked off about a year later.

So we can safely say these ETFs have created new silver demand of nearly 400m ounces since 2006. But if we look at the implied investment figures from 2006 (inclusive) investment demand totals only 271.1m ounces. That leaves a 100m plus ounce discrepancy and we haven't even factored in sources of Silver Investment demand outside of the three big ETFs.

Now you might not think that this discrepancy is a big deal until you consider another piece of information. Do you remember how Bear Stearns collapsed in 2008 and the Federal Reserve helped finance its takeover by J.P.Morgan?

It turns out that Bear Stearns held a massive short position in silver futures at the time. Being 'short' a commodity or stock means you are betting on a fall in price. When prices rise, you lose. When they fall, you win. Now, the Silver Price was rising strongly at the same time as Bear Stearns was going down the gurgler (Feb/March 2008). Perhaps Bear was covering its shorts in an effort to stem losses? (Short covering can produce very strong price increases). But J.P.Morgan soon took over Bear Stearns and assumed Bear's short silver position. This did not become apparent until months later when newly released data showed that J.P.Morgan held the largest silver short position in the market.

At the time, prominent silver market analyst Ted Butler pointed out that one or two US banks (J.P.Morgan being one) were short a massive 169m ounces of silver. This constituted an unprecedented concentrated short position. It will come as no surprise then to see that the Silver Price collapsed as soon as J.P.Morgan took over the short position.

Is it possible that some investment banks are making up the difference between actual Silver Investment demand and available supply by taking short positions on the futures market? We think it is, especially if the silver ETFs don't actually have all the physical metal they say they do and are instead gaining exposure via the futures market.

The physical and futures precious metals markets (gold and silver) are a byzantine world and one we don't pretend to understand in full. But examining simple supply and demand data, it is hard to ignore that the recent increase in physical demand for silver, if sustained, could be very bullish for the price over the next few years.

Along with the big jump in demand for silver coins, the increase in investment demand suggests that silver is in the formative stages of being re-monetized. A global population suspicious of what governments will do to the value of their money in coming years is the driving force behind this remonetization.

As we pointed out last week, silver's role as money declined in the 19th century not because people decided voluntarily against using it, but because government's around the world virtually took it out of circulation.

If this trend towards silver as money continues, and we think it will, the gold/silver ratio should improve in favor of silver. However it is a tad optimistic to think the ratio will get back to its historical norm of 15:1.

There is one other bullish aspect to the silver story – its price. If silver really was just an industrial metal and not in the process of re-monetization, would it be trading close to its all time highs? No other industrial metal is.

Silver's recent price-high occurred in early 2008 (as Bear Stearns was crumbling). From there it fell heavily. It is difficult to put this circa 50% fall entirely down to the global deleveraging cycle because the majority of it occurred a few months before the panic of 2008 set in. Something else was driving the price down.

After bottoming at around US$9 in late 2008, the Silver Price has rebounded strongly and is now trading just below US$19. If silver can sustain a break through the US$19 area, we reckon it will go on and record new highs in a matter of months.

There are no guarantees in investing. There are only probabilities. Weighing all the evidence though, we think it is probable that silver prices will move to the upside in the months ahead. We therefore recommend that subscribers to Sound Money, Sound Investments take a small position in physical Silver Bullion (we will allocate 2% of 'Our Portfolio') and add to this on a sustained break above the US$19 area.

Our advice for how to go about acquiring physical silver is the same as for gold. We are not keen on ETFs and instead recommend you check out or as relatively simple and cost effective options to get access to physical silver. Both companies provide secure, audited vaulting services. In other words, you know that your money is there.

Disclosure: Sound Money, Sound Investments does not receive any commission for recommending the use of BullionVault and Goldmoney. The author has used BullionVault services to buy gold previously.

The addition of silver to 'Our Portfolio' continues our strategy to build a position of around 20% in precious metals and precious metal companies. Silver's story as a monetary metal is not well understood by the market and we think it makes for a compelling long-term investment.

Investing in silver via the equity market is much more difficult in Australia. Nearly all silver production here is as a by-product. However there are a couple of interesting investment options and we will take a look at these in the weeks to come.

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Greg Canavan is editor and publisher of Sound Money, Sound Investments, a weekly financial report devoted to unearthing great value investments amid today's "money illusion" of fiat currency. Formerly editor of Australia's market-leading finance newsletter, Greg has been a regular guest on CNBC, ABC and BoardRoomRadio, as well as a contributor to publications as diverse as and the Sydney Morning Herald.

See the full archive of Greg Canavan.

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