By Greg Peel
"The short answer is that the results astounded me, as I think they will astound you. I must confess – it takes something very special to make me feel I have underestimated just how bullish silver really is. This study has had that effect on me". Theodore Butler is a self-confessed "silver bug" and, to his fans, a silver guru. The study to which Butler refers is one he has conducted recently, and clearly has been moved by. Critics may scoff, but the reality there is a groundswell of belief that while there may be reasons to feel the gold price could see new highs, there is potential for the silver price to explode to levels never previously imagined. Before turning to the fundamentals of Butler's study, it is necessary to look more closely at the "poor cousin" metal that is silver. Silver has the highest electrical and thermal conductivity of any metal, the highest optical reflectivity, and the lowest contact resistance. Silver is classified as a precious metal, but it is the only metal with the chemical reactivity to act as a catalyst in several applications. While "precious", the vast majority of silver's usage today is in industrial applications. "Silver is arguably the most versatile of metals", notes silver expert Richard Karn, "as is witnessed by more patents being filed for new uses of silver each year than for all other metals combined". Karn notes that that there are two approaches to investing in silver – as an industrial metal (or "commodity"), or as a store of wealth in terms of monetary inflation in the same vein as "precious" cousin gold. This dichotomy has, in the past, resulted in a clash between both camps in the market. In 2004, when the overwhelming success of the first US-based gold exchange traded funds led to talk of an equivalent silver product, the Silver Users Association was up in arms. An ETF must store the amount of metal it sells through the fund, and thus take it off the market. Silver has been in deficit for years, in terms of demand versus new production. "There isn't enough silver!" cried the SUA. SUA represents those manufacturers, from jewellery-makers to industry, who buy physical silver. Their cries fell on deaf ears and in 2005 the first silver ETF was listed. The price of silver jumped almost overnight, from around US$7.50/oz to over US$12.00/oz. While ETF buyers were no doubt cognisant of silver's industrial profile, it was as a precious equivalent to gold that they sought investment. In previous times, buyers of silver for industrial use had often met precious sellers coming back. While this often made for a chaotic market, everyone was happy. Now the two camps are aligned, and Richard Karn, in the latest Emerging Trends Report, suggests the two will have to live together. Not only do inflated commodity prices reflect increased demand out of the emerging world, but they also reflect the diminishing purchasing power of the US dollar. "Make no mistake," says Karn, "at some point the dollar will inflate itself into oblivion as has every other fiat currency in history; when, however, is anyone's guess". One of the arguments for a much higher gold price in the near future is that the US government has artificially propped up the US dollar through hedge fund and tech-wreck crises and recession. It has done this by selling gold under the radar, through leasing arrangements and derivative instruments. This means the amount of gold left in central bank vaults is becoming critical, and derivative obligations are covered by printing cash. If gold runs, so will silver, but even without that consideration the bullish story for silver as an industrial metal is no less compelling. The global slump in commodity prices began after the boom in capacity following World War II and bottomed in the recent technology boom. As is often cited, capacity expansion in recent times has been non-existent, given it's all miners have been able to do to survive, let alone expand. When China took off so did capacity development, but China had a very substantial start. One way mining companies survived was by consolidating, such that any growth came from acquiring existing reserves rather than developing new ones. This is why the "super-cycle" theory was born, and why resources analysts took a long time to shake off long-held belief in the cycle of supply rising to meet demand. China has kept growing, but mining capacity has lagged significantly. It has also meant that costs have increased substantially, as there is now an undersupply of technicians, workers, equipment and mining supplies. But while costs can harm profit margins, Karn suggests it's naïve to think producers will not pass cost increases on to consumers. This has largely played out. There is a groundswell of feeling that the Chinese economy simply cannot keep growing at current levels, and look out when it slows down. One argument is that the massive infrastructure boom underway will end as soon as the Olympic cauldron is doused in Beijing 2008. But in the 1950s the US consumed half the world's commodities. Karn suggests that if (the much more populous) China can do the same, we still have a long way to go. Silver is used in a surprising array of industrial applications, albeit usually in small quantities. One of the traditionally extensive uses is in photography. But silver use in photography has declined by 22% since 1999 when the digital camera became commercially accessible to all and sundry. This is one reason silver followers have been unenthusiastic about the metal as the new century unfolded. However, the flipside is that photographic plates – once the major source of scrap silver – will eventually disappear. Moreover, another factor that has yet to take effect is that unless today's photos are printed out on silver-backed paper, they will quickly deteriorate. Nor are CDs and DVDs indestructible. In fact, we all now realise that an audio CD will develop a "scratch" just as quickly as an old vinyl LP. Some pundits actually believe that while the typewriter may have been superseded, the old 35mm camera will not be. Photography may or may not be a victim of technological development as far as silver is concerned, but technology has also opened up a whole range of new uses for silver. Since 2000, silver's industrial use has only slipped 5%. At the same time, usage of silver in computer chips has increased 3%, 50 million ounces were used last year alone in the development of superconductors, and sales of plasma television screens are expected to triple by 2008. A 42 inch screen uses as much as an ounce of silver. This has all occurred while the silver price has increased by 10%. Silver is also used in solar energy systems and water filtration systems. Think of the upside there. Growing demand is all well and good, but the fallout from a growing price in any metal is usually substitution. Part of the current drop in the copper price is attributed to the search for different, cheaper alternatives. Indeed, already silver has been replaced in various applications by stainless steel, aluminium, rhodium, tantalum, and antimony. Such substitution will be a factor of price, but on the flipside silver has also been used as a substitute itself, for gold and platinum. That's the demand side. Let's now consider the supply side. For the last thirty years, the consumption of silver has exceeded the production of silver. The difference has been made up from scrap (principally photography) and inventory sell-down. Photographic sources are running out, and it is estimated only about one to two years of global silver inventory remains. The deficit still exists despite silver production increasing by 8% in 2005. But the other factor, peculiar to silver, is that only 29% of the new metal actually came from silver mines. The remainder was extracted as a by-product from copper, lead, zinc or gold mines. Notes Karn: "Ironically, 450 years of advances in extraction technology have relegated silver mining to a secondary source of silver ore." There would thus have to be a significant increase in the development of new silver mines to make any dent in the deficit, and the Emerging Trends Report knows of none planned. So low has silver fallen in reputation, that miners of base metals have in the past been selling their silver by-product forward at bargain basement rates in order to assist in mine funding. Karn notes that silver is actually tipped to go into surplus in 2006, but only because silver bought by ETFs is counted as non-consumed, and thus it eventually must be sold. While the US government alone held 2 billion ounces of silver in the 1950s, today's estimates suggest only 88 million ounces are held by governments world-wide (most of it by India). There is thus no real lender of the last resort in the silver market, other than that which is held in private hands. Calculations suggest 42.5 billion ounces of silver have been mined in the history of mankind, and that about half of that has been consumed. Of the remaining 22 billion ounces, only 5% is held as bullion or coins. The rest of it is in Granma's cutlery drawer. Yes – 95% of the world's silver has been fashioned into forks or trays or trophies or jewellery or religious icons. While most doubt religious icons would ever be sold just because of a high silver price, there has always been much debate as to at just what price the average citizen might be prepared to part with Granma's cutlery. If everyone sold their silverware, that's a lot of silver. The rule of thumb used to be US$7/oz, but here we are at US$13/oz. This suggests that very little silverware is being melted down. In the meantime, newfound investor interest is surging. At the end of July, silver funds held 120 million ounces of metal. This supply is not allowed to be lent back to the market, so it is effectively removed from the market (until the time to sell out is reached). No one knows the answer to the silverware sale price question, so let's go back to bullion. There is about one million ounces of silver held as bullion or coin. By comparison, there are 5 billion ounces of gold held "above ground" in the world according to the World Gold Council. Most of this is jewellery. On that basis, Theodore Butler suggests that the "market capitalisation" of gold is US$3 trillion (5 billion x $600), and the market capitalisation of silver is $12 billion (1 billion x $12). In other words, gold is capitalised at 250 times silver. Here we arrive at the beginnings of Butler's study – that which so astounded him. Butler set out to further investigate the "gold/silver ratio". This price ratio has been a determining force for the price of silver over the last centuries. The mid-point is held to be around 50 times, and in over a hundred years it has moved only between 15 and 100. Now, before we proceed there is one obvious flaw in Butler's logic. He counts gold jewellery as part of all gold held, but dismisses silverware, silver jewellery etc. This assumes gold jewellery will be "traded" but Granma's silverware will not be. This is not too farfetched, as gold is bought in jewellery from as much for investment as for adornment, while Granma once actually used her cutlery. Butler argues there is little evidence of silverware being sold in any great amount to date, and if it is it would probably be snapped up by investors. Says Butler: "To conclude that silver is not a good investment at current prices, strictly because more supply may come on to the market at higher prices, is strictly absurd". So there. We will proceed on the basis that Butler's logic is accepted. By multiplying the amount of known gold by its price in 1900, 1950, 1975 and 2006 we get a growing market cap – from US$20 billion in 1900 to US$3 trillion now. The same exercise with silver sees only a growth from US$8 billion to US$12 billion. The peak was US$20 billion in 1975, but known metal has rapidly diminished. The gold/silver price ratio has moved from 30 to 44, 38, 50 across those years. But (and this is the big but) the market capitalisation ratio has moved from 2.5 to 9, to 23, and now to 250. Apply the same figures, and throw in world population growth, the value of gold held per capita in the world has grown from US$13 to $28, to $113 and on to $462 now. Silver's equivalent value has changed from US$5 to $3, to $5, to $2 now. Now you know why Butler was astounded. If the market capitalisation had remained static since 1900 silver would be worth US$1000/oz. Taking only the per capita valuation ratio gives a silver value of US$175/oz. However you play with the numbers, Butler muses, you still end up with a silver price much, much higher than it is now. (Add back the other 21 billion ounces in unknown silverware – that which Butler has dismissed - and those numbers become US$45/oz and US$8/oz.) So there you have it. Two arguments, coming in from different angles, predict a major surge in the silver price. Both have an unknown factor – silverware. The question is thus: at what price will this hit the market? One thing is for sure – we won't see 21 billion ounces worth on eBay at US$15/oz. And US$15/oz is the figure that Goldfields Mineral Services is targeting for silver. GFMS is a lot more bullish on gold, suggesting it should reach US$750/oz, even though it dismisses all arguments of price manipulation and overstated central bank inventories (these arguments have gold as high as US$2000/oz or more). But GFMS has actually warned against getting too bullish on silver. Its main argument is that despite growing investor demand, the fall-off in industrial demand at higher prices will ensure the silver price has only limited upside. Production is also increasing. Silver will follow along with gold, GFMS suggests, until slowing global growth will undermine the price just as it does base metals. GFMS recommends a short term silver investment will most likely be profitable. Butler and Karn believe there is a lot more upside in silver than in gold. If the silver price bursts through US$15/oz then maybe we'll have a clue who's right. Richard Karn's Emerging Trends Report is a US based "predictive Business Intelligence service". Free ETR reports as well as reports to purchase are available on www.emergingtrendsreport.com.
A collection of Theodore Butler interviews and analyses can be found at http://news.silverseek.com/TedButler/ and at http://www.investmentrarities.com/tb-archives.html. Or simply visit www.butlerresearch.com.
