January 25, 2008

Ted Butler: The Coming Investment Boom in Silver

The Coming Investment Boom in Silver

By: Theodore Butler

From the very beginning of my interest in silver, my focus has been on basic supply and demand, with particular emphasis on remaining inventories. And why not? I am a commodity supply and demand analyst and the world did experience a structural deficit in silver for more than 60 years, beginning with World War II and lasting up until very recently. What could be more bullish for a commodity than drawing down and depleting an inventory that took thousands of years to accumulate?

Despite this fact, I have never dismissed the potential impact of increased investment demand on silver. I always felt that investment demand would be a bonus, or icing on the cake. Especially with the certainty of higher prices brought about by consuming more of something than what was being produced. By and large, that certainty has come to be recognized, as silver prices have risen amid growing awareness that world inventories have been depleted. Gone are the days when there was universal talk of inexhaustible inventories of silver.

A while back, I may have caused some consternation among silver enthusiasts when I wrote that the structural silver deficit appeared ended. I thought the days of unrestricted drawdowns from inventory, due to industrial consumption outpacing current production, were over. I based my thinking on the fact that the silver structural deficit couldn’t continue forever, as inventories available for depletion were finite and would eventually be exhausted. Sooner or later, all commodity deficits must end. The wonder in silver was that its deficit endured for more than 60 consecutive years, due to a variety of highly unique factors, not the least of which was an unusually large inventory to start with. I was careful to conclude, however, that the eventual end of the deficit didn’t necessarily imply that silver must then decline in price.

In reality, it does now appear that the industrial consumption silver deficit that the world witnessed for decade after decade is now over. Recent statistics indicate a balance, more or less, between total current supply (mine production plus recycling) and total current fabrication demand. I know many consider the talk of current fabrication demand being in balance with current total production to be blasphemy, but an analyst must deal with the facts as they develop. Besides, as I wrote at the time, industrial consumption deficits could return, from time to time, if world demand, especially from the BRIC countries (Brazil, Russia, India, and China) continued to accelerate, as appeared likely. More importantly, we were at a point when the industrial fabrication deficit, as the primary price influence, was about to be replaced by something else.

That something else, in my opinion, is the coming wave of investment demand about to engulf silver. If my thinking is correct, the time could be very short before silver will no longer be available for accumulation near current prices. There are a number of factors that lead me to believe that an investment surge is about to hit silver and influence its price for years to come. Some of these factors are developments that I would have never imagined could occur when I first started analyzing silver, more than 20 years ago. So bullish are these developments, as I have written previously, that I could not have dreamed them up even if I wanted to.

Going, Going, Gone

At the top of the list is the fact that the silver structural deficit lasted as long as it did. Commodity deficits, in which inventories must be drawn from in order to balance supply and demand, are always temporary situations, usually weeks and months, rarely stretching to more than a year. In silver, we had the shocking circumstance of a consumption deficit lasting more than half a century. How could this be?

The short answer revolves around a starkly unique confluence of verifiable events; a build up of massive quantities of inventories as a result of thousands of years of accumulated production, and the transformation of what was a monetary and cherished precious metal into a vital and modern industrial commodity that resulted in the depletion of the accumulated production. Long-time readers know that the depletion of thousands of years of accumulated silver inventory has always been a central theme of mine, as has been the resultant rarity and scarcity of above-ground silver. The less supply there is of something to invest in, the greater the price impact will be when demand appears.

Because the industrial and fabrication demand is, in my opinion, in balance with total production (mining plus recycling), none of the silver currently being produced is, effectively, available for investment demand. The only real source of silver for new investment demand is silver already held as investment, namely existing world inventories. In other words, since all newly produced silver is already spoken for by industrial and other fabrication demand, the only real silver available for new silver investors is the sale and resale of silver by existing silver investors.

In this sense, silver is now similar to gold, because gold’s total current production has always largely been taken by jewelry and other fabrication, with existing gold inventory the primary source of supply available for new investment. The key difference, of course, is that the available above ground gold inventory towers over the equivalent available silver inventory, both in ounces, by as much as 5 to 1, but particularly in dollar value, by more than 250 to 1.

One other difference between silver and gold is that for the life of the 60+ years of the silver structural deficit, there was very little, if any, net investment in silver. That has changed in recent years, and it is precisely this change, the rebirth of silver as an investment asset that is a shockingly bullish development. Think of it – the world draws down and depletes silver inventory for more than 60 consecutive years, exhausting the very source of what is available for investment, and only then collectively decides that silver is a good investment. Silver appears on the investment horizon at precisely the time there is less available as an investment than ever before.

I have long used the number of one billion ounces of silver bullion equivalent as a world inventory amount. This is higher than most accepted published accounts. In dollar terms, that comes to $15 billion. That is a very small amount, especially when compared to the $4 trillion dollar value of world gold inventories. But it is not just the extremely limited dollar value of silver inventories; it is also my sense of the nature of who holds the silver.

Closely Held

An extremely small percentage of the world’s investors, certainly way less than 1%, have any knowledge about the real facts in silver. That’s why there is limited investment. Those that do hold silver as an investment are about as rare as silver inventory itself. I run across a larger than normal number of silver investors, large and small. Maybe this is somewhat unscientific, but I’d like to share a few observations.

The vast majority are looking for substantially higher prices before selling. (Perhaps they have been influenced by my writings.) My strong sense is that many more are looking to add to their silver holdings, especially on price dips, rather than those looking to sell on near-term price rallies. For those holding real silver, either exclusively or in addition to mining stocks and leveraged positions, the real silver is considered core to be held for the longest holding period possible. In fact, holders of real silver rarely think of selling and converting to other assets, including cash. They think more in terms of specific long-term personal financial goals, or of passing on to heirs or charity, rather than selling.

My point here is that an incredibly small quantity of silver is held for investment and it is held in extremely strong hands. To pry this silver from these investors is going to take an unusually high and attractive price. Whenever you have a small and tightly held supply, you have the makings of a price boom on even modest demand.

There was a short period of time in the late 1970’s when speculators, led by the Hunt Bros., caused prices to climb ten-fold. And there was a quick doubling of the price of silver in 1998, when Warren Buffett bought a chunk. But, by and large, there has been no sustained broad net investment buying of silver over the past half century. That has now changed, for a variety of reasons.

For one reason, thanks to the Internet and instant, uncensored communications, more people are becoming aware of the investment merits of silver. Though the number is currently small, never in the history of the world has there existed so much money and so many investors looking to deploy that money. That the real silver story is still largely unknown is a powerfully bullish factor, as more investors are bound to uncover the story as time goes by.

Nothing brings more attention to an investment item than a rising price. It is dogma that in the investment world higher prices beget more investor demand. And while silver prices have lagged a bit this year, for the past five years silver has recorded bigger price advances than gold, platinum and palladium. Combine rising prices with a great investment story and you have the potential for an investment rush.

Most recently, nervousness and stress are in the investment air. The mortgage and housing and credit crises get more serious by the day. The impacts on the economy and the markets are great. The losses and write-downs from credit securities have been massive. The reaction from investors has been clear; a move to safety.

There has been a pronounced flight to the quality of the highest-grade securities. To paraphrase Will Rogers, the return of principal takes precedence over the return on principal. Nothing could be of higher credit quality than assets that are no one else’s liability. While most investors instinctively turn to gold, it is undeniable that silver is an asset as liability-free as gold.

Flight to quality buying isn’t something I normally dwell on as a reason to buy silver because there are so many who already advance this as a reason. What I would like to emphasize is that because there is so little inventory available that could be purchased, a fevered rush to safety in silver takes on added significance as a price factor. That a rush to the safety of silver has yet to occur is potentially a lot more bullish than one that has already occurred.

Big Money

Perhaps the most profound potential impact on the coming investment boom in silver is the newly created ability for institutional and other stock-only investors to buy silver. Of course, I’m referring to the recent creation of silver exchange traded funds (ETFs), as well as existing closed-end fund, the Central Fund of Canada. For the first time in history, institutional investors have the ability to invest in silver. In less than 2 years, the US-listed silver ETF, plus the versions in London and Switzerland hold 170 million ounces, with the Central Fund holding more than 40 million ounces. For all intents and purposes, this is more than 210 million ounces of silver that has been indefinitely taken off the market.

That this quantity of silver has been acquired is remarkable, in that it has occurred without any real signs of investment frenzy. While the price of silver has basically doubled since the announcement of the first silver ETF, there is no denying that the price rise feels subdued. Certainly, I never imagined that 170 million ounces of silver could have been purchased with such a muted price impact.

But I think there is a specific explanation for how that much silver could have been bought with so little relative impact on price. Further, I think that it would be a mistake to assume, as some do, that additional large quantities of silver are available to the ETFs at similarly muted prices.

I believe that a very large part of the 170 million ounces bought by the three ETFs so far is the same silver that I have previously written that Warren Buffett got snookered out of at the time the first silver ETF was introduced. If my analysis is correct, then a lot less "non-Buffett" silver resides in the ETFs than would appear. My point is that if a big chunk, or perhaps even the majority, of the ETFs’ holdings came from Buffett (who was said to hold 130 million ounces) in a single transaction, that would go a long way to explaining the muted price reaction (only a double) for the balance of the silver bought.

Most importantly, again assuming I am correct, the Buffett silver was a "one-off" transaction, that can’t be repeated, because there is no known silver hoard of that size in the world. In other words, the next 100 million ounces to be bought by the ETFs will cause a price impact greater than the last 100 million ounces purchased. To assume otherwise would be a mistake.

Another reason for optimism for silver investment demand to get kicked into high gear on higher prices is simply how investors collectively behave. The remarkable thing is that the silver ETFs now hold, by a wide margin, the largest known silver stockpile in the world. What the heck will those holdings amount to when a true silver buying fever hits?

While I have been pointing out that the ETFs allow, for the very first time, institutional investors to participate in silver, that’s not to suggest, in the slightest, that the silver ETFs will be, or should be the preferred choice for silver investors. Nothing is safer than what you hold yourself or is stored for you (with the clear ability to take possession of your specifically ear-marked holdings on your demand). The ETFs don’t allow this, except under certain thresholds (such as large minimum quantities, like 500,000 ounces in the US-traded version). And ETFs do involve additional levels of middlemen that complicate pure ownership. For institutions or other accounts that couldn’t own silver otherwise, the ETFs are fine, and will have a big ongoing impact on price. That’s my point.

Let me try to state something that I strongly believe in, yet don’t recall ever writing about before. I believe the very best form of silver you can own is physical silver in your personal possession. The next best form, and only if it is logistically impossible, due to the quantities involved, is silver stored for you by an independent storage facility (not the dealer you bought from) in which you know the serial numbers and weights (in the case of 1000 ounce bars).

I know it can be a pain in the neck for most people to buy and hold your own silver (in a safe deposit box or other personal safe storage), especially those who never bought and held silver before. But I am convinced that it is precisely this inconvenience that will enable the average person to hold his or her silver for the long term, through thick and thin.

When something is real easy to buy, it is usually real easy to sell as well. Futures and options and ETFs and mining stocks are much easier to buy and sell than real silver. That automatically makes them much harder to hold. When a quick phone call or the click of a computer mouse is all it takes to initiate or liquidate a large investment holding in an emotional reaction to a short-term price rise or fall, especially when margin may be involved, that is not always a good thing. Easy to buy and sell, and hard to hold can be very bad when it interferes with a long-term position. I have seen too many, including myself, disturb a long-term position in moments of weakness, with later regret. All because it was too darn easy. I have rarely seen anyone liquidate a long-term physical position on a whim. Since the big gains come with long-term positions, the fact that physical silver forces you, more than any other form of silver, to hold is a very good thing.

In summary, I believe we are in the very early stages of a long-term price boom in silver that will be caused by investment demand. The combination of an extremely small and tightly-held existing investment inventory, combined with a large potential investor base, funded with the largest buying power in history, hungry for the next hot investment, and still unaware of the true silver story is the stuff that makes investment dreams.

I have not forgotten, for one second, the industrial supply/demand situation, the coming industrial user inventory buying panic and the resolution of the largest concentrated short position ever witnessed, but an analyst should look at everything that promises to greatly impact prices. The purpose of this article is to get you to add the coming investment demand into the mix when you think about silver. But not before adding more silver to your holdings.

New Uses Give Silver Reasons to Shine

New Uses Give Silver Reasons to Shine

By Jane Louis
23 Jan 2008 at 02:45 PM GMT-05:00

St. LOUIS (ResourceInvestor.com) -- When compared to gold, silver often seems like the ugly stepsister - moving in gold’s shadow, always trying to catch up to gold’s sparkle but ultimately reacting with extreme volatility - and 2007 was no exception. As gold gained 28% on the year, silver added 18% while suffering bouts of extreme ups and downs.

And much like gold, silver can be used as both an industrial commodity and as a monetary investment - though industrial uses are by far the main driver of the silver market.

The market functions based on basic supply and demand fundamentals. Supply largely comes from mine production, which accounted for approximately 70% of global supply in the past decade. Recycled silver scrap is the second largest source of silver, totalling about 20% of global supply. The remaining supply comes from producer hedging, government sales and implied net disinvestment.

But according to the VM Group and Fortis Bank’s latest edition of “The Silver Book”, demand has been trailing off since 2006 due to the significant drop in photography use demand. In the past, photography uses were a main source of consumption, but that has fallen off considerably with the popularity of digital cameras.

Thus, the VM Group is predicting a supply surplus of 7,315 tonnes in 2008 - up 16% over the supply surplus of 6,141 tonnes in 2007.

“Metal available to the investor, which in a strong market as we have recently experienced, appears to be relatively easy to absorb,” the commodities consultancy said in the report. “We expect jewellery demand to make a modest recovery as consumers adapt to higher prices, whilst photographic demand will continue to fall.”

Ultimately, it is the investor who will decide the supply and demand balance, Jessica Cross, chief executive of the VM Group, told Resource Investor.

“The silver market is in a chronic state of surplus, and this is metal available to the investor,” Cross said. “If there is scant investment interest as there was in 1990s, then the silver price will decline. If there is buoyant investment interest, the price will consolidate and increase.”

New Sources of Demand

Industrial applications are the main source of demand in the silver market. Silver is a good thermal and electrical conductor, making it useful in switches and fuses. It is also used in batteries, and its quality as a bactericide allows it to be used in water purification systems and a wide range of consumer products. The use of silver in wood preservatives was expected to be introduced this year, but licensing was delayed. Wood preservatives are predicted to be a significant consumer of silver in the coming years, the report said, and the delay in 2007 affected the supply and demand balance.

“This application remains at the licensing stage and therefore it is not surprising that product developers are remaining tight-lipped about the developments and progress of this licensing. Our figures therefore reflect this delay.”

A new use of silver is growing in popularity, however, VM reported.

The technology for radio frequency identification devices (RFID) has been around since the Second World War, but only in recent years has the updated technology grabbed the attention of commercial and military supply-chains for its use in inventory tracking. Similar to bar codes (which, in fact, are the biggest competition to RFID tags), the devices can be used to identify and track goods.

“The original active RFID technology includes a battery-powered, high data capacity tag that transmits radio frequency energy across a radius of up to 300 feet,” according to the report. “This is now being replaced by passive RFID technology, which has no battery but relies on a radio frequency signal from a transmitter to activate the tag. The tag then sends out information to a receiver, which reads the information and processes it.”

Research firm IDTechEx said it expects the number of tags produced in a year to increase by a whopping 93% to 25.90 billion by 2017. That is incredibly good news for the silver market, as RFID tags each contain about 10.9 milligrams of silver. And even better news - the tags are hard to recycle, the VM Group said.

While RFID tags are not truly competitive to bar codes right now due to their high prices, “The Silver Book” said it’s only a matter of time before the technology is adapted and used extensively. The use of silver in RFID will not completely replace the loss of silver consumption in photography, the report said, but it does have an advantage over photography in its difficulty to recycle.

“This is vital if silver is to hold its own in the light of declining offtake in photography as a result of digital (cameras),” Cross said.

Silver Outlook

Despite the potential oversupply in 2008, many analysts are staying bullish on silver.

“As primarily a by-product of base metals mining, (silver) remains moderately price inelastic, and it can expect rising mine production based upon increases in production of the host metals, primarily copper,” Ross Normal of TheBullionDesk.com said in the London Bullion Market Association’s “Forecast 2008”.

“Silver’s price gains, however, can be attributed to solid demand-side investment, and that appetite looks set to continue in 2008 as the race between the old world and the emerging economies to corner the world’s natural resources intensifies... be it a mine or simply physical metal. The fly in the ointment may be the slowing global economy and, more so than in gold, this could signal a more modest increase than in former years.”

David Davis, analyst at Credit Suisse, agreed.

“Silver prices only rose 14% year-on-year (2006 -2007), having put gains of 25%, 38% and 42% over the previous three years,” he said in the “Forecast”.

“We believe silver prices will likely play ‘catch up’ when compared to the year-on-year increases of the previous years, but also and more importantly, silver prices will likely receive impetus from the upward trend in platinum and gold prices and the investment (ETF) market. In the long term, gold and silver prices have been closely correlated. The fundamentals of the silver supply and demand dynamics are unlikely to have a major effect on driving the price. Silver has the potential to break through $20 by the end of the year.”

The iShares Silver Trust ETF [AMEX:SLV] has seen its rate of accumulation slow in the past two years, but new ETFs were launched in the UK and Switzerland this year, which have both experienced steady gains, “The Silver Book” said.

Cross said she expects silver to trade in the $12 to $18 per ounce range in 2008, with “lots of upside but possible liquidation of longs.” March silver dropped 17.5 cents to trade at $15.93 an ounce in mid-day trading today on the New York Mercantile Exchange.

January 5, 2008

Mogambo Guru: Solid Gold Silver Surge

Solid Gold Silver Surge
By Richard Daughty "The Mogambo Guru" *

Jan 4 2008 9:04AM

Roger Reynolds of the famous "Shame on you Federal Reserve!!!" newsletter, (sporting three exclamation points for added emphasis!), notes that gold, "ALWAYS does well as long as the inflation rate is above the interest rates."

And in case you ain't noticed, inflation in consumer prices is almost 300% higher than even the yield on the 30-year T-bond! And gold is up over 30% this year! See how it works, my darling Junior Mogambo Rangers (JMRs)?

And in case you STILL ain't noticed, even though I just freaking pointed it out to you, inflation in consumer prices is so horrific that it is (when measured the old-fashioned way) running north of 10%, and the growth in the money supply is running north of 15%, meaning that consumer prices will continue to go terrifyingly up, and up, and up for a long, long time, meaning that (here I pause to let you come up with the answer on your own, which you don't because you can't, because you don't pay attention when I am talking to you, which I have already spoken to you about, which you have no doubt already forgotten, too) the lesson is that gold will continue to go up and up and up and up for a long time.

How much will it go up? Since you asked, I will merely quote James Turk of the Freemarket Gold & Money Report, who fearlessly forecasts that in 2008, "Gold will finally break into 4-digits, which will be an event that gains worldwide attention. I think the high in 2008 will be $1,500, and the low will be $780."

Seeing how excited we are at this glorious news, he goes on, "Gold will probably end the year at $1200-$1300, generating at least a 50% gain in 2008. The same monetary problems driving gold higher for the past six years continue, including: (1) the dollar will continue to decline, threatening its 6-decade global monetary stranglehold as the world's reserve currency, (2) inflation will worsen as the prices of commodities as well as other goods and services rise, (3) the federal government budget deficit will grow, further debasing the dollar, and (4) global trade imbalances will continue to create huge pools of hot-money looking for a safe home, much of which will end up in gold."

Now, for those who ponder the timeless riddle of why all of the people in history always rushed to gold in economic turmoil, and who turn in desperation to the Loudmouth Mogambo Know-It-All (LMKIA) to ask me why they do it, I tell you: "I don't know. They just do. Go away!"

But perhaps a part of the answer may be gleaned when he goes on to say, "Add to the above monetary problems a new worry - counterparty risk. This risk was highlighted by the bank-run at Northern Rock, and the depositor withdrawals presently underway in some institutional money-market funds in the US. Funds and more financial institutions will collapse in 2008, further highlighting this growing counter-party risk. Gold will benefit from this turmoil because it is the only money without counterparty risk - its value is not based on the promise of some financial institution", and that, "This attribute of gold will become more widely recognized in 2008, significantly increasing worldwide demand for gold."

And as for silver? I'm glad you asked! He thinks, "Silver will clear $30 in 2008, as the (gold-silver) ratio falls below 40. A $1200 gold price and 40-to-1 ratio puts the price of silver at $30. Silver is the best play for 2008, but silver is never a smooth ride."

And if you think that silver could go to its rough 15-to-1 long-term ratio to gold, then a $1,200 per ounce gold price would mean an $80 per ounce silver! Wow! The stuff is selling for 15 bucks right now!

And for those holding gold mining stocks, too, the news is just as good or better, as he figures that "The XAU Index will nearly double, closing over 300 at some point during the year." Double!

Then he started getting into that technical analysis stuff, which is over my head, so I started to leave, maybe grab a burger. But I was halted mid-stride when he said that "the technicals are fascinatingly bullish", and that the long-term silver chart has shown that "silver continues to trade within its long-term accumulation pattern" which it has, "been forming for more than two decades." A two-decade accumulation period? Wow! Who the hell ARE these long-term thinkers?

He doesn't want to get stuck in one of my wild conspiracy theories, and to change the subject by waving a shiny object in front of my eyes, he says that one highly unusual thing is silver's chart pattern of an "upward pointing flag", which he says is significant because "Upward pointing flags are rare. They illustrate unusual strength. In effect, there is so much demand for silver, every dip is bought. Buyers (particularly the shorts) therefore get anxious, and don't wait for a price retracement. They just keep buying, which describes what's happening. Silver is being accumulated".

I was hoping to make some sense of it, maybe make a few bucks on it, but since I am clueless and stupid, it promises to be a long night of research and work. Fortunately, I was saved from the prospect of actual labor when he volunteered, "2008 will be the 'Year of Silver'. Look for silver to outshine gold in 2008." Wow! Just what I wanted to hear!

You, too, I'll bet!

* The MOGAMBO GURU, e-economic newsletter,
by Richard Daughty, the angriest guy in economics.
e-mail: RichardSmithGroup@Verizon.net