A Silver Lining in an Unstable Market

As the stock and real estate markets struggle and the U.S. dollar declines, commodities—particularly silver—may provide attractive opportunities for investors. Although silver has far more practical applications than …

As the stock and real estate markets struggle and the U.S. dollar declines, commodities—particularly silver—may provide attractive opportunities for investors. Although silver has far more practical applications than gold, it is often overlooked by investors who are drawn to gold by its glitz and emotional status as a hedge against currency inflation and instability. In fact, silver may not only act as a currency hedge, but it has also growing demand from industrial and technology sectors.

Uses for silver

“Demand for silver is built on three main pillars; industrial and decorative uses, photography and jewelry and silverware,” according to The Silver Institute. “Together, these three categories represent more than 95 percent of annual silver consumption.”

Industrial applications made up by far the greatest percentage of silver demand in 2006, at 430.3 million ounces, while the photographic sector consumed 145.8 million ounces, the jewelry market consumed 165.8 million ounces and the silverware market consumed 58.1 million ounces, according to The Silver Institute.

Strength, malleability and ductility, electrical and thermal conductivity, sensitivity to and high reflectance of light and the ability to endure extreme temperature ranges are among the unique properties that restrict silver’s substitution in most applications, according to The Silver Institute.

For example, “Silver is the best electrical conductor of all metals and is hence used in many electrical applications, particularly in conductors, switches, contacts and fuses,” according to The Silver Institute. “Every time a home owner turns on a microwave oven, dishwasher, clothes washer, or television set, the action activates a switch with silver contacts that completes the required electrical circuit.”

In addition, silver is a bactericide with important medical applications; it is used in health care products that prevent bacterial infections in burn victims, wound dressings and wound care and surgical gowns and draperies, according to The Silver Institute. It is also used in water purification systems in hospitals, remote communities and domestic households, according to the institute.

The photographic process uses silver halide crystals and is likely to continue to rely on silver rather than other technologies because of its superior definition and low cost, according to The Silver Institute. Silver is also used in solar cells, x-rays and silicon cells in satellites, according to the institute.

Silver is popularly used in jewelry and silverware for its beauty and because it is more affordable than gold. “Silver possesses working qualities similar to gold but enjoys greater reflectivity and can achieve the most brilliant polish of any metal,” according to The Silver Institute.

Like gold, silver has been traditionally used as a medium of exchange, and because it was in greater supply and of less value than gold, silver coins formed the main circulating currency in many nations until the late 19th century, according to The Silver Institute. Many countries issue silver coins and medals, including the U.S., Germany, Canada and Mexico, according to The Silver Institute.

Silver is also used in batteries; steel bearings used in high-tech and heavy-duty applications such as jet engines; brazing and soldering to join materials for purposes such as plumbing and refrigeration; as a catalyst used in the plastics and textile industries; electroplating; mirrors; eyeglasses; and computer keyboards, according to The Silver Institute.

Scarcity and demand

Like gold, silver is in limited supply, and a synthetic production method has not been developed. Given silver’s complex and unique characteristics, synthetic production seems unlikely.

Although gold was historically rarer and thus more valuable than silver, the above-ground supply of silver is now smaller than that of gold, according to silver analyst Theodore Butler. “Starting in the middle of the last century, we have been industrially consuming the world’s silver inventories. This has caused the reversal of the relative size of world gold and silver stocks.”

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“The main difference between gold and silver is that you can never have a shortage in gold because it is not industrially consumed. The price of gold can go higher, of course, but not because of a shortage,” according to Butler. “Silver, precisely because it is an industrial commodity (in addition to being an investment item), must go into a shortage, considering the disappearing inventories.”

Most of the gold ever mined remains above ground in easy-to-melt forms and is not actually consumed, whereas ounces of silver come and go, according to Doug Casey of Caseyresearch.com. “Silver, unlike gold, is chemically active. When silver is used, much of it gets used up—consumed beyond practical recovery.”

As more and more uses for silver are discovered, industrial demand for silver has continued to increase; industrial applications posted a 6 percent gain in 2006, recording the fifth consecutive year of growth in this category, according to The Silver Institute.

Global silver mine production edged up fractionally in 2006, but the supply of silver from above-ground stocks dropped by 4 percent for a slight overall decline in supply, according to The Silver Institute. As the total supply of silver dropped slightly, so did total silver fabrication.

Sectors with fabrication declines included jewelry and photographic demand. Jewelry fabrication posted nearly a 5 percent loss because of price-related losses in India, although Indonesian and Chinese jewelry fabrication grew by 18 and 16 percent, according to The Silver Institute. Photographic demand fell by 10 percent in 2006 as a result of lower consumer demand caused by growth of digital imaging technology, according to The Silver Institute.

“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,” according to Casey.

Because silver is hard to replace and is used in small relative quantities, the price could double or triple without having a major impact on industrial usage, according to Casey.

The top five silver producing countries include Peru, Mexico, China, Australia and Chile, according to The Silver Institute. Most silver mines are really lead-zinc-silver mines, copper-silver mines or gold-silver mines, with 70 to 80 percent of all silver produced as a byproduct of copper, lead and zinc mining, according to Casey.

This means that rises in silver prices do not necessarily result in increased mining efforts, so supply may lag behind demand, causing prices to rise further. Many analysts have predicted a silver shortage in light of increasing industrial demand and limited supply.

Without more recycling, if every human on the planet were to consume silver at half the rate of an average U.S. resident today, the world would run out of silver in 10 years, according to crude calculations by New Scientist. These calculations do not take into account increase in demand by new technologies, and they assume that current production equals consumption.

Increasing industrialization and the difficulty of substituting other materials for silver indicates that industrial demand for silver is likely to remain strong, though demand for silver in jewelry, photography, coins and investments may fluctuate more widely based on economic factors and alternate photographic technology.

Historical prices

“Throughout the last several centuries, a ratio of silver’s value to gold’s has always seemed to come back to the 16:1 area, where about 16 ounces of silver equals one gold ounce,” according to a SilverSeek.com article by Chris Weber of weberglobal.net.

“The ratio between gold and silver has historically ranged from 10-15:1. Now it is over 50:1. Many analysts feel that silver is extremely undervalued,” according to First National Bullion.

The gold spot price on the New York Stock Exchange on October 3, 2007, closed at $729.40, while the silver spot price closed at $13.330, according to Kitco.com, a ratio of more than 54:1.

Silver prices have been on the rise since 2004, according to figures from The Silver Institute:

1997: $4.897
1998: $5.544
1999: $5.220
2000: $4.951
2001: $4.370
2002: $4.599
2003: $4.879
2004: $6.658
2005: $7.312
2006: $11.549

Silver is clearly rising after remaining between $4 and $6 in the late 1990s and early 2000s, but it is still significantly lower than its 1980 high. Silver hit its high at $48.70 in 1980, which is $120 in August 2006 dollars, according to Casey.

“The all-time high for gold is about twice today’s price. The all-time high for silver is seven times today’s price,” according to First National Bullion. “With that in mind, we feel that is would be far easier to see larger percentage returns in silver than we would in gold.”

Investors who expect the gold to silver ratio to return to historical levels of roughly 16:1  are bullish on silver’s prospects, and Butler’s argument that silver has now become rarer above-ground than gold suggests that even the 16:1 ratio does not adequately value silver.

Investing in silver

Silver trades on the COMEX division of the New York Stock Exchange. Investors can gain exposure to silver in a variety of ways.

Investors who wish to own physical silver can purchase bullion and bars from silver and commodities dealers. Investors may choose to store the silver in a home safe, but because silver is so much less expensive than gold, large investments in physical silver can be heavy and impractical to store at home. An alternative is to pay a small fee to have the silver stored at a bank or financial institution.

Electronic silver dealers such as e-bullion and GoldMoney are available for those who wish to own physical silver without storage costs. Investors dealing with electronic dealers should conduct careful due diligence to ensure that the dealers are legitimate and credible.

The Central Fund of Canada is listed on the American Stock Exchange (CEF), and its “purpose is to hold gold and silver bullion on a secure basis for the convenience of investors in the shares of Central Fund,” according to the Central Fund of Canada’s website. This fund allows investors to benefit from gold and silver prices without paying storage or transaction fees, according to the site.

The first silver exchange traded fund (ETF), Barclays’ iShares Silver Trust, was launched in April 2006. This has made investing in silver even easier for beginners and may have helped to spur silver’s price rise.

Silver mining stocks are a more speculative avenue for investors and can be accessed through the stock market. Mines that focus only on silver can have volatile reactions to market prices, while those that produce a few different minerals may be slightly less volatile because they are more diversified.

Even more speculative investors can purchase silver futures or options, but those methods should be used only by investors with significant knowledge and experience in silver’s volatility; they are not recommended for beginners.

The U.S. government may classify some types of silver investments as collectibles and tax them at a higher rate than the standard capital gains rate, so silver investors should research the tax implications with a tax professional before investing.

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