Silver Poised to Skyrocket
by By The Texas Hedge
Todd Stein & Steven McIntyre
October 22/04
We think that silver is a once in a lifetime opportunity to participate
in the meteoric rise of a dramatically undervalued commodity. The real
story on silver is the massive inventory depletion that has taken place
over the last decade as depicted in the graph below. Since 1991, the above
ground silver supply has declined from about 1.4 billion ounces to an
estimated 600 million ounces (130 million of which legendary investor
Warren Buffett may or may not still own from his 1998 purchase). Silver
deficits now run between 50-100 million ounces per annum. 130 million
ounces and possibly much more of the roughly 500-600 million above ground
ounces are owned by investors like Buffett, who have no intention to sell
anytime soon. In all likelihood, less than 350 million ounces are available
to fill supply deficits at anywhere near current prices.We are running
at critically low silver reserves and it is entirely possible that some
time in the next few years that silver shortages may occur.
The only way to bring the supply/demand in balance for silver is higher
prices. This is where the dynamics of the silver market become very exciting
for silver bulls. Silver has a dual role as both an industrial metal and
a precious metal. The majority of silver's current demand (560 million
of 840 million ounces) comes from industrial and photographic uses due,
in part, to its high conductivity. The rest of the silver demand is filled
in by jewelry, silverware, and coinage. Investment demand in the last
few years has been minimal but is picking up as concerns about the U.S.
dollar abound. Silver supply is perhaps an even more intriguing situation.
65% of silver mine production is the by-product from copper, zinc, and
lead mines. Only 35% of silver demand comes from pure silver mines and
from gold primary mines where silver is a by-product. This interesting
dynamic sets the stage for a potentially explosive move higher in the
silver market.
We believe silver will do well, even if we are wrong about the economy's weakness to come. In a strong economic scenario, a resurgent industrial and electronic demand should propel silver demand higher, creating 50-100+ million ounce annual deficits, which should force prices significantly higher as inventories are depleted. Even better for silver would be the weak economy scenario, which we believe is destined to occur. In that scenario, silver's unique supply characteristics could cause a very large price increase. As strange as it may sound, zinc, copper, and lead prices are the primary driver of silver production in the form of by-products. Zinc, copper, and lead are base metals used in broad ranges of industrial production applications. These base metal mines (65% of silver mine supply) will produce more silver when the economy is doing well and less when the economy is struggling and base metal prices are depressed.
In a weak economic scenario, you could see many base metal producers
shutter production and as a consequence, the world silver supply would
decrease. At the same time, a weak U.S. economy may lead to a weak dollar,
which spurs investment demand for both gold and silver due to the monetary
nature of the two precious metals. In such a scenario of declining silver
production and rising demand, the price increase required to bring on
material amounts of silver supply could be quite large. To quote Warren
Buffett, "and because...demand is...relatively inelastic, we don't think
[that the] price change required to reestablish an equilibrium between
supply and demand would necessarily be minor."
Both gold and silver have long been neglected commodities, but we believe
they are still in the early stages of a secular bull market for precious
metals. We think that gold could again challenge its early 80s highs of
800 bucks an ounce. But, as bullish as we are on gold because of its constrained
mine production and the continued debasing of all fiat currencies (particularly
the dollar), we believe the move up in silver could be several times
higher than gold. And in what we believe is a very unlikely scenario
of the economy and the dollar doing well in the next few years, silver
will hold up much better than gold because of the tightness in supply/demand
and its industrial nature.
We appear to have another catalyst coming in 2005 to drive the silver
price higher. A silver ETF (Exchange Traded Fund) is in the works of being
introduced. A gold ETF is slated for early 2005, and once it is done,
the Silver Institute intends to follow suit. Estimates we have seen floated
of up to 200 million ounces in demand seem quite possible to us (you have
got to remember just how difficult it has been for individual investors
to buy, transport, and store silver in the past).
The chart above shows the net asset value for the 10 largest U.S. ETFs.
It is illogical to think that a gold or silver ETF might have anywhere
near the investment interest of the S&P 500 or Dow or even the Russell
2000. That said, we do not think that the investing public's demand for
the "Russell 1000 Value" index is extremely high yet it has $2.7 billion
in net assets. Why couldn't a gold ETF have investment demand at least
high as the Russell 1000 Value Index? And why couldn't a silver ETF be
perhaps one third the size of a gold ETF? At that rate, the silver ETF
would be $900 million in size and at a current price of $7.00 an ounce
that would chew up roughly 140 million ounces of silver (about two years
worth of annual supply deficit cushion gone). The great thing about
a silver ETF is that we do not think that it would drain much demand from
other silver assets, but rather be additive as individuals who didn't
take the time to buy silver in the past (because of the hassle) can now
push a button on E-trade and own silver. If the silver ETF takes off,
all of the sudden you might have less than a year's above ground supply
to fill the deficit and there is no practical way that additional mine
supply can come on-line that quickly. Throw on the uniquely bullish fundamentals
of silver itself and it is easy for us to be bullish on the grey dog when
everyone else seems to be so bearish.
Todd Stein & Steven McIntyre
Texas Hedge Report
Todd Stein & Steven McIntyre are internationally known analysts and editors of The Texas Hedge Report, a market newsletter that highlights under and overvalued securities in the equity, bond, currency, and commodity markets
For more information, go to http://www.texashedge.com/