The Five Myths of Silver Investing

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Oftentimes perception, and not reality, rules the day with the thousands or millions of speculators placing short term bets with assets like silver. These perceptions are particularly strong given that paper players in the silver market often control the price in the short term (6-8 months), since there is so much more paper silver than physical metal out there. As I write this, we are seeing the unwinding of quite a bit of speculative, paper activity at the COMEX, with open interest numbers (meaning the number of players in the casino) lowering to levels just above where they were in the fall of 2008 (when silver was below 10 dollars). The price of silver has fallen, but as far as I’m concerned, there is no fundamental reason for silver to be so cheap. Instead silver fundamentals are badly overshadowed by misconceptions (or outright lies) about silver. Here are five common myths about silver that I bet many speculators still believe are true:

1. Silver is an “economically sensitive” metal

During the recession of 2008-2009, the CPM Group estimated that silver demand from photography, jewelry, and industry dropped by roughly 80 million ounces (CPM Silver Yearbook, p.69). Mine supply also increased by about 30 million ounces, along with a 15 million or so increase in recycling. So in order for the price of silver to remain stable (theoretically), you would need investors to make up this roughly 100 million ounce difference, which is exactly what they did. Given the fact that people understood the need to buy precious metals during a banking crisis, investment demand for silver increased by nearly 100 million ounces at the same time as demand fell and other sources of silver also increased. (p.11)

Over the course of 2008 and 2009, the silver price more or less remained stable, even as it saw wild swings induced by paper trading. So, during one of the worst recessions in modern memory, real, physical demand for silver cancelled out declining industrial use. An important point to remember when someone tells you the silver price is destined to go down in the next recession.

2. Silver coins and bullion are more plentiful than gold

In fact, it is the exact opposite. Being generous (and using data from the CPM Group as well as the Silver Institute) there are maybe 1.4 billion ounces of silver coin and bullion in the world, versus roughly 3 billion ounces of gold coins and bullion. Yes, it is true that recently about 80 million more ounces of silver bullion/coins are produced each year than gold ones, but that still means that it will take over 15 years before the silver stockpile in the world even equals that of gold, let alone becomes greater. So why is the price of silver something like 50 times cheaper than gold? Ask the paper speculators above.

3. The high price of silver will drive down demand from industry

This one has had no basis in fact for the period from 2000 to 2010. During that decade, industrial demand, according to most estimates, basically remained flat (GFMS World Silver Survey, 2010). This is amazing, when you consider that the price of silver went from 4 dollars to over 20 in that period. But because silver is used in such small amounts in things like electronics and solar panels, increasing silver costs have yet to dampen demand for highly desired toys like computers and cell phones. And many silver experts believe that such demand will only increase in the years ahead. You should realize that a rising silver price does not seem to dampen industrial demand.

4. At the right price, billions of ounces of silver will get recycled

Many do believe that there are nearly 6 times as many ounces of silver jewelry (and silverware) than gold jewelry in the world. So you might think that there is a lot of silver that will get melted down someday. One problem with this argument is that much of this silver either a) costs way more than even the current bullion spot price and b) is held in very small amounts all over the world by over 1 billion people (oftentimes women). They won’t care to sell for a very long time—if ever.

But there is an even more important point here. I bet most people who claim to follow precious metals don’t realize that as of 2010, we had yet to see more silver recycled than during 1980. That is thirty years of silver recycling more or less going nowhere, even as the price of silver spent more time above 20 dollars an ounce in 2010 than in 1980. I am going to be generous and guess that we will finally best the old recycling high this year in silver (at over 300 million ounces). But in a world where 300 million ounces of silver is only 10 billion dollars, and in a world where investors are slated to purchase nearly that much silver in physical form over the next couple of years, you really have to wonder why anyone would think there is all of this silver just lying around ready to be brought to the market to cool off silver’s price. And given what I said about how impervious industrial demand is to silver price increases, a lot of whatever silver jewelry gets recycled will be used and consumed by industry (even assuming that preservation techniques get better as the price goes higher.)

I also would not expect mine increases to somehow meet demand: few industry experts believe silver can increase more than 4 or 5 percent a year (roughly 50 million ounces, or less than 2 billion dollars), especially when nearly 80% of silver is a byproduct of metals like copper, lead, and zinc.

5. Retail silver investors are fickle/ there is no plan to remonetize silver

This myth had some basis in truth, at least according to the experts who tracked silver buying and selling activity in the 1980s and 1990s (such as the CPM Group or Silver Institute). Many agree that retail investors (probably following the lead of governments) sold far more silver than gold during the twenty years between 1985 and 2005. Probably to the tune of over 1 billion ounces. So many felt that silver investors were flakes who really didn’t have the staying power of gold investors. Or, as I mentioned above, it may have just been the case that average investors followed the lead of governments, since those governments dumped far more silver than gold during the same period (gold is the only precious metal held by central banks, in addition).

But in recent years, I am struck by how many proposals there are like the one from Hugo Salinas Price in Mexico attempting to bring back silver coins into the market in his country. Then we have all of the state legislation in the United States aiming to bring back both gold and silver into economic transactions. Remember, silver is perceived to be the money of average people (even as it is rarer than gold) so any grassroots effort to bring back precious metals into everyday transactions will dramatically increase silver’s value. We have already seen the amazing turnaround in silver retail investment buying over the past few years (hundreds of millions of new ounces) and I think some people are slowly waking up to how undervalued silver is. But believe it or not, many, many more have yet to do so.

Don’t Be Fooled By Silver Market Myths

As I said above, I understand that fundamentals often have no place in markets. This is why so many traders focus on chart patterns, or volume indicators, or anything other than the underlying, real-world reasons for an asset to move up or down in price. You can also see the lack of interest in fundamentals from those large speculators who believe that rumor-mongering is a safer way to make money than actually focusing on legitimate distortions in the market. You might be surprised how much money you can make from simply playing games, or from manipulating others’ emotions—at least in the short term.

In the end, of course, I don’t think gambling or trading wins out. Yes, there are those few great traders out there, just like there are a few great gamblers around. But there are far more people who are simply the sucker drawn into the great casino called “the market.” This is a sad commentary on how our current financial system incentivizes reckless, speculative behavior. But that is just the way our world works — at least for now.

However, every day we see more evidence of the need for retail investors to truly diversify their portfolios with an asset that is set apart from the stock/bond market or banking system. The world is not going to end, but gradually, perception will come around to the cold, hard facts that currency debasement, financial repression (artificially low interest rates), combined with fiscal austerity are here to stay. In an environment where measures such as quantitative easing are really only easing the transition to a downsized economy (at best), people will be looking for those assets that never took part in the bubbles associated with the world before 2007 in the first place. Those assets which don’t need leverage to move higher (even though leverage is a part of the silver market), or those assets which don’t rely on endless consumption or indebtedness on the part of the consumer in order to become more valuable.

You may think silver will keep getting cheaper, and you might be right in the short term. But in the long term, this price correction really will be a blip on a screen, and when silver’s price one day explodes higher again, you will kick yourself for having bought into misconceptions like the five myths regarding silver.

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