The Nature of the Silver Market

By Reginald W. Ogden

Sep 29 2008 12:14PM
www.ultimategold.ca

Silver, in modern times, has had difficulty shaking off its “Cinderella” image. The total value of the silver bullion market is a mere 10% of the value of the gold market and thus of limited economic significance. The silver market is currently subject to major structural changes in both demand and supply.

Goldfields Mineral Services estimates that current world silver bullion stocks of coins and silverware stand at a mere 400 million ounces. By the end of 2008, world government inventories could well stand at or close to zero if present trends continue. Although a large percentage of production is relatively insensitive to the price of silver, as it is a byproduct of base metal mines, the amount of scrap offered for sale can still be very price elastic. For instance in 2003, as the price of silver surged, scrap recycling increased exponentially to 16 million ounces (a gain of 235%).

SILVER IN HISTORY

Historically, silver has seen a much greater usage in coinage than gold. Its greater availability and lower value made it a more practical commodity to use for commercial transactions. Most countries were on some form of commercial silver standard until the late 19th century. The large increase in physical gold production that came with the gold rushes enabled gold to replace silver as the universal “currency coinage”.

The majority of the precious metals plundered and mined by the Spanish took the form of silver. Gold was too expensive and difficult to mine. Most of the gold came from alluvial deposits or as a byproduct of silver mines in Mexico and Peru. So much silver was exported to Europe that its value, once comparable to gold, declined to 1/15th of the price of gold. Spanish silver ended up spread across Europe as Spain paid off its large war debts to foreigners. It has been estimated that 95% of all the bullion exported from South American to Europe was silver. Between the years 1500 and 1800, an estimated 100,000 metric tons was shipped from Central and South America, creating inflation in 16th and 17th century Europe.

Until the mid16th century, silver had been rare in Europe. Once it became abundant, it was used in furniture and tableware, as well as being exported to Asia in exchange for spices and silks.

Between 1545 and1546, silver was discovered in Peru and Mexico. Until then, the Spanish had been content to steal it from the natives; from then on mining became the main source.

Prior to World War II, after coinage the major consumption of silver was for jewelry and silverware. Technological development and advances in electronics and photography led to new consumer silver usage products in the post war period. This increased demand was not met immediately by an increase in mine supply. In the early 1950s, as a result of the 1946 Silver Act, the U.S. Treasury was allowed to buy and sell unlimited amounts at between $0.91 and $0.95 per ounce. Consequently, an arti- ficial lid was placed on the price of silver, as producers sold to the Treasury.As industrial demand grew, the Treasury became the main source of supply. Low silver commodity prices discouraged the recycling of silver scrap and led to the closing of marginal silver mines.

Since the end of World War II, silver consumption has gone from the dining room table to the medical operating table to industry and technology. By far, the biggest damper placed on silver demand has been the decline of silverware for table dining. Between 1973 and 1990 alone, tableware demand declined from 22% of total demand to a mere 2.4%. As an ornament, it has been replaced by ceramics, glassware and stainless steel cutlery.

Silver film in medical imaging has been replaced by digital electronics, in newspapers by plastic plate, in mirrors by aluminum and rhodium and silver plates in surgery by tantalum.

Annual demand for silver usage in photography is currently declining at a rapid rate as digital cameras replace film.

CHINA AND THE SILVER BULLION METALLIC STANDARD

In the 1930’s China was the only major country left on the silver standard. Early Chinese paper money grew out of the desire to do business transactions without having to transport hundreds of thousands of kilos of silver coins over long distances. Today the Chinese word for bank literally means “silver movement”.

During the Ming Dynasty metallic coins and raw bullion were replaced by paper fiat currency.

As silver lost its monetary value in the post 1870 period, the 19th Century prevailing gold/silver ratio of 16:1 went as high as 76:1 lbs. In 1933 there was a decline of 5:1 in the value of silver to gold spanning a 60 year period. In 1935 the US government brought silver at above market prices in a program to bail out silver producers. As the US government purchased silver at artificial prices, silver was exported from China to the USA leading to Chinese domestic deflation.

THE US GOLD/SILVER BI-METALLIC STANDARD

For centuries silver coins were used for every day commerce as gold was too scarce and valuable for the purchase of everyday items.

For most of the 19th century, the U.S. dollar was backed by 22.5 grains of gold or 371 grains of silver (1 grain = 0.065 grams).

Following the Panic of 1873, there was a strong populist movement throughout the Midwest and South USA centered on the Greenback Party to inflate the economy, mostly amongst farming communities in an attempt to inflate the economy by changing the silver gold ratio so as to reduce farmers indebtedness.

The political battle between the “gold bugs”, primarily North Eastern bankers and “free silver” advocates, mostly creditor indebted farmers in the Midwest and the South, was eventually terminated once the White House was in the hands of the Republicans.

In 1900 Frank Baum published the wonderful Wizard of OZ which was interpreted by many critics as satire on the “gold bug” community with the scarecrow representing the rural farmer and the wizard the head of the New York Reserve Bank. The debate over scarce gold and abundant silver was essentially made obsolete by gold discoveries in South Africe, Alaska and Colorado.

SILVER DEMAND AND SUPPLY

Currently, 32% of silver is used in jewelry fabrication, 25% in photography and 40% in industrial manufacturing. Ever since 1990, the demand for silver in fabricated products has exceeded new mine supplies. The 1990 inventory surplus of over one billion ounces has now been worked off, but one needs to bear in mind that India has 20 years of estimated annual supply above ground in the hands of individual investors.

In January 2000, the silver market was fully deregulated in China. This led to increased demand from the industrial electronics and chemical industries. Despite the decline in photographic usage, total Chinese fabrication demand in 2003 was up 16% to total 860 million ounces. The effect of the decline in photographic usage is essentially a short-term factor as 80% of the silver used in film is recycled. The decline in silver film usage will, however, mean that tourism is no longer a major factor in the seasonal supply/demand equation for silver.At present, 30% of world supply is from recycling (mostly from photography), which we would expect to decline over the next 5 to 10 years.

SILVER AND INTEREST RATES

Ever since silver has been demonetized and commoditized, its price and behavior have been closely allied to the expansion and contraction of the economy. It has become more of an industrial material than a store of value. Gold bullion, on the other hand, has its short-term price determined and driven by monetary factors.

SILVER MINES AND MINING

Less than 30% of mined silver comes from ores where the prime or major mineral is silver. The rest comes from:

Lead/Zinc deposits: 31%
Copper /Zinc deposits: 25%
Gold/Zinc deposits: 14%

Coeur D’Alene and Hecla are the only two major primary silver producers in the U.S.A. Less than 25 major or pure silver deposits of any magnitude exist in the world Pan American Silver has interest in four of these. This leaves two-thirds of the world reserves of silver associated with base metals ore bodies, most of which are at great depths. Most known major silver deposits tend to occur in dry desert areas such as Mexico, Peru, Chile and the U.S. Southwest.

SILVER EQUITIES

Over the past 20 years, silver bullion has been plentiful, causing the commodity to suffer from low prices. As a result, very few silver mines have been profitable. There is an old stock market adage “Buy Scarcity, Sell Surplus.” The fact that profitable silver stocks are rare, gives the surviving silver equities a scarcity value many times their rational economic value. This has always been true of silver equities. A glance at the prices silver equities traded at their peak bears this out:

Hecla Mining: $35 US Equity Silver: $66 CDN
Coeur D’Alene: $36 US United Siscoe: $25 CDN
United Keno: $68 CDN Silverstock: $36 CDN
Sigma Mine: $36 CDN

Only Hecla and Coeur D’Alene are still in operation today.

In the recent precious metals recovery market that began in 2001, Silver Standard, Pan American Silver and Sterling Mines all made exponential moves. Many of the silver deposits have been acquired over the past five year period at a cost close to $0.05 to $0.10 an ounce in situ resources, while the market is placing a value of close to $1.00 per ounce of reserves in market capitalization. Over the past two to three years, several developments by junior and independent companies have occurred to change the scenario of “abundant commodity” and “scarce silver equities”, so that the description of a “profitable silver mine” is no longer an oxymoron.

In recent years a “derivative based” company Silver Wheaton has become a leading silver equity It’s main operating function is to buy silver at a set price for an equity injection to junior and independent companies.

The exploration and development of large low grade gold/silver properties adds a new dimension to silver mining.

SILVER AND GOLD

In 1900, world gold production was 386 tonnes and silver production 540 tonnes. Gold production increased 7.3 times from 1900 to 2003, while silver production increased a mere 3.4 times. Since 1900, there has been a large variance in the ratio of the price of silver to gold, with the silver price ranging from 1/20th to 1/80th the price of gold.

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