Every good carpenter understands a little about wood. Pastry chefs know flour. Perhaps it stands to reason that investors should also think a little about money. We live in a curious age, where money is intangible and created at no apparent cost by governments and their central banking bureaucracies. It was not always that way.
Prior to 1971 most wealthy countries issued scrip backed at least in principle by gold or silver. However, today’s investor has precious few “hard currencies” from which to choose as a store of wealth. In 2009, I see no government paper as attractive as silver, which may now be the world’s most undervalued currency.
That silver is a currency, of course, is a point of much contention. Although accepted as such for thousands of years – to the extent that the word for silver, argent, literally means money in our country’s other official language – many investors think of silver’s monetary significance as a mere remnant of a barbarous past. It is possible, however, that we are confusing fundamental debasement with technological advance.
Growth in Money Supply, Shrink in Silver Supply
Since 1980, the supply of currency, bank deposits and other cash-like financial assets that the US government calculates as M2 has grown between five and six times. Zero-maturity money has grown by over nine times. The St. Louis Fed website offers wonderful charts outlining the spiraling growth in these monetary aggregates.
In lock-step with this increase in money supply, salaries, house prices (even now), stock market indices and many other assets have risen in sympathy. Some factors have risen more quickly (baseball salaries, for instance, are up 22X), while others have risen more slowly (a brand new Pontiac is only up about 5X). However, silver prices are actually lower in 2009 than they were in 1980, when the metal traded hands at an average price of US$20 per oz. Adjusting the start point of this analysis can offer somewhat different results, but it is very difficult to conclude other than silver has lost considerable value share over the past few decades.
In stark contrast to the growth in money supply, the “silver supply” has been shrinking. In 1975 silver inventories were 5 billion ounces, currently they are down to about one billion ounces. Mine production has not kept pace with silver consumption.
Silver vs. Gold
A straight comparison against gold is also flattering to the pearly metal. If we look back at historic money systems, the ratio of value between gold and silver was usually between 10:1 and 20:1 in favour of gold. If one considers the ratios of physical inventories, then the scarcity factor is even less favorable to gold. There is actually much more physical inventory of gold than there is of silver (5 billion oz of gold vs 1 billion oz of silver by one estimate). While much silver exists in the form of cutlery and jewelry, it would be surprising to see that supply rush into the market unless prices were much higher. Given this historical relationship, and the inventory levels, the current price relationship is surprising. On yesterday’s fixing it took about 65 silver ounces to buy one gold ounce.
Weakness in silver has been partly due to the metal’s diminishing industrial use in the area of photography. However, photography’s share of silver end use has already declined from almost a third of demand to about ten per cent. The industrial use of silver is now far more prevalent in growing applications relating to electronic components, data storage and batteries. An average cell phone, for example, contains about a third of a gram of silver.
As an overall proposition, silver at $14 per ounce seems to be a solid investment. Compared to holding a bond denominated in paper currency, for which the marginal cost of production is zero, and the ultimate security of which depends on the success of heavily indebted western governments in holding back the forces of compound interest, holding a little silver seems like a fairly rational long-term diversification.
What to own
For the truly paranoid, nothing beats physical silver, preferably buried in a number of small quantities at locations known only to the holder. However, for the foreseeable future, ETF’s are likely to do the trick. The i-Shares Silver Trust (SLV) seems to be a pretty reasonably priced offering. There are double-leveraged long and short ETF’s which have the unadvertised effect of magnifying longer-term gains and losses beyond the 2X factor due to their daily rebalancing. I would tend to avoid these.
As for a target, how about 20:1 gold to silver? At today’s prices that would imply about $50 per ounce silver. That would be well within the bounds of historic precedent.