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Silver Investing

In the world of investing, it is gold that attracts all the attention whether in the financial press, on the national news channels, or on the dealing and trading floors around the world. For centuries, buying gold has been recognized as one of the best ways to preserve one’s wealth and purchasing power, and yet if we look more closely at silver, it provides one of the best supply demand relationships in the commodities sector, due to its ever increasing demand for industrial and commercial applications. Unfortunately it has often been considered the “poor mans relation” to gold, and yet as a metal for investment, scratch the surface a little and the opportunities for investing in silver become more apparent.Silver is primarily obtained from two sources. The first of these is from traditional silver mines, mining silver ore, which represent approximately 25% of world supply, a percentage that has fallen year on year as these gradually become uneconomic. At present there are only 23 0r 24 pure silver mines currently operating around the world. The other 75% comes from secondary extraction from other mining for gold ore, copper, lead and zinc ore. The five largest producers of silver are Peru, Mexico, China, Chile and Australia.

In order to consider benefits, or otherwise of investing in silver, we need to consider the metal, from several different aspects, simultaneously. We have already looked at the supply and demand relationship when considered as an industrial metal, and have seen that as prices increase, demand falls, and as prices fall, demand increases such that the market eventually discovers an optimal price where supply satisfies demand. But how does this relationship differ when we consider the metal as an investment? The answer to this question  provides an odd paradox for us as invertors, and put simply it is this – as prices fall, demand generally falls, but as prices rise, demand can also rise which is the reverse of what one might expect. The reason for this perceived paradox is that as investors, we are always looking for rising prices, and as the price increases, fuelled by media speculation and the general buzz about a good investment opportunity, we buy into the move along with everyone else. In many ways silver is a superior metal to gold, both in terms of its many uses, but perhaps more importantly since the supply and demand fundamentals for silver are better, allowing investors to make better returns on silver than gold.

In the world of economics, there is a term for this phenomenon and is referred to as Veblen goods, which in simple terms suggest that as the commodity increases in value, so does demand. Luxury cars are often suggested as being Veblen goods, as the more expensive they are, then the more desirable, being an outward sign of wealth and affording the owner a form of exclusivity. Conversely a reduction in the price of the commodity or item will reduce demand as exclusivity diminishes. Many “high end” luxury goods could be classified as Veblen, and almost anything with an exclusive label. Now one might argue that the same applies to gold and indeed in some ways it does, but there are two fundamental differences between gold and silver which are as follows. Firstly, silver is in shorter supply than gold, and secondly, since much of the silver mined or extracted is consumed and not retained for investment, this makes this commodity rarer as supplies are exhausted. This is a complex relationship for the investor since it involves the aspect of a Veblen good, with the paradox of industrial metal . So is silver a precious metal, or an industrial one, and does this matter to us as potential investors? By the terms of the markets, it is now considered as an industrial metal, so does this mean you should not consider it as a good investment. Certainly not – in my view, the opportunities for silver investing are probably better longer term than for gold, and here are several reasons why.

First of all, silver has almost always produced a better percentage increase in price than gold during bull market runs, and in many cases the returns have been double or treble those for gold, and whilst there is a direct relationship between gold and silver prices, the rate of increase and decrease do vary. As we have seen, industrial use drives the silver market, and in the last twenty years  mining supplies have failed to meet industrial demand since 1990, with the deficit being met from above ground stock.  Coupled with this, many analysts believe that the above ground supplies are also critically short, and despite the economic downturn that is affecting world markets at present, it is almost inevitable that higher prices will follow in the next decade once the economic problems of 2009 and beyond diminish, with a return to more stable market conditions. Unlike gold, the above ground stockpiles are falling all the time and as an example, in 1995 COMEX stood at 250 million ounces, whilst today these stand at around 100 million ounces. Finally, many people invest in gold for the wrong reasons, either because they are following a trend, following the herd, or simply prefer to invest in gold for the status of owning gold bullion or gold bullion coins. Silver for the longer term is probably a better investment, but you will need to overcome the mindset that this is the poor relation to gold, in order to see the opportunities for this often over-looked investment opportunity. It is the supply side of silver and it’s relative rarity, that will ultimately dictate the future spot price of silver.