Intended Audience

Investors looking to speculate on the price of silver through ETFs or publicly traded silver companies as well as those looking for a store in value against inflation.

Summary Points to Take Away

Inherent supply constraints will restrict the ability of silver to react to changes in demand; thus, overall supply is inelastic – which would put upward pressure on the price of silver should demand increase.
Silver is one of the most industrious items in the world – highest reflectivity, thermal and electrical conductivity of all the metals; thus, difficult to substitute all its industrial uses should the price of silver spike.
Store of value during inflationary periods
Future growth in Solar Energy could propel demand for silver, resulting in higher future prices
Cyclical good; thus, short term price will trend downward during the low point of the business cycle
Demand for silver over the past decade from the photography industry has declined – which still represents a sizeable portion of total demand that is likely to deteriate over time.

Introduction

The price of silver has been historically volatile as it can fluctuate between the demands of industrial users and investors using the precious metal as a store of value. At times this can cause wide ranging valuations in the market, creating volatility.

Analysis

Supply Constraints

Overall silver producers are slow to react to higher levels of demand; thus, low levels of supply will ensure the price of silver doesn’t collapse on excess production, etc. Two significant factors depressing supply growth are:

(1)   Unlike gold which is hoarded, silver’s primary use is for industrial applications (approximately 40% of demand); thus, the majority of silver used in this capacity is either thrown out by the end consumer or is consumed during manufacturing. Less than 1% of silver gets reused and recycled; thus, continued supply is necessary to continue to fulfill the industrial demands upon silver. Though new silver is mined and brought to the market place – a significant portion of it ends up in the landfills. This is unique to precious metals, and very unlike gold which is hoarded (i.e. used for jewelry or as a storage of wealth, not many industrial applications;) – i.e. most of the gold ever mined throughout our history is still in existence; thus, supply continues to build upon each other unlike silver

(2)   Producers can’t react to higher prices because 75% of silver that is produced is the secondary by-product of the original mining operation (typically gold, copper, zinc and lead); thus, given that the primary resource being mined is not silver – higher prices of silver won’t provide an incentive for mining companies to speed up production as their decision making process focuses on the demand/supply issues they face for the main resource they’re trying to extract – silver is an afterthought. This is very uniqe to silver as most other metals are specifically mined for – not the pro-product produced from non-related mining activities.

It is evident by the above two points that there is strong potential of future price spikes in combination with a general upward trend for the price of silver over the long run.

Not Easily Substituted for

Silver is one of the most industrious materials in the world – highest reflectivity, thermal and electrical conductivity of all the metals; thus, difficult to substitute all its industrial applications should the price of silver rise sharply. This makes demand relatively inelastic; thus, a rise in price would be followed by a smaller decline in demand; therefore the higher price will persist (keeping in mind of the above discussion about the slow response from silver suppliers). Keep in mind that this is based on current operating conditions and technology; therefore, future developments could change the current substitution possibilities available to users of silver – but this is purely speculative at this point; thus, not a current critical threat to the price of silver.

 Store of Value in Inflationary Periods

Silver along with gold are precious metals that store buying power, protecting it from periods of high inflation (i.e. unlike currency which decreases in value during inflation, precious metals will hold their buying power and can be converted into more currency then used to purchase it to compensate for the higher levels of inflation). RecentlyI most of the significant global economic powers are issuing their respective financial institutions significant amounts of liquidity (ex. U.S. with AIG , Fannie Mae, Freddie Mac) that will expand the money supplies of the relevant nations. Though this may stabilize the economy in the short term – it will lead to excessive levels of inflation as they’ll be more money in the system chasing after the same number of goods; thus, it’ll take more of those dollars to buy those goods. In general – most investment experts recommend investors have 10% of their investment portfolio in precious metals to protect themselves in instances described above – take a look at silver to fufill this need.

 Impact of Growth in Solar Energy

 As the price of fossil fuels (ex. Oil, natural gas, etc.) rise in value due to scarcity, alternative sources of energy are being seeked. Global scientists and governments have become interested of the promise associated with solar cells to produce electricity. Silver paste is used in 90 percent of all crystalline silicon photovoltaic cells (the most common type of solar cell). Demand from future solar energy projects is estimated to triple from current levels by 2012 – brining demand to 40.6 million ounces – which is note worth though not significant given 2007 global demand of 894 million ounces. This forecast is the lower end of the estimate and should the upper end of  the demand estimate be realized – demand would go to 142 million ounces from solar energy projects. Given the supply constraints of silver (as discussed earlier), the prospect of growing demand for solar energy projects is a potential catalyst that could lead to significant increases in the price of silver if the high end estimate is reached (representing a 16% increase in demand without an equal increase in production, which keeps the price high). Readers should continue to track the growth of solar energy projects as well as competing fossil fuels as the lower costs of oil or fuel alternatives could slow down these projects and demand. Investors should continue to monitor this potential catalyst.

 Risks

 Current Global Recession

 As mentioned earlier – silver has numerous industrial applications (including new home construction and automobile manufacturing); thus, though the long term prospects appear strong, like many metals – it is subject to business cycle swings. Based on present economic climate – manufacturing is slowing; thus, demand for silver will be depressed during the low point in the current business cycle, not making purchasing silver a good prospect for short term traders. For investors who have a long term outlook – the current period may represent good buying opportunities as the price of silver has suffered throughout the year due to lower demand from industry – specifically it is down 48% from its peak during 2008 (March 17, 2008 – $21 US/Ounce) as compared to current price of $11 US/Ounce (December 31, 2008). Prices taken from NY Spot Market.

 Photography Industry

 Silver-based photography is based on the use of chemical ‘developers’( the differences in light intensity form negative images), which can then be processed into paper pictures by using silver-imbedded paper. Because of the growth of digital photography, the use of silver-based imaging by consumers has been steadily dropping as many picture takers either keep their images in digital form or use low-cost, ink-jet printers. Silver demand from photography has dropped from 225 million ounces (27% of total demand) in 1998 to 128 million ounces (14% of total demand) in 2007, and based on the above analysis this trend will likely continue. Though demand from photography has dropped year after year – it is has been replaced and succeeded by increased demand from industry (316 million ounces (38% of demand) in 1998 to 455 million ounces (51% of demand) in 2007). Should demand from industry slow down or stop the impact would severly depress the price of silver as industrial uses is currently the largest contributor to total silver demand.

 Where to go from here?

 Based on the above analysis, silver is likely a good buy at current prices given the strong fundamentals (ex. expected upside in price from supply constraints, higher demand for inflation sensitive assets (i.e. store of value) and potential growth in demand from solar energy projects).

 Several ways to invest in Silver

ETFs – some ETFs track precious metals, while others are completely dedicated to silver. These are a low cost situation as transaction/storage costs are low due to the fund buying in bulk. Note that storage costs are reflected in the market price of the ETF, not something an investor pays for separately. Word of warning – there is a theory that in a time of market crisis where precious metals would be used as a medium of exchange, etc – a silver ETF market price may not reflect the actual value as ETFs are part of the overall financial system; thus, if there is a market crash – demand may drop for ETFs (even those of precious metals) along with other stocks as well. This prevents the user to utilize from using their true silver asset holdings. This is only a theory and speculative at best – so take it with a grain of salt.

Purchasing shares of publicly traded companies with significant silver operations (ex. BHB billiton, Barrick Gold, etc. – note these are not recommendations but rather options, do your research if you choose this path). A word of warning about this route – remember that companies can always go bankrupt, but commodities can’t, meaning if you choose this route you are vulnerable to company specific risks (ex. Underperforming secondary product lines, fraud/accounting scandals, etc.)

Silver bullion & Coins – this is literally buying physical silver and storing it yourself (at home or in a safety deposit box, etc.). Provides you the safety of physically having access to it should you need it (ex. Market crash, no confidence in local currency, etc.), but on the negative side – you’ll have to find a place to store it and incur significant transaction costs (around 10%).

THANKS,

SIMON GIANNAKIS

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