My long term silver investment thesis
First, it’s important to consider that silver is not like other commodities. It sounds kind of silly, but if we were talking about wheat, oil or pork bellies, the supply and demand would have to balance, in the long term and the short term. Gold and silver are mostly valued based on existing stockpiles. They have been mined for thousands of years, and for most of that time, excluding the last 150 or so years, almost everything ever mined was still in some sort of usable form. This is why these metals can act differently than almost any other commodities. If the price of corn spiked higher, farmers would switch crops to farm more, and it would eventually correct the price to the cost of production and a reasonable profit margin, since every year all the corn in the market is consumed and grown again. Gold or silver could go for a long time being too expensive or too cheap, and it wouldn’t immediately correct itself, since the price is based more on the huge stack already mined, rather than just what’s going to be mined in the next year. This one frame shift is really key to understanding the current state of the market.
Silver is primarily mined as a byproduct of Copper, Lead, Zinc, and Gold mines. This may seem like a random interesting fact, but it actually effects the market a whole lot. If we were talking about lithium instead of silver, and the lithium price went up 5x, every lithium mine in the world will go into overdrive, try to expand production as fast as possible, build any new mines they could, and that will eventually reverse or slow the price increase. If you have a mine that produces 90% of their revenue from lead and zinc, they aren’t likely to do the same expansion if the 10% of production that’s silver goes up 5x.
I’ve heard some people talk about the market size of silver as being $1.5T. That’s the rough value of all silver ever mined in 3000 years, and is pretty irrelevant in this context. The amount of silver in investible bar form is under 3B oz, which is less than $58B. The Comex has about 35M oz, in registered inventory, and 266M oz in eligible inventory. Eligible inventory is bullion in a depository, that could be put up for sale if the owners wanted, so it might not be for sale at any given price. The LBMA has 1B oz, but around 85% is already owned by ETF’s. There is lot of silver in the world, but very little for sale in an investment grade, at anywhere near current prices. For a market apparently worth $1.5T, it seems like you could buy every bar in available in the world for a little over $4B. That’s obviously not counting the existing demand, so it might not take much new demand to move this market significantly.
Never forget that every oz of silver in the world is already owned by someone. When people talk about “new” supply coming on the market, that has to be someone who wasn’t willing to sell at the old price but is willing to sell at the new price. Until very recently, mines have always been price takers, selling at whatever the current price happens to be. This year, First Majestic withheld selling 1.4M oz, and Endeavor silver just withheld about 1M oz, because they think current prices will go up significantly. If this plan works out for them, it would easily become a trend.
Although there has been much more silver mined through history, silver inventories have been chipped away for decades by industrial consumption, while gold inventories have grown. Don’t forget that although gold inventories have grown, so has the human population, and especially the population those with enough wealth to own gold or silver. Silver inventories have shrunk in absolute terms, but far more compared to the number of people who could buy some.
The whole mining industry has been slumping for a very long time. Discoveries of new significant deposits are not only down, but new additions to PM reserves fail to add as many oz as are produced each year. If you consider that it takes years or decades between prospecting, exploring, drilling, permitting, more drilling, and construction of a new mine, there could be a very big lag between the price going up, and any significant new supply entering the market. I’m no mining expert, but I’ve heard it could be at least a 5 year lag for new mines (not counting any already in the pipeline). That pipeline isn’t exactly flush given the insanely low prices over the last 5 years.
Some people say that if the price goes up any significant amount, a flood of silver will come in from old coins, silverware, jewelry, etc, and correct the problem. In 1980 when silver hit $50, there truly was a giant rush of silverware and old coins, that impacted the supply demand fundamentals, but I don’t have the exact numbers. In 2011, when silver hit $50/oz again, the amount of silver recycled, went up about 50%, from around 100M oz to 150M oz, but that increase was only a small fraction of the mine supply (over 800M oz), so the broader supply demand picture didn’t really change much. There’s still a lot of silver in coins, silverware, jewelry, etc, but if it didn’t come back into the market at $50 in 2011, why would it come out of hiding now, for less? Also, although there are still lots of old silver teapots and spoons, they don’t make a lot of new silverware and every year that stockpile shrinks as old spoons get melted down. Much of the silver used in the “silverware” portion of the current demand pie, is used for electroplating, and that silver is never getting recycled.
Over the past few decades, some of the supply demand imbalance in the silver market has been compensated by governments eroding their silver stockpiles. Many countries used to make coinage from silver, so they had to keep stockpiles, both functionally for making coins, but also as a strategic and central bank asset. Today, the US, Canada, UK, and most other developed countries, have sold the effectively all of their silver reserves decades ago. The US government had 350M oz in 1970, and around 50M oz from 2006 to today. All they hold today is working inventory for coin sales.
Silver is found in the earths crust at about a 14/1 ratio to gold. Current mine production is about 8/1, and existing stockpiles of investment grade product are not known well enough to compare, but I’ve heard estimates ranging from 3/1 to 1/1. The current price is 84/1. Gold hit it’s all time high in 2020, but silver was half it’s nominal all time high, or less than a quarter of it’s inflation adjusted high.
If you take a more broad view of value over time, gold and silver have historically been valued along the lines of their production and naturally occurring scarcity, from 10/1 to 15/1. This ratio held for thousands of years. If you look at an inflation adjusted chart of silver prices going back many hundreds of years, silver prices were usually many hundreds of dollars. From 1720-1900, the silver price never dipped below $100, and was as high as $500, in todays dollars. For most of the last 3000 years, an average skilled labourers days wage was 0.1 oz of silver.
Lots of people are talking about a shortage of silver, and it’s so much bigger of a deal than most realize. Mints are admitting they can’t source material, and shortages that were once limited to small bars and coins, have spilled over into 1000 oz bars. Post covid, we have seen shortages in so many things recently, so it’s seems normal, but this shortage is nothing like the others. As I said at the beginning, if most other shortages are self correcting by the functioning of the markets (planting more corn, etc), but this market is valued based on a stockpile built over 3000 years, then a shortage means the market has run out of the stockpiles, and the one and only thing that can correct the supply, is higher prices. Given what we saw in 2011, with very little new silver coming back into the market at $50 (or an average though the year in the mid 30’s), it’s safe to conclude that the price it would take to truly balance the market, with no more stack to erode, may have to be dramatically higher than that.
To be clear, other than what industry used, that formerly stockpiled silver still exists, but it’s been distributed. It used to be owned by central banks, bullion banks, and regular banks, and now it’s finding it’s way into ETF’s, and investors hands. Many of those banks left the PM market altogether and others hold leveraged comex contracts instead of bullion.
The most important thing to understand about the demand side of the silver equation, is how it’s changed over time. For thousands of years, silver was money. Before the industrial and digital age and the silver consumption it introduced, pretty much all the silver ever discovered was still around, and the demand was that it became money the moment it was found. That’s a pretty simple demand case. If you were a prospector in the 1700’s, you could walk into a bar and spend silver or gold you found in a creek that day. If you spun some wool, you’d have to trade that for silver or gold before you could spend it.
Over time, more and more uses for silver started to appear. This is when silver gained its hybrid, monetary and industrial status, and this status is really key to understanding silver in the world today.
Today, around 60% of silver demand comes from industry, and that demand is quite inelastic. If a company makes smartphones, and the average phone uses $0.35 worth of silver, you don’t stop making phones when the price of silver quadruples, and your phone needs $1.40 worth of silver. Silver is used very broadly, since it’s found in alloys used in most electronics. Because of that broad industrial usage, and the difficulty recovering such small quantities, about 80% of the silver consumed is never recovered. If you have a gold watch, someday that watch will break, and the gold will probably end up in a gold bar. If you make a cell phone, one day it will break, and most will end up in a landfill.
Also, industry demand is almost always hard to substitute. Silver is the most conductive element, most reflective element, and has natural anti microbial properties. These properties are elemental and irreplaceable. I’m sure if people could easily use copper instead, they probably already would have. There is a natural trend where a single product, like a solar panel, will use less silver per unit, as manufacturing becomes more and more efficient, but that effect is counteracted by more and more products using silver and higher quantities of production driving that efficiency.
It’s also important to consider that although silver is only more conductive than copper by a small amount, in electronic applications, performance is measured in billionths of a second, so being a bit better means a lot.
Silver’s industrial demand is highest in fast growing sectors like electric vehicles, solar panels, and electronics. EV’s use significantly more silver that gas cars, and also use lots in their charging infrastructure. The average solar panel uses 0.6 oz of silver, and 5G networks are expected to increase silver demand significantly as they roll out. The trend is clear, the future needs silver, and things that haven’t been invented yet, will probably need the irreplaceable properties only silver can offer.
The other side of silver demand is its monetary or investment demand. At the core of this demand is silver’s historical role as a store of value, as well as the investment case I’ve been spelling out in this post. Silver’s monetary history revolves around it having the key properties of money: durability, portability, divisibility, fungibility, uniformity, limited supply, and acceptability. It’s worth noting that every element on the periodic table that meets these characteristics is already considered money. If you eliminate all gasses, all the elements that are reactive and non durable, all the elements that are too abundant to be portable (lead, iron, etc), the elements that aren’t easily divisible and fungible, so they can’t be divided and reformed, at the end of all that, you are left with only the precious metals. Maybe you can make the case for copper and nickel, but those have been used for money as well.
So, we’ve established that silver is a store of value based on inherent qualities. That makes it a safe haven investment, since people look to stores of value when the future becomes uncertain. For decades now, the world has been lulled into a false sense of security by the US dollar global standard, coinciding with a period of particularly low inflation. A key driver of that period of low inflation, is deflation in prices of consumer goods, because of globalization. To oversimplify, we keep printing more and more money, but China keeps cheaply producing more and more products. This has kept inflation contained in localized asset bubbles (stocks, real estate, art), and most people haven’t seen it effect their lives much (until recently). That could change quickly. The low prices we’ve grown accustomed to, probably won’t keep dropping as we keep printing more money. In short, once China already produces everything, there’s no prices left to bring down to offset the printer, and if production moves back onshore, you get the reverse effect, huge inflation regardless of QE/QT.
Another way to look at the inflation question is to ignore money printing, as modern economists often do, and just look at price inflation. More people with more money means higher prices. Well, most people don’t have more money, but a small minority has a vast amount. So, we basically only see inflation in what those people want (stocks, real estate, art). Those people can’t really go buy all the tomatoes in the world, unless they just plan to sell them again, but precious metals by their nature are concentrated wealth, so my theory is that we’ll eventually see that 0.1% group piling into anything they can, and they definitely can with silver and gold. They just aren’t paying attention just yet. Silver is barely on the radar of the 1%, let alone the 0.01%,…. but that could change quickly.
For years, pretty much every country in the world has been printing money like crazy, and the only thing that makes it not look crazy, is the fact that everyone else is doing it, and currencies are only valued relative to other currencies. People call this the race to debase, and ends when the value of all currencies end up going down through the floor (into de basement lol). Inflation has gone from a non issue in the minds of the world, to the issue of the day, and that’s unlikely to change any time soon.
Much of the developed world has forgotten about gold and silver, with academics referring to it as a barbarous relic, and with the biggest pools of money, hedge funds, pension funds, endowment funds, and the uber rich, collectively owning less than 0.5% of their portfolios in gold, and around 0.015% in silver. Over the last few decades, the fund average allocation to gold was 1.5% to 2%, so just a return to the average would be a massive inflow of money into the space. For the masses, the percentages are probably a bit higher than for funds, but as a share of all wealth in the west, precious metals are a microscopic rounding error, even today and even with all the attention we give to the space. It’s just not on most people’s radar yet. This sounds discouraging as people here are trying hard to grow WSS numbers, but it should actually be really encouraging.
Basically, we have a good case that demand should be higher, but it’s actually at generational lows in the grand scheme of things, with most individuals owning none and even the biggest funds not bothering to hold any. Despite this, let’s consider how the market is holding up to this (actually very low) investment demand.
I can remember a couple times when interest among retail investors spiked up, and premiums on coins and small bars went up dramatically. Every time this happened before 2020, the market would stabilize in months and premiums would fall back down. Producers of small bars and coins got a bigger incentive to make more, so they did, and the market calmed. In 2009, my local dealer would sell me high premium coins, but he could also get me 1000 oz bars at $0.60 over spot.
When covid hit, premiums rose again, but this time they stayed high. The reason is that this time the shortage is across the entire market. My local dealer passes on the prices he pays with a small markup, and his prices have stayed high on coins and bars, but also now his premiums on 1000 oz bars are up to 4-5x what they were in 2009, and have been that high since covid started.
The thing to keep in mind with premiums, is that it’s actually pretty simple to make silver bars. I’ve made a simple foundry and melted and poured aluminum bars in my back yard, just for kicks. It cost a couple hundred bucks in materials and took hours, not even days to learn and set up. If silver was readily available in large quantities, any period of high premiums would become self correcting. New entrants can easily set up operations to pour bars, and any existing player could easily ramp up production by buying more cheap equipment. The only thing that could keep premiums high for years is scarce supply of raw materials. Also, these days there are two raw materials to consider, silver (which seems to be getting scarce) and fuel to melt it with. A lot of that melting happens in Europe, and they are not exactly having a fun time in the fuel department these days. Even still, if silver were plentiful, it could be loaded on ships and planes, flown to the US, where they have lots of fuels and easily and cheaply melted to capture those premiums. That’s simply not happening at scale, and I can’t think of any reasons why other than real scarcity.
Scarcity is an incredible driver of behaviour. There are a lot of companies who really rely on silver, and who currently use just in time inventory, so they keep ordering constantly, and they can’t keep their operations going for long without new inventory. If I recall the toilet paper aisle in March 2020, when people start to sense a shortage, they tend to stock up. Unlike toilet paper, this won’t just be driven by fear and need. This would be driven by fear, need, want and greed. Imagine if toilet paper were a target of huge speculators that could easily and cheaply, house many years of global production, and suppliers couldn’t easily ramp up production, to respond to the shortage. It probably would have left a whole lot more desperate people, willing to pay a whole lot more.
Silver is a market that probably deserves more demand than it’s getting, but in reality has so little demand that the biggest funds and investors barely notice that it exists. Even this tiny demand has been enough to clean out existing stockpiles and create a shortage. The sleeping dragon in this situation is that industrial users need to buy, regardless of price or market conditions. Prices may rise, shortages may grow, and then industrial users would have to compete with a larger and larger group of investors for scarce supply, and investors will know this and try to front run those industrial users. As this starts to unfold, it will bring silver more and more attention from more and more investors.
Paper and Leverage
Comex open interest (OI) is the amount of contracts trading at any one time. It’s the best measure of size of that market. LBMA is a more opaque market, so we just have to assume it’s relatively similar in structure, even if the scale is different. Every month, contracts expire and most close their contracts in cash or roll to the next month, but some take delivery, shrinking OI and inventory. Lately, there has been a trend, where the Comex silver inventory is shrinking quickly.
Right now comex open interest is about 139,000 contracts for 5000 oz. That means that OI is 695M oz, and registered inventory is around 35M oz and eligible is around 266M oz, so there’s roughly 40% the silver in vaults as their are contracts.
The more contracts get delivered, the lower OI gets and the lower inventory gets, but the ratio also shifts. If you think of it as 700M to 300M, it’s around 2.3/1. If another 200M oz gets delivered that number drops to 500M to 100M or 5/1. One way to think about it is this, for every contract that takes delivery, at least one other contract will never be able to take delivery, or the seller will have to scramble to find any bullion it can at any price.
Here’s where it gets really interesting, Registered is around 35M oz and eligible is 266M oz. Registered can be drawn for delivery, but eligible only meets the requirements, so it could be delivered in theory, but only if the owner wants it to be. If registered is draining aggressively, who is going to want to put up their eligible silver? If you think of those numbers without the eligible, its 700M to 35M or 20/1, and if just 20M gets drained, now it’s 680M to 15M or 45/1. If 30M gets drained, it’s 670M to 5M or 134/1. As soon as the math become clear to everyone, it all just disappears and people try to figure out the next way to get inventory.
The reaction will be predictable, comex will try to change the rules on the fly to cap the price and keep inventory, but that may drive people to question if the paper contract really is the same as the bullion. Physical demand increasing creates this problem for the exchanges, but then uncovers a new one. The leverage means that there’s a whole lot of people who think that they own silver that they really don’t. As more move to physical, less and less is left behind.
This is a small market, with growing and inelastic demand, and an existing supply demand imbalance, that has been eroding available inventories for years. It’s currently in short supply (in an investable, deliverable form), and that shortage is getting worse by the day. The silver market is historically prone to wild spikes, and this time, a large spike up in price would actually be reverting to a more normal historical price (over the very long term), in terms of the ratio with gold, and in absolute inflation adjusted price. The physical price diverging from the paper price may force the Comex and LBMA to make more deliveries than they are basically built for, dry up any available inventory, and may cause a large number of leveraged paper contracts to owe physical metal they have no way of obtaining at anywhere near current prices.
Industrial users need hundreds of millions of oz per year to operate their businesses, and historically rely on just in time inventory. If they are forced to wait to get inventory, they may start to see a shortage ahead. Some may decide that the risk of not getting product or having to pay much higher prices is too great, so they need to take some of the dwindling inventory for themselves. The more scarce it becomes, the more industry will want to stock up. Speculators will get wind of this, and further compete for the last scraps of bullion.
This situation looks to me like a big bonfire, soaking in the gasoline of paper leverage, that may ignite anytime. I’ll be sitting by with my marshmallows, waiting to sell into a market that might look much different than when I bought.