Archive for the ‘Silver’ Category

How much has the silver stockpile been depleted?

Friday, June 5th, 2009

During the Great Depression, President Franklin Roosevelt signed the Silver Purchase Act of 1934. That started the world’s greatest stockpile of silver, peaking at 3.5 billion ounces in the 1950s.

As we wrote in Third turning point for silver, the US government sold down its massive silver stock in the 1960s in an attempt to keep its price down. Also around the same time, as we wrote in What determines the gold-silver ratio?,

… scientific discoveries in the 1960s saw the widespread industrial applications of silver.

The problem with industrial use of a metal is that it gets ‘consumed’ and used up in microscopic amounts, thrown away and eventually ends up in the landfill. Therefore, unlike gold, most of the silver ever dug out from the earth are lost through ‘consumption.’ Only jewelery and silverware preserves the silver.

By 1980, only 2.5 billion ounces of silver are left. By 1990, 2.1 billion ounces are left. As in late 2008, only 20 million ounces of silver are left in the US government’s stockpile. Other government around the world did likewise. Today, government stockpiles around the world hold only 0.016 percent of the original 3.5 billion ounces that the US government used to hold!

In other words, the amount of silver left in the world that is available for investment is less than gold! Gold, on the other hand, has a rising quantity of stockpile. If all mining activity are to stop today, the aboveground stocks of silver will only last 4 months!

Third turning point for silver

Sunday, May 31st, 2009

Today, we will continue on the topic of silver investment. This article will form part of a series on silver. In this series, we will explain why we believe silver is going to be a great investment in the coming years, probably even better than gold. As we travel along this series, we will collate the articles in a guide, Why silver will be a better investment than gold in the coming years?.

Previously, in What determines the gold-silver ratio?, we talked about the current and average historic ratio between gold and silver. Today, we will talk about what’s happening in the silver investment market..

By the early 1960s, silver price had risen to US$1.29, due to monetary inflation. At that time, coins in the US had silver in them. At that price, the value of silver content was approximately equalled to the face value of coins. But as monetary inflation continued, Gresham’s Law kicked in- it became more and more profitable to melt the coins and sell the silver for a profit in the spot market, which means silver coins were disappearing from circulation. Hence, the US government began selling silver from its then 3.5 billion ounces stockpile to keep its price down. Eventually, the government removed the silver from coins. As we wrote in Artificially undervalued coins: government interference cripple the free market,

This is exactly a repeat of what happened in the 1960s when the US government made it illegal to melt silver coins. The fact that the underlying value of a coin far exceeds its face value proves that there is a serious underlying problem in the monetary system.

As a result, the public became net buyers of silver in the 1960s.

In 1979, as silver price rose rapidly, the public became net buyers of silver for the second time in history, causing silver to explode to above US$50.

In 2006, the public became net buyers of silver again. As the CPM Group Silver Yearbook reported in 2007,

Last year and this year represent major turning points in the silver market years in which a tectonic shift in the silver investment demand occurs the likes of which are very rare. Specifically, investors shifted from being net sellers of silver into the market from 1990 through 2005, to being net buyers of silver in 2006.

This is the third turning point in the history of silver.

What determines the gold-silver ratio?

Thursday, May 21st, 2009

Our loyal readers will know that we wrote extensively on gold. In contrast, we seldom mention silver. So, we will be devoting some time on silver in the coming days.

First, as we wrote in A brief history of silver and bimetallism, both gold and silver functioned as money in most of history. Historically, each unit of gold were priced as 12 units of silver on average. There were variations across different regions and time period. For example, in Ming Dynasty China, the gold/silver exchange rate was 1:4 while in ancient Egypt, it was 1:1. But overall, the ratio was 1:12. As we wrote in The behaviour of silver and gold prices,

During the 20th century, the ratio was at an average of around 1:47, from a low point 1:38 in 1910 and 1:101 in 1990. Currently, it is at a ratio of 1:49 [March 2008].

Today, the ratio is at 1:66. It even reached past 1:70 recently.

Gold and silver prices track each other very closely. As we wrote in The behaviour of silver and gold prices,

Since 2001, silver and gold prices have been consistently moving together at a correlation of 0.98 (0.00 means completely no correlation and 1.00 means perfect correlation). Though they tend to track each other, the ratio between them tends to vary.

So, why did the ratio moved from 1:47 in March 2008 to 1:66 today?

To understand why, we must first understand the nature of silver. Silver is viewed as a monetary asset in the same way as gold. From this perspective, both gold and silver are monetary relics from the past. But for silver, it has broken from the past. Unlike gold, silver has much more industrial use. In fact, it is said that silver is the indispensable metal as scientific discoveries in the 1960s saw the widespread industrial applications of silver. Here are some examples of silver usage: batteries, bearings, biocides, brazing catalysts, coins, electrical conductors, electronics, electroplating, jewellery, medical equipment, mirrors, reflective coatings, photography, silverware, solar energy cells, soldering and water purification.

The short-term correlation between gold and silver prices are due to the market’s view of  both of them as monetary asset. But the variations in their exchange ratio are probably due to the industrial demand for silver. This is most obvious in the second half of 2008. As the global economy fell off the cliff in that year, industrial demand collapsed, driving base metals and asset prices to the floor. At the same time, the gold-silver ratio shot up. Over the past couple of months, the ratio drifted downwards.

Understanding the big picture in the inflation-deflation debate

Sunday, August 24th, 2008

Right now, there are just too much confusion over the inflation-deflation debate. In fact, this debate is so polarising that many of our readers are thoroughly confused and bewildered by the many millions of conflicting reports, chatter and opinions on the blogs, forums and media. As one of our readers said in Will deflation win?,


I’m getting more and more conflict signals from bases put forward by those who argue for inflation and those who argue for deflation.

So, which will win? Inflation or deflation? Today, we will attempt again to explain the big picture so that you can understand what is going on. As we said before in Failure to understand Black Swan leads to fallacious thinking,

For this reason, that is why we delve more on the big picture and economic history and get mired less on minute statistics and detailed numbers. In technically philosophical terms, it means we are taking on a meta-view i.e. we are taking on a view of our view. At times, this means we have to expand our circle of understanding and venture outside of finance, investing and economics into fields such as psychology, politics and history. The broader our circle of wisdom and experience (that includes borrowed experience from a study of history), the less vulnerable we will be to being caught out like that turkey.

First, let’s take a brief look at the history of money at A brief history of money and its breakdown- Part 1. As that article explained, humanity started off with bartering, which was highly inefficient. Eventually, for whatever reason, the free market chose gold and silver as money. It is interesting to note that gold and silver was the coincidental choice across almost every ancient civilization. In any case, regardless of your view on gold, the point is that in most of the 6000 years worth history of human civilization, money always existed in the form of a physical commodity. That is not to say that monetary inflation cannot happen- ancient Rome debased their own silver coins by diluting the silver with some other less precious metals.

If you think about it, it was un-intuitive for money not to be in the form of a commodity. In one of the movies about Marco Polo, it showed a scene whereby Marco Polo was astonished to see his Chinese slave exchanging goods for pieces of paper:

He ask, “What are you doing??!!!?”

His slave replied, “I am buying something.”

“But money is gold and silver! How can a piece of paper be money?!?!”

If you lived back then, it was obvious why money should not be pieces of paper backed by nothing. Firstly, such money is vulnerable to forgery. Secondly, it can be re-produced at almost no cost. Thirdly, as we said before in Recipe for hyperinflation, the integrity of such money depends on the integrity of the authority that issues it:

To illustrate this point further, imagine you are the only person in town who has the authority to create money out of any piece of paper with your own signature. Wouldn?t this make you a pretty powerful person in town? With such power, you can acquire anything you wish at the expense of others.

Basically, it WAS obvious why paper money, especially the ones backed by nothing but ‘confidence’ and made legal tender by government decree, is not a good form money. Such money is called “fiat money.” The free market, if left to its own devices, will never favour it. But that did not stop ancient governments from dabbling with fiat money. The ancient Chinese was probably the first to try that (see Ancient Chinese fiat paper money) and failed. Today, the entire world is back to using fiat money again (see A brief history of money and its breakdown- Part 2). History shows that there were many attempts to make fiat money work and all of them failed. In other words, excluding the current one, the failure rate of fiat money is 100%.

To make fiat money work even for a time, some kinds of rules or ‘mechanism’ are needed to maintain its integrity (if it can really be achieved indefinitely). As we said before in Recipe for hyperinflation,

Therefore, some kinds of ?rules? are necessary to fetter and curb such vast power. Without these ?rules,? it is impossible to maintain the integrity of money. If money loses its integrity, the financial system and economy will break down and we will be reduced to primitive bartering.

That is why an independent central bank is part of this complex system of ‘mechanism’ (see Why should central banks be independent from the government?).

What are the ‘mechanisms’ that are used?

  1. Commodity backing– Technically, if a paper money is backed by a commodity (i.e. the paper can be redeemed for a commodity), it is not a fiat money. Today’s fiat money was originally warehouse receipts for gold. If too much warehouse receipts are issued than there are gold in the vault, then the issuer has essentially committed fraud and runs the risk of legal/economic repercussions.
  2. Self-expiry– In ancient China, during the Song Dynasty, paper money had a limited life-span, after which it would become no longer be legal tender. As this article from Financial Sense explained,

    The S’ung dynasty was the first to issue true paper money in 1023, and it did so at first cautiously, issuing small amounts, used in a limited area, and good for a specific time period. The notes would be redeemed after three year’s service, to be replaced by new notes for a 3% service charge, a neat way for the government to make money.

    The abuses started immediately. Though the notes were valued at a certain exchange rate for gold, silver, or silk, in practice convertibility was never allowed. Then, the notes were not retired as they printed many more of them. The government made several attempts to support the paper by demanding taxes partly in currency and making other laws, but the damage had been done, and the notes fell out of favour.

    The idea is that at any one time, certain amount of self-expiry money will be retired from circulation and thus, ‘protect’ the integrity of the money. Today, if you look at Zimbabwe’s currency, you will find an expiry date on it.

  3. Credit-system– This is the system used in today’s money (see Are we heading for a deflationary type of recession?). The basic idea is that money is created in the context of credit, which must be returned plus interest.

So, the world’s fiat money system works under the ‘mechanism’ of credit. Because money has to be returned, it acts, in theory, as a check against abuse and rampant monetary inflation. But as we all know from the sub-prime crisis and credit crunch, it got abused to the extreme in practice.

The fact that the global financial system is facing acute deflation threat shows that this credit-system ‘mechanism’ is working to protect the integrity of fiat money! From that perspective, we can see why the US dollar is appreciating in the context of deflation. But at the same time, if the integrity of money is to be protected, then all these years of credit abuse will come home to roost in a colossal economic pain for the masses.

The issue is, do the masses want to avoid great financial pain or does it want to maintain the integrity of fiat money? Reality dictates that it can only choose one but not both. If they choose the former, the only way to do that will be to repeal the credit-system ‘mechanism,’ which will mean the loss of integrity for the current fiat monetary system. Such loss of integirty will manifest itself in the form of hyperinflation.

In summary, whether you believe the end game is deflation or inflation will depend on your faith in human nature.

Get paid to borrow gold and silver?

Wednesday, April 2nd, 2008

For the vast majority of us, gold is a lump of metal that does nothing. As we said before in Is gold an investment?,

… since gold is a boring, inert metal that does not have much pragmatic use and does not pay dividends, income or interests, it is completely unfit for ?investment.?

But for a certain class of gold owners, they DO earn interests on gold. Right now, instead of receiving interest for lending out gold, they are paying people to borrow gold. Who are these gold owners?

They are the central banks. The ‘interest rates’ on gold is the gold lease rates. Typically, central banks lend out gold through bullion banks, which then pass them on to the market. Eventually, the gold has to be repaid with ‘interest’ paid with more gold. Sometimes gold producers pre-sell their gold by borrowing them from central banks first and then repaying those borrowed gold (with interests, of course) later through their own production.

Right now, at this point of writing, the gold lease rate for 1 month is -0.0483%. This negative lease rate has been going on since last week. For silver, the lease rate for 1 month and 2 month is -0.04% and -0.0379% respectively.  This is a very curious phenomenon. In other words, central banks are paying for others (e.g. bullion banks, gold miners,  hedge funds, etc) to borrow gold to sell to the market. In other words, central banks are paying for others to ‘short’ gold.

That could be the reason why gold prices had been falling recently.

What is the future of silver?

Monday, March 3rd, 2008

Today, we will continue from The behaviour of silver and gold prices and explain what we believe the future of silver ought to be. The assumed knowledge of today’s article will be Why should you invest in gold?. As we explained before in our previous article,

But please note that since there is a difference between what we think should be and what the market thinks is the case, then there will be a difference between what we think ought to happen and what will happen.

If you think we may sound a bit too verbose with this explanation, it is because we want to make it absolutely clear that we are not making any claims on the future of silver prices, especially in the short to medium term. This is because no matter how logical our deductive reasoning is (assuming that it is sound in the first place), there is no guarantee that the market will behave rationally. As Keynes famously said, “The market can remain irrational longer than you remain solvent.” Therefore, bear that in mind. Investors have lost money because they forgot that (including Warren Buffett, who suffered a loss in a bet against the US dollar).

Anyway, here comes the meat of this article: Will silver regain its monetary status once again, as a junior partner of gold?

First, why was silver ever money in the first place? In A brief history of silver and bimetallism,

As we said before in Properties of good money, a commodity has to be sufficiently rare to qualify as money. But it cannot be too rare. Silver, the less rare sister of gold, was useful for smaller transactions because gold was too rare for further smaller sub-divisions.

Now, assuming that gold will one day function as money (i.e. play an important role in the global monetary system), will there still be a need for silver to function as small change money? The answer to this question is the crux of what we believe the future of silver ought to be.  We believe the answer is “No.”

Why?

Obviously, even if gold is going to function as money in the near future, it is highly unlikely that no one will carry physical gold in their wallets. The inconvenience of carrying physical gold was real even more than 100 years ago. That is why, as we said before in Entrenched perception on the value of paper money, warehouse receipts for gold, which existed in the form of paper, was invented. Warehouse receipts for gold slowly evolved into today’s fiat paper money.

Today, we have a very powerful technology that can solve the convenience and sub-divisibility problem (see Properties of good money) associated with gold money- computers. All we need is a trusted central repository of gold (perhaps today’s central bank can change its institutional role for this purpose) and let computer systems keep track of ownership and transfer flow of gold money. In other words, the gold is physically kept in a secure central location while the finer sub-divisions and change of ownership of gold money is recorded as bookkeeping entries on computers. No physical movement of gold is necessary. In a sense, this is already happening with fiat paper money today. Much of today’s commerce is happening in the form of electronic transactions, with relatively minuscule amount of physical cash involved. Therefore, it should be possible with gold money. If those who still have doubts of such a possibility, we would like to point out that this idea is already implemented at GoldMoney.com. We have no doubt it is possible to be implemented on a national and international scale.

In this case, will there still be a need for silver? If not, silver is better off being a purely industrial commodity.

The behaviour of silver and gold prices

Sunday, March 2nd, 2008

When it comes to gold, our conviction is clear (this article assumes you have read Why should you invest in gold?). But when it comes silver, the answer is not that straightforward. As we explained before in A brief history of silver and bimetallism, silver used to function as money alongside gold, albeit as a junior version of gold. Assuming that one day, gold will once again play a very important monetary role in the global financial system, will silver be reinstated as secondary money along with gold?

In the past, when silver was money, there was hardly any industrial use for it. As we said before in Properties of good money, it is due to the lack of consumable industrial and practical use that makes a commodity suitable for functioning as money. Today, there is widespread industrial use for silver- see this Wikipedia article for more information on that. In 2006, industrial usage of silver accounts for 63% of silver supply. It is expected that the industrial usefulness of silver will increase, which will, on the other hand, be offset by secularly declining usage in photography (supplanted by digital photography).

This is in stark contrast to gold. As we explained before in Is gold an investment?,

Therefore, conventional supply and demand analysis cannot be applied for gold because it is not a commodity (see Is gold a commodity?). This is because with its extremely limited industrial use, gold will not be worth that much at all. It is worth so much because its value is largely derived from outside the realm of industrial and pragmatic usage (i.e. monetary value). Similarly, how much industrial and practical value is a piece of crisp US dollar? If there is no pragmatic use for a piece of paper called the US dollar, then why is it in so much demand (e.g. drug dealers use them for transactions)? Therefore, in conventional supply and demand analysis jargon, the monetary value of gold is consigned into a conveniently labelled group called ?investment demand.?

The same could not be said for silver because currently, it has both the properties of an industrial commodity (e.g. iron, zinc, copper) and money (e.g. gold).

Since 2001, silver and gold prices have been consistently moving together at a correlation of 0.98 (0.00 means completely no correlation and 1.00 means perfect correlation). Though they tend to track each other, the ratio between them tends to vary. During the days of bimetallism (A brief history of silver and bimetallism) in the 19th century, the prices were fixed by law at a ratio of 1:15.5. During the 20th century, the ratio was at an average of around 1:47, from a low point 1:38 in 1910 and 1:101 in 1990. Currently, it is at a ratio of 1:49. There are some who analyses the trend of this ratio as an indicator of what the price of silver will be. We have not comment on that yet.

However, relative to gold prices, silver prices tend to be more volatile because of its perceived dual nature (industrial and monetary). Assuming that (1) gold and silver prices will still maintain a tight correlation, (2) gold prices (measured in terms of fiat currencies) is on a long-term up-trend (perhaps even exponentially), silver can be interpreted as a ‘leveraged’ hedge against loss of confidence against fiat money (see What should be your fundamental reason for accumulating gold?).

Now, coming back to the original question: Will silver regain its free-market status as secondary money? We have our opinions on what the future of silver should be. But please note that since there is a difference between what we think should be and what the market thinks is the case, then there will be a difference between what we think ought to happen and what will happen. This means that in the short to medium term, our ‘predictions’ will not be ‘fulfilled.’ But if we are right, then it will be ‘fulfilled’ in the long run.

We will continue on what we think the future of silver should be in our next article.

A brief history of silver and bimetallism

Wednesday, February 27th, 2008

If you have been with us for a long time, you would know that we cover gold extensively. If you have not already, we suggest that you read our guide, Why should you invest in gold?, before reading the rest of this article. The material for today’s article comes from Professor Murray Rothbard’s book, What Has Government Done to Our Money?.

Today, we will talk about gold’s troublesome sister, silver. As we quoted the late Professor Murray Rothbard in our earlier article, What about silver?,

It is very possible that the market, given free rein, might eventually establish one single metal as money. But in recent centuries, silver stubbornly remained to challenge gold.

Why did silver stubbornly remain in circulation as money? As Professor Murray Rothbard continued,

Silver remained in circulation precisely because it was convenient (for small change, for example).

As we said before in Properties of good money, a commodity has to be sufficiently rare to qualify as money. But it cannot be too rare. Silver, the less rare sister of gold, was useful for smaller transactions because gold was too rare for further smaller sub-divisions.

Hence, in the free market of the past, both gold and silver circulated side-by-side,

The relative supplies of and demands for the two metals will determine the exchange rate between the two, and this rate, like any other price, will continually fluctuate in response to these changing forces. At one time, for example, silver and gold ounces might exchange at 16:1, another time at 15:1, etc.

In that sense, we can see gold and silver as two different ‘currencies’ whose values fluctuated freely against one another according to the free market. But then, the government came in to ‘help’ the market to ‘simplify’ matters by fixing the exchange rate between gold and silver. The fixed gold-silver ratio was known as bimetallism. The next step after bimetallism was to give specific weight of gold (and silver) a national name (e.g. dollar, pound, etc). Once these national names (instead of a specific weight of gold and silver) take root, it eventually became an abstract unit of value of its own, thereby losing its original meaning in terms of a specific weight of gold and silver. Eventually, these abstract units became the national currencies of today.

Bimetallism helped the government to manipulate money. But it introduced its own set of problems. The free market’s exchange rate between gold and silver would always be freely fluctuating, depending on the supply and demand relative to each other at each instance of time. But by fixing the exchange ratio between them, it introduced the situation whereby one will always be artificially undervalued or overvalued relative to each other. When that happens, Gresham’s law will kick in (see Artificially undervalued coins: government interference cripple the free market for an explanation of Gresham’s law), which resulted in the state of affairs that Rothbard described,

Gold then disappears into cash balance, black market, or exports, when silver flows in from abroad and comes out of cash balances to become the only circulating currency in Ruritania [hypothetical country used as an example]. For centuries, all countries struggled with calamitous effects of suddenly alternating metallic currencies. First silver would flow in and gold disappear; then, as the relative market ratios changed, gold would pour in and silver disappear.

Eventually, what happened? As Rothbard continued,

Finally, after weary centuries of bimetallic disruption, governments picked one metal as the standard, generally gold. Silver was relegated to “token coin” status, for small denominations, but not at full weight.

The next question for investors is this: assuming that one day the world will return to the gold standard, will silver regain its free-market status as secondary money? We will explore more on this idea next…

What about silver?

Saturday, June 9th, 2007

In our previous article, A brief history of money and its breakdown- Part 1, we mentioned that

But over the course of centuries, gold and silver, for whatever reason, were eventually selected by most civilisations as money?gold for larger exchanges and silver for smaller exchanges.

In Murray Rothbard?s excellent book: What Has Government Done to Our Money?, it mentioned that

It is very possible that the market, given free rein, might eventually establish one single metal as money. But in recent centuries, silver stubbornly remained to challenge gold. It is not necessary, however, for the government to step in and save the market from its own folly in maintaining two moneys. Silver remained in circulation precisely because it was convenient (for small change, for example). Silver and gold [41] could easily circulate side by side, and have done so in the past. The relative supplies of and demands for the two metals will determine the exchange rate between the two, and this rate, like any other price, will continually fluctuate in response to these changing forces. At one time, for example, silver and gold ounces might exchange at 16:1, another time at 15:1, etc. Which metal will serve as a unit of account depends on the concrete circumstances of the market. If gold is the money of account, then most transactions will be reckoned in gold ounces, and silver ounces will exchange at a freely-fluctuating price in terms of the gold.

As we said before in Is gold a commodity?, gold is not a commodity the way industrial metals like copper, zinc and iron are. What about silver?

Silver, the monetary cousin of gold, is more troublesome. Unlike gold, there are much more industrial use for silver. In addition, annual world demand for silver exceeds its annual production every year since 1990 and is projected to continue. Thus, there is a belief among many that the global silver stockpile is set to decline further, which means that its price is most likely to continue rising.