Why the silver price looks set to surge

Silver has an ugly reputation as the ‘poor man’s gold’. Most investors hate it. In fact, many would prefer to class it among the base metals – along with nickel, zinc and copper.

But they are missing out on what could be a pretty remarkable investment opportunity. Because in truth, silver is probably the most undervalued of all metals in the market today. Why?

Well, the strongest recommendation for silver at this time is that it is both a precious metal and an industrial metal. And that means two opportunities to profit. The first will be if economies continue to recover and industrial demand rises. The second is as an inflation hedge if economies perform less well than I expect.

Silver is an investment ‘each-way bet’ – we could win on one count, or we could win on both. And having lagged the price of gold, now is a great time to buy into silver.

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Let me show you a bit more about why silver is such an unloved metal.

Why silver is perceived as a ‘dinosaur metal’

For the best part of a century, photographic film was silver’s major industrial application. In 2000, 218.3m ounces of silver were used in film manufacturing; by 2008 this had halved to 104.9m ounces. It dropped again in 2009 to 82.9m. Digital cameras have been eating into this market to the extent that film is declining in use at something like a 20% per annum compounded rate.

It’s clear that the decline of silver’s traditional applications in recent years has put the metal in the shadows, but in fact silver’s less than sparkling reputation goes even deeper. Metals analysts have always regarded silver as a bit of an orphan for two important reasons.

Two reasons why metals experts have always scorned silver

First, it is rarely mined on its own. It is much more frequently produced as a by-product (or co-product) of mining for copper, lead, zinc or gold. This means it gets mined irrespective of the silver price, so analysts cannot construct a meaningful cost curve for its primary production. It is seen as insensitive to its own price economics.

The second reason for its orphan status is that its use in photography gave rise to extremely efficient recycling. With the exception of medical x-rays, which are retained, silver is washed out of the film during both manufacturing and processing. It is quite easy to recycle. Silver used in batteries and electronics can also be recycled relatively cheaply.

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VM Group, a commodities analytics firm, estimates that around 400m ounces of silver are being returned through recycling annually.

This needs to be set against 2009 mine production of just over 700m ounces. But even so, the dynamics of both the industrial and investment markets for silver are improving dramatically. Let me explain.

Two reasons why we’re about to see a resurgence in the industrial use of silver

Silver as a conductor

On the industrial side, silver is valuable for two special qualities: it is the best thermal and electrical conductor available, and it is a super-effective steriliser.

As a conductor, silver is used in radio frequency identification (RFID) tags for goods and people (in passports and ID cards, for example). VM Group estimates that the manufacture of such tags will exceed 30 billion units by 2020.

Another growth area for silver is solar energy. Here, each crystalline silicon solar cell that is produced contains some 1.2g of silver per watt of energy produced. VM Group estimates that by 2020, solar energy equipment will be using around 50m ounces of silver annually.

Finally, on silver’s applications as a conductor, we are all aware of silvered mirrors, but what about ‘invisible silver’? This is a transparent coating of silver on double-pane thermal windows. It reflects the heat from the sun back outside and the heat from inside back into the house.

According to the Silver Institute, claims are made of 95% efficiency, and such technology could generate a huge new market for silver.

Silver as a steriliser

Silver oxide (a highly-charged silver) is finding new and wide application in the treatment of bacterial disease.

For example, the cosmetics companies Beiersdorf and Johnson & Johnson have both introduced silver-based bandages. These new ranges use silver in the wound pad to disinfect and protect cuts, scrapes and scalds. Silver is also used in catheters, pacemakers, heart valves, orthopaedic implants, and increasingly in surgical clothes and bed linen.

Food hygiene is also becoming an important sector in terms of silver demand because silver acts as a ‘biocide’, a type of bacteria killer. It is used increasingly in work surfaces and vending machines, as well as for the linings inside cardboard milk, soup and juice containers.

Obviously, the amount of silver in each ID tag, catheter, band aid or pair of pong-resistant socks is minuscule. But a tiny bit in each of billions of applications adds up to a potentially huge market.

So much for the industrial case for silver. What about the investment side? Here, we find the case is even more compelling.

The trend that makes the investment case for buying silver

In contrast to gold, which currently trades at just about historical nominal highs, silver is nowhere near its historical highs of 30 years ago.

This does not exactly make it ‘cheaper’, because those highs were in many ways artificial. That’s because the Hunt brothers’ attempt to corner the silver market in 1980 sent the metal soaring to $50.

Still, there is a sound case for maintaining that silver is cheap relative to gold. A glance at this 20-year chart showing the ratio between the two metals will best illustrate this:

Click here to enlarge

An ounce of gold currently sells for just under 70 times the price of an ounce of silver. The 20-year range has gone from 100 in the spring of 1993 to just over 40 in the spring of 1998. So the current ratio of 66.5 is slap in the middle.

What makes the chart particularly compelling though is the spike in gold’s relative performance in 2008 and the subsequent drift back towards silver.

The previous major gold peaks of 1993 and 2003 took several years to fully wind down to the ultimate low levels. If history is to repeat itself, we might expect the ratio to continue in favour of silver for some months to come.

Silver – a ‘double whammy’ precious metals play

So there are a number of reasons to hold both gold and silver in current markets. But silver has the edge.

Of course, it is possible that the silver price will struggle to gain further upside, or that some of the technological developments which rely on silver as a component could be discontinued.

Another risk to consider is the prospect of a double dip in the economy. This may hurt industrial demand for silver, causing softness in the price.

But on balance, we like it as an investment idea. If economic growth does re-accelerate as we expect, silver will get the ‘double whammy’ effect of being an industrial metal as well as a precious metal.

And if economic growth disappoints, silver should still maintain its historical role as a long-term source of value.

This article was written by Joss Smith, editor for The Zurich Club

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