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Can Physical Silver Really Change Your Life?

Posted by John Adams | Chief Economist at As Good As Gold Australia on

As the world heads towards an inevitable economic crisis resulting from an ever rapidly global debt bubble, speculation abounds within elements of the investor community that ownership of physical silver will have the ability, in the midst of the crisis, to change people’s lives potentially on the scale of the 2011 - 2017 price explosion of Bitcoin.

Such is the optimism among some silver investors that price forecasts ranging from $US 40 per ounce to over $US 1000 per ounce are now publicly discussed openly on the internet which is well in excess of its current price of approximately $US 14.50 per ounce.

In Australian terms, given the current exchange rate of 71 US cents for every one dollar, this would translate in a physical ounce of silver rising from approximately $AUD 20.42 to between $AUD 56.33 per ounce to $AUD 1408.45 per ounce.

Such an explosion in price, even if limited to the lower bound of the forecast, would result in a rate of return of at least 176 per cent. If silver reached the upper bound of the forecast, a rate of return of 6,797 per cent would be achieved.

Such forecasts, if they were to occur, would represent an almost once in a generation opportunity (other than the recent explosion of bitcoin) for ordinary citizens to not only survive an economic crisis, but to thrive.

The question becomes how realistic is current sentiment and the price forecasts among silver bugs?

To answer this question, there are a whole host of factors which investors need to consider before assessing whether such claims by silver bugs have any rational justification. 

These factors include:

1) The state of the global economy

With global debt continuing to grow rapidly and reaching a current historic record high (including in relative terms to global GDP), systemic risks of both a macroeconomic and international monetary nature continue to rise across the global economy and financial markets.

This phenomenon combined with a global outbreak of inflation and rising interest rates point to an inevitable systemic global financial crisis which will impact the global capital markets and banking systems.

With such an economic crisis, confidence in conventional liquid financial asset classes such as shares, bonds, fixed interest products and bank deposits historically evaporates resulting in a herd of people and their money rushing to precious metals such as physical gold and silver bullion in order to hold their wealth in a well-tested physical form outside of the digital financial system that preserves their capital.

2) The silver spot price vs mining costs

Several industry experts such as David Morgan (of the Morgan Report) have noted that the current average spot price of $US 14.50 is at or below current silver mining costs for many primary and secondary silver mining companies on an ‘All in Sustaining Cost’ basis.

The consequence of this is that several primary and secondary silver mining companies are struggling to remain profitable at current prices. Within the mining sector, this is a historic signal that the price of a commodity is undervalued and typically manifests itself in three ways:

  • Mining companies reduce physical production or even temporarily cease production at particular mines until the commodity price rises to a profitable level;

  • Mining companies either merge or acquire other smaller players that results in industry consolidation and fewer mining firms; and

  • New exploration activities are put on hold.

3) A tightening physical silver market

According to the Washington DC (USA) based The Silver Institute, there continues to be a tightening of the physical silver market which has been in train for the past few years. This tightening includes:

  • a continuing year-on-year fall of the global annual physical supply of silver since 2014 (see table 1 below);

Table 1: Annual silver supply expressed in ounces (Silver)

Year Total Silver Supply Scrap Silver Supply Silver Mine Supply
2014 1,050,000,000 165,400,000 867,800,000
2015 1,044,000,000 141,400,000 895,100,000
2016 1,009,400,000 139,700,000 888,600,000
2017 991,600,000 138,100,000 852,100,000
  • total physical silver demand continuing to outstrip supply (albeit physical demand has been falling since 2015) (see table 2 below);

Table 2: Annual silver demand expressed in ounces (Silver) and net physical silver surplus or deficit

Year Total Silver Demand Physical Silver Surplus/(Deficit)
2014 1,118,000,000 (68,000,000)
2015 1,165,300,000 (121,300,000)
2016 1,041,900,000 (32,500,000)
2017 1,017,600,000 (26,000,000)

4) More industrial applications for silver

According to the data from The Silver Institute from 2012-2017, approximately 58.5 per cent of the annual silver supply is required for industrial purposes, driven by electronics applications (including smart phones and electrical cars) and solar panels (among other applications).

Industry executives such as Keith Neumeyer, Chief Executive Officer of Canadian silver mining company First Majestic Silver Corporation have publicly stated that the industrial demand for physical silver is expected to increase robustly in the coming 10 years as car manufacturers, for example, seek to expand its production of electric cars [1].

5) The gold to silver price ratio

One market metric that investors use to determine the relative attractiveness of silver is what is known as the gold-to-silver price ratio (i.e. the gold international spot price divided by the silver international spot price).

The gold-to-silver price ratio currently stands in excess of 85 (a 23-year high), which is far beyond:

  • the annual gold to silver mining production ratio which according to Keith Neumeyer stands at 1 to 9 (i.e. for every one ounce of gold mined, there is 9 ounces of silver mined); and

  • the historical gold-to-silver price ratio which according to silver experts such as David Morgan (of the Morgan report) is approximately 15 to 1.

6) Net Long Commercials Futures Silver Position

In September 2018, organisations which are defined within the ‘Commercials Category’ (i.e. banks + miners/merchants/processors/users) of the Commitment of Traders (COT) report of the Chicago Mercantile Exchange (CME Group) went briefly net long on silver for the first time in at least 25 years, although they have currently reverted back to a small net short position.

Many analysts believe that among the significant market participants which are included in the ‘Commercials Category’ is JP Morgan Chase.

This net long position indicates that the physical silver industry and bullion banks have, in net terms, purchase a greater number of ‘buy’ future silver contracts than ‘sell’ future silver contracts indicating an optimistic sentiment for the future price of silver.

Alternatively, the ‘Non-Commercials Category’ of the COT report (i.e. large technical speculators that include managed money funds) went briefly ‘net short’, but now have reverted back to a ‘net long’ position.

Although the net long commercial position was relatively short-lived for now, analysts believe that the fact that a net long position among the ‘Commercials Category’ was achieved is a strong positive sentiment for the future price of silver.

7) A Breaking of the ‘Paper Silver Market’

According to leading silver analysts such as Steve St. Angelo [2], there is a significant mismatch between the value of physical investment of silver versus the quantum of money that is invested within the ‘paper silver market’, i.e. the notional silver futures contracts markets traded on markets such as the COMEX (as part of the CME Group) and London Bullion Market Exchange (otherwise known as the LBMA).

This discrepancy between demand and supply forces of the physical silver market and the notional paper market has led to a significant distortion in price of silver, with several analysts such as Bill Murphy from the US based Gold Anti-Trust Action Committee (or GATA) arguing that the international spot price of silver is artificially low by a significant material amount.

Silver analysts maintain that a materially low artificial price for silver will lead to a significant hoarding of physical silver to the point that physical shortages of silver will become evidence in the wholesale and retail physical silver market.

Silver analysts believe that the effect of the physical shortages of silver will manifest itself in the following two major ways:

  • wholesale and retail sellers of physical silver will charge higher premiums above the international spot price for those who wish to secure physical silver that will lead to a greater divergence between the paper market silver price and the physical market silver price; and

  • greater demand will be placed on the holders of short future silver contracts (i.e. contracts that commit the holder of contract to sell and deliver physical silver) to deliver actual physical silver that they are contractually obliged to deliver rather than settle the short contracts in an equivalent cash amount.

This will in turn lead to a dramatic bidding up of the international spot price as short contract holders will scramble to purchase silver to meet their contract delivery obligations.

What do these factors tell us?

Reflecting upon these seven factors and it would appear that the market silver is seeming to point a much higher price which justifies the optimism of silver enthusiasts and the rationale to hold physical silver bullion that is within your direct control.

Whether silver will meet price forecasts of the silver bugs only time will tell, however, as the world heads to an inevitable economic climax crisis resulting from rapidly growing record levels of global debt, one thing is for certain, it will in all likelihood be a very bumpy ride.