Dwindling Supply and Unprecendented Demand Make Silver an Attractive Investment

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It has been nearly two years of pain for investors in silver, but I think the time to start accumulating has come. Prices have stabilized. Inflation is slowly starting to creep up in corners of the world. Some investors have felt burnt by the metal from 2009 to 2012, when quantitative easing was pushing silver to the moon, nearly to $50 per ounce. And yet, here we are at $19 an ounce. The metal heavily reversed course in the fall of 2012, and the precious metal sector as a whole has failed to gain traction. But is now a good time to buy silver? The short answer is yes, particularly for the long term, as I see prices continuing to rise due to inflationary pressures over time. However, there are also key supply and demand issues that you need to be aware of.

Demand for silver is strong. Last year we saw a shortage of both American Silver Eagles from the U.S. Mint as well as junk silver available (that is, pre-1965 U.S. dimes, quarters, and half dollars). In addition, silver ETFs continued buying silver coins and bullion at a record pace. Thus, demand for the metal is there, and has helped keep silver above the $18 mark. This mark serves as an important technical resistance point. It has bounced off this level several times since last fall. Aside from silver being a precious metal, it also has many industrial and technological applications. There will always be some level of demand, but such demand should pick up significantly when the global economy comes fully out of recession.

Despite the stock markets in the U.S. setting all-time highs, the broader economy is still just limping along. Our GDP is barely showing expansion. Further, the jobs picture has yet to improve markedly, though unemployment has come down, albeit slowly. This slow growth has led to industrial demand for silver, but the growth is slow enough to keep the Fed on the easing accelerator, which bolsters the precious metal side of the metal.

When the economy rebounds, there will be a spike in demand in many areas. The demand will not be just in coin and bullion form, but also in jewelry, silverware, and dentistry. On the technology front, silver is one of the most conductive metals out there, and it is utilized in photography, electronic devices, optics, medical devices/tools, and most recently, in nanotechnology. One lesser-known growth area for silver use is in technology, and that is where a lot of demand will be generated as we further delve into an era dominated by Apple’s (NASDAQ:AAPL) iPhones, iPads, and its competitors’ similar products.

Apple, with its millions of iPhones sold, has created massive industrial demand for silver. As sales are strong, this demand will continue. It is clear that new phones will always be in demand. There is also demand for more than $1 billion worth of silver in just new mobile devices alone. There is a lot of silver in old cell phones, photography chemicals or medical devices that already have been taken out of the market. Although there is a push to recycle electronics and reclaim costly elements like silver within them, in situations where silver is used in very small portions (such as new smartphones), it is not cost effective or even practical to recover the silver. Thus, new silver will be utilized in these devices.

At the time of this writing, silver is priced around $19.70 per ounce, approximately 65 percent off its all-time highs set in April 2011. Gold is currently priced at about $1,270 per ounce. That represents a 64-to-1 gold-to-silver price ratio, whereas the historical ratio is 16 to 1. The respective prices of gold and silver have not approached this historical ratio in many years, and I believe a reversion is long overdue.

To achieve this reversion, gold would have to fall almost $1,000 per ounce or silver will have to rise at a greater rate than gold in value in the coming years. I believe the latter is far more likely than the former, especially in a climate of endless monetary easing. Combine this with rising demand in the technology sector and the fact that industrial demand will return in full force once we have moved completely out of the recession, and we have a strong case for an investment in silver. The ratio has crept up this year to date, but it has generally been in the 50-to-54 range for some time.

There are many sources of demand for silver, as I cited above. Precious metal demand is strong, as is industrial demand. In fact, megatons of silver are consumed in industrial processes, and further, while sometimes recyclable, silver is often discarded into landfills, never to be recovered. This is the result of silver having been intentionally underpriced for many decades because it is not worth the labor prices to recover used silver.

Industrial processes have been intentionally designed not to consume gold (and silver is a better conductor), and at the high prices gold has commanded for decades, it is nearly all recycled. It is said that 99 percent of all gold ever mined is still in existence above ground. For these reasons, silver stockpiles as a percentage of all silver ever mined is so much smaller than gold stockpiles as a percentage of all gold ever mined. I like to frequently cite the research of Ted Butler, who really put the situation best. Each time I read his work, I want to add to my silver holdings.

Butler is quoted as saying this nearly 15 years ago: “At the end of World War II, total known stocks of silver amounted to ten billion ounces (with the US government holding 4 billion ounces of that total amount). At that time, we were just entering an era of unprecedented global economic expansion that has lasted to the present. In this era, silver was consumed in a variety of vital modern applications at a phenomenal rate. Today, known stocks of silver have shrunk over 95%, to maybe a half a billion ounces.

“The nine and a half billion ounce draw down in total silver inventory, was the result of the persistent shortfall between supply and demand, which continues to this day. Not coincidentally, the current 200 million-ounce annual deficit in silver mirrors the long-term trend line average. This continuing deficit is remarkable in that there has been decent growth in world production of silver over the past 50 years, but obviously not enough to satisfy the surge in industrial demand.”

I wholeheartedly believe that this argument is correct. You see, demand for silver is unprecedented. In smartphones alone, more than $1 billion worth of silver is utilized annually. Include a few extra billion dollars for all of the computers, tablets, and televisions sold each year — it really adds up. It’s too cost inefficient to recycle in most cases. This is just in technology alone. Now think about all of the other industries using silver (jewelry, dentistry, nanotechnology ,etc). It is in finite supply with ever increasing demand. Eventually, this needs to normalize, and when it does, silver prices stand to benefit tremendously. Under $20 per ounce, silver is very attractively priced. While I wouldn’t quite tell you to “back the truck up” at these levels, I would suggest accumulating at these levels.

Disclosure: Christopher F. Davis owns physical silver and a multitude of gold- and silver-related equities.