Like gold, silver is a precious metal that has been coveted by mankind for some 4,000 years. Like gold, it’s long been used in making jewelry and as a currency. And, like gold, it’s a dense, malleable metal.
But the similarities stop there. Investing in silver has some things in common with investing in gold, but the market for the two metals have a lot more about them that’s fundamentally different. If investing in gold is like living in the Wild West, investing in silver is like…a more volatile version of the Wild West. The Very Wild West, if you will. There are many more factors that can cause the price to fluctuate, and low market liquidity means that investors themselves can swing the price per ounce just by buying or selling in large quantities.
Like any other metal, silver is mined. The global silver production as of 2011 was about 23,800 tonnes with the world’s production leaders being Mexico (4,500 tonnes), Peru (4,000 tonnes), and China (4,000 tonnes). The remaining countries all produce less than 2,000 tonnes and the United States is good for 1,160 tonnes. Silver is rare in its native form, more often combined with elements like sulfur, arsenic, and chlorine. It’s also commonly found in ores. Subsuquently, silver usually has to be extracted through amalgamation or electrolysis.
What Supply and Demand Mean to Silver Prices
Silver has much stronger market forces acting on it than gold. With the price of gold exceeding silver by a factor of close to 60 (more on this later), silver’s industrial uses are imminently more affordable than any potential use for gold. It’s a simple concept to grasp: one would never make a fork out of gold, it just costs too much. And, as such, much of the world’s silver supply ends up going into industrial uses. Only 11 percent of the world’s gold production is used for industrial purposes, while some 50 percent of silver is used for non-investment purposes. Silver is used in dental fillings, a variety of medical applications (silver is an antibiotic), photography, jewelry, silver ware, microchips, and photovoltaic cells.
While tracking the price of gold, one need only focus on investors and traders, for the most part. But in silver, commodity investors influence the price, along with a variety of other market forces acting through different industries. For instance, the rise of digital cameras has cut the legs out from under one of silver’s biggest industrial uses: photography. In 1998, 30.98 percent of the silver consumed in the world went to photography in the form of silver nitrates and silver halides. By 2001, that number had shrank to 23.47 percent, and by 2010 it was down to 6.8 percent, including a 38 percent decline in just three years. However, for all the silver not being used in film anymore, new uses were springing up in the form of the rapid expansion of the solar industry.
Silver as an Investment Vehicle
With all of the different applications for silver, it’s easy to forget that it’s also traded in the form of bullion and futures contracts just like gold. However, for an investor to do so would be at their peril. While silver’s not at all like gold because of its myriad practical uses, it’s also not at all like iron or tin because of its status as a precious metal. Despite the wild volatility, many investors buy and sell silver. In fact, Warren Buffett purchased 130 million troy ounces of silver in 1997 for $585 million (and announced to investors that he was completely divested as of May 6, 2006).
One number that’s important to any discussion of silver investing is the gold/silver ratio. It measures how many ounces of silver would be needed to purchase an ounce of gold, and has varied from as low as 12 during the days of the Roman Empire to 100 in the early 1990s. Despite some wild fluctuations, the average gold/silver ratio over the last 35 years has been about 55. Some serious silver bugs watch this ratio carefully, looking to make trades that accumulate more metal holdings rather than dollar-value profits, but most rational investors want no part of that action.
The Hunt Brothers and Silver Thursday
Any discussion of silver investing would have to include the story of Silver Thursday and the attempt to corner the silver market by the Hunt brothers,if for no other reason than as a warning of what the silver market can hold. One major factor one must consider when investing in silver is low market liquidity. Physical demand for silver is only about $15.2 billion a year, and the silver market ultimately comes to almost 20 times less money than the gold market. As such, big trades by large investors have the capacity to move the market for the precious metal. And the attempt by the Hunt brother to corner the market is one such example.
Beginning in 1973, the sons of Texas oil billionaire Haroldson Lafayette Hunt, Jr., Nelson Bunker Hunt and William Herbert Hunt, began an attempt to corner the market on silver. Believing that inflation would increase silver’s value as a safe haven while simultaneously wiping out the value of any paper investments, they began buying up all the silver they could, often buying on margin. With the death of their father in 1974, the Hunts had immense resources at their disposal because of a massive inheritance. What’s more, they could leverage the family fortune many times over and get better deals on credit and loans than other speculators because of the reputation of the Hunt family name.
The Corner of Brotherly Love
The combination of the massive increase in demand connecting to the Hunts’ purchase of over $1 billion worth of silver and the rush by other investors to jump onto the bandwagon meant that the price of silver started to skyrocket. The price of silver jumped from $6 per troy ounce to $48.70 in 1979, a new record high and a modest 712 percent gain in a single year. It was a major short squeeze, and the Hunt brothers were estimated to hold one third of the world’s silver supply not held by governments. People everywhere were pawning their silver coins and jewelry to take advantage of the market, and the value of the Hunts position increased to $4.5 billion. The situation became so dire that jeweler Tiffany’s ($TIF) took out a full-page ad in the New York Times criticizing the Hunt brothers.
However, the Hunts weren’t far from running into serious trouble. On January 7, 1980, the New York Mercantile Exchange adopted new rules regarding purchasing commodities on margin, limiting the ability of investors to use leverage. It also prevented investors from taking any more long positions on silver futures. The rule, known as “Silver Rule 7,” was most likely a specific response to the practices of the Hunt brothers, and it had the desired effect. With only short options being written, the price of silver started to slip and the Hunts were faced with more and more margin calls on their holdings. The Hunts managed to persist for some time, relying on their family’s sparkling credit to continue taking out loans so they could meet the millions of dollars in margin calls.
It culminated on March 27, 1980, now known as Silver Thursday. Angry with the Hunts ability to persist in manipulating the markets, the Federal Reserve strongly encouraged banks to stop giving loans for speculative activity. So, when March 27th rolled around and the price of silver continued to decline, the Hunts were finally issued a margin call of $100 million that they couldn’t meet. The markets immediately went into a panic, and the price of silver plunged to $11 a troy ounce, 77 percent off its high at $48.70.
In the end, the Hunts managed to survive the crisis by getting a consortium of banks to give them a $1.1 billion line of credit against the family’s assets. However, those assets continued to lose value over the course of the 1980s and the Hunts declared bankruptcy in 1988.
No Silver Lining
Investing in silver is not for the weak of heart, and while we’ll most likely never see an episode quite like the one created by the Hunt brothers ever again, that doesn’t mean that prices can’t fluctuate a great deal from day to day. Classic supply-and-demand forces combining with the price pressures created by investors and speculators make for a unique and unpredictable commodity play.