15th Consecutive Annual
Silver Shortage!

By Patrick Heller
Liberty's Outlook

        Precious metals and rare coins activity have been at near frenzied levels for the past two months, with gold hitting its highest price in nearly 18 years!
        Silver has jumped as much as 11% from its end of August lows. The U.S. government has issued regulations that take effect in three months further eroding financial privacy.
        With so much going on, however, I think we will be even busier in the months to come. So, this month I will review the latest information on the long-term supply and demand fundamentals for the silver market.

Silver's Track Record

        In 2004, the average price of silver for the year was $6.70, a 36.7% increase over the average 2003 price of $4.90.
        Despite this surge in price, industrial and coinage demand for silver in 2004 increased 1.1% over 2003!
        For almost the entire period from 1993 to late 2003, silver ranged from $4.00 to $5.50. Since late 2003, silver prices have been rising overall. A large number of new investors have entered the silver market over that time, many who have no previous experience in precious metals markets.
        Once again in 2004, for the fifteenth consecutive year, the silver market had a huge supply shortage.
        Total supplies from mine production, recycling, and government sales were 750.0 million ounces, falling 55.0 million ounces (6.8%) short of covering industrial and coinage demand of 805.0 million ounces.
        For 2005, despite ever higher silver prices, a shortage of another 43 million ounces is projected!
        Since the beginning of 1990, almost 2 billion ounces of silver inventories have been consumed to cover supply shortages. At the end of 2004, less than 1 billion ounces of inventories remain.
        As I have said before, the 1970s string of shortages did not end until the price of silver soared above $50.00 in early 1980.
        The shortages of the past 15 years dwarf those of the 1970s.
        One the basis of this information, one would anticipate that the price of silver could explode upward.
        I actually expected much higher silver prices long ago. Instead, the price has largely been stagnant. The silver price did climb to $8.20 in the spring of 2004 and topped $8.00 again later in the year.
        This year, silver demand has been strong any time the price dipped below $7.00.
        Could silver be building a solid base for a major boom?
        Perhaps.
        Analysts have been mystified as to why the price of silver did not soar years ago. But the fundamental supply and demand information is indisputable.
        I believe that the silver market is destined for huge price increases within the next four years, perhaps within the next year.
        To give you the background on my thinking, let's review the four major factors affecting silver prices: supply, demand, inventories, and investor psychology.
        Supply: The four major sources of silver supply are primary silver mines, as a by-product or co-product of gold, lead, copper, zinc, and other mines, recycling, and government sales. In 2004, silver supplies rose 1.2% from 2003 to an all-time record 750.0 million ounces:

        Mines: Primary silver mines only account for 20-30% of newly mined silver. The balance comes as a byproduct or co-product of other mining operations.
        For instance, the world's largest silver mine is the BHP Cannington lead zinc mine is Australia, which produced 41.3 million ounces of silver in 2004. The second largest silver mine, the KGHM Polska Miedz copper mine in Poland produced 39 million ounces of silver in 2004.
        Around the world, mine production rose 5% over the year before, and will likely rise another 3% in 2005. Technological improvements make it easier to discover new silver reserves and to economically extract lower purity ores.
        Higher silver prices have a delayed effect on the expansion of silver mines. A new mine project takes about three years to begin production. When the price of silver reached $50.00 in early 1980, it took until 1983 for mine production to increase 10% from 1979 levels.
        Recycled silver: Recycled silver supplies in 2004 were down a small amount from 2003.
        The largest component of recycled silver, about 202 million ounces in 2004, comes from spent photographic papers, films and solutions, x-rays, old batteries, and industrial waste. As the use of silver in photography declines, the amount of photographic silver that is recycled also declines. This pretty much offsets any increased recycling from other sources brought on by higher prices.
        The government of India is still trying to eliminate its ban on exporting silver. Should that occur this year, look for total recycled supplies to rise in 2005, perhaps as much as 5%.
        Government sales: Government sales are minor mainly because governments have only small silver inventories.
        China was a net exporter of silver in 2005, but at levels that were down about 75% from the year before. Domestic demand in China is growing enough that it may stop exports in 2005.
        Summary: Silver supplies should be higher in 2005 than in 2004, setting a new supply record in the process.
        Demand: Because of its relatively low price, silver may not deserve to be called a "precious metal." In fact, it is highly sought for industrial applications because of its low price.
        As I said earlier, industrial and coinage demand rose in 2004 despite sharply higher prices. The low prices over the past decade have stimulated research into new uses for silver. Demand has also grown because the world population is growing as is the world's per capita wealth.

        Jewelry and silverware: Jewelry and silver 2004 consumption dropped 7.6% from 2003, in response to the 36.7% higher prices. This is the most price-sensitive form of silver demand, yet you can see that the total demand, in dollar terms, actually rose more than 25% in 2004!
        Despite higher prices in 2004 and again in 2005, this sector may see an increase in demand for 2005 compared to 2004.
        Photography: Despite the surge in the use of digital photography over the past few years, photographic silver usage has dropped barely 10% from its 1999 peak. The total photographic market is expanding, with x-rays leading the way.
        Still, photographic silver demand is expected to slide further as the years go by. It could fall by as much as 8% in 2005 compared to 2004 levels.
        Electronics and batteries: Silver is used in connectors, conductors, switches, contacts, relays, fuses, batteries, and lots of other applications. Demand was at its second highest level ever in 2004, topped only in 2000.
        For 2005, silver usage may rise another 5% in this category.
        Coinage: Silver used for coinage in 2004 rose 5% from 2003. The U.S. Silver Eagle Dollar is the largest component of this demand.
        As more investors and collectors purchase physical silver, demand in 2005 should show another increase.
        Other uses: Silver has a wide range of uses, from catalysts, mirrors, brazing alloys, water purification systems, solders, paints, medications, and so forth.
        As more research is conducted on possible uses for silver, demand for silver for other uses is growing faster than any other segment - having doubled in the past 15 years! Demand soared more than 21% in 2004! Expect another 8% increase in demand in 2005.
        Summary: The strength of silver demand for new industrial applications will continue to push total silver demand higher in coming years, more than offsetting the decline in photographic usage.
        Because silver is such a small component of many fabricated products, rising silver prices have minimal effect on demand. From 1976 to 1980, for instance, the average annual silver price rose 263% (adjusted for inflation). Despite this soaring price, total silver demand only dropped 29%! The price of silver could triple or quadruple from current levels with only a modest effect on demand in this sector.
        Inventories: Deriving inventory levels is difficult, because only a small percentage of total inventories are registered and reported on commodities exchanges.
        However, it is unmistakable that inventories have declined sharply since the beginning of 1990 - almost 2 billion ounces!
        At the end of 2004, here are mid-range estimated inventories potentially available for industrial and coinage uses:

        The major source of inventories consumed in 2004 to cover shortages came from the Comex, and private holdings in the U.S., Europe, Asia, and Latin America. As a group, these inventories dropped 27% from year earlier levels! That leaves barely 150 million ounces.
        These are the major sources of silver available to cover continuing shortages.
        The other forms of silver inventories are not that available to cover supply shortages. Manufacturing inventories are still down one-third from 2000 levels, for instance. The amount of coin silver is actually increasing as more Silver Eagle Dollars are struck. The remaining silver inventories are in forms that were not liquidated when silver hit $50.00 back in early 1980.
        Summary: This inventory tabulation is a mid-point of the range from the lowest to highest in categories where exact figures are not knows. It excludes many forms of fabricated decorative silver objects that, for all practical purposes, would not be sold simply because of a dramatic rise in the price of silver. It includes all silver coins struck worldwide since 1800 less any than have been melted in the past few decades.
        With most silver coins now selling to investors at a premium to silver value, there is little likelihood that they would soon be sold for melting down and refining at current prices.
       If you look at only the inventories that are readily available to cover shortages, there is only enough to last a few more years!
        Because silver is no longer a reserve asset (at today's price, all government holdings combined are worth less than $1 billion) governments have little incentive to manipulate the price. As a result, the price of silver is free to respond to market signals much more than gold.
        Investor psychology: With the fundamental supply, demand, and inventory figures for silver showing a near- and long-term shortage of silver, why hasn't the price already soared? Will it ever do so?
        Above and beyond the data, there are several factors that affect investor psychology.
Of course, investors' choices are affected by all the economic, political (and weather!) events. In times of greater uncertainty, there is a definite trend in favor of owning tangible assets.
        The surge in silver to $50.00 in 1980 prompted a lot of people to invest in the metal. However, silver supplies gradually increased while industrial demand slowly fell over the following years. This surplus lasted through 1989, gradually forcing down prices.
        Even though the fundamentals had changed since the beginning of 1990, there are still a lot of former silver investors that are scared that there is still a glut of silver on the market that will knock prices down in the future. That has limited investor demand over much of the past 15 years.
        But the times are changing.
        When the stock and bond markets dropped in 2000 and stayed relatively weak for the next couple of years, many investors expanded their investment horizons to other assets, including silver.
        Silver's attractive fundamentals brought in substantial new investment demand. LCS sold record quantities of silver in the first half of 2003, for instance.
        At the same time, the psychology of existing silver investors changed. For much of the 1990s, any temporary jump in the price of silver would lead to a flood of liquidation. There is still some increase in liquidation as prices rise today, but at much lower levels.
        These two trends are much like we saw in the late 1970s before silver prices exploded.
        In the boom back then, investors didn't really start selling their silver until the price passed $20.00. In fact, most didn't sell until after it passed its $50.00 peak.

How High For Silver?

        In the past 34 years, silver demand has exceeded new supplies by 5%. In 2005 dollars, the average silver price over this time was about $17.00. Since that price was not high enough to establish a long-term equilibrium, I think the price deserves to be higher.
        Silver supplies cannot rise quickly if the price of silver shoots upward. Therefore, I expect any run to rise well beyond $17.00 before settling back.
        Last year I anticipated that the price of silver would reach $10.00 by the end of 2005. Although there is still one month left, that doesn't look so likely now. Since prices are still rising over time, that just tells me that I was premature in the forecast, not flat out wrong. Maybe it will hit that level in early 2006.
        Even though you cannot buy silver as cheaply as you could three years ago, higher silver prices still look like almost a "sure thing" to me. Mega-billionaires Bill Gates and Warren Buffett have significant investments in silver.
        For most people, I currently recommend that silver make up half of your precious metals holdings.
       Editor's Note: Patrick Heller is editor of Liberty's Outlook, published by Liberty Coin Service, 300 Frandor Ave., Lansing, MI 48912, 1 year, 12 issues, $79. Liberty Coin Service has been a dealer in rare coins and precious metals since 1971. www.libertycoinservice.com.
       Copies of CPM Group's Silver Survey 2005 is available for US$150 from CPM Group, 30 Broad St., 37th flr., New York, NY 10004, (212) 785-8320 or may be ordered online at www.cpmgroup.com.