Editorial: Silver paper

It used to be said in the Canadian Football League that the Toronto Argonauts won the Grey Cup every June. Silver is the Toronto Argonauts of the metals: it has had its breakout year every December since the Hunt Brothers made their celebrated play to corner the market back in the 1980s. And like the Argos, it left its supporters reaching for the crying towel every time.

Nobody’s crying in 2006, at least not yet. Silver appears to have said goodbye to US$5-per-oz. and is suddenly the darling of the precious metal markets. The ratio of the gold price to the silver price has fallen sharply — in other words, while gold has been going up, silver has been going up faster. When, year to date, gold is up 25% and silver 54%, you know it’s been a good stretch for silver.

When the precious metal markets heat up like this, a decline in the U.S. dollar is always part of the reason. But the dollar has not been weak in foreign-currency terms; the Federal Reserve’s broad dollar index has fallen only 3% in the same period. Even from its high-water mark in early 2002 (when gold was US$279 and silver US$4.29) the dollar has only fallen 17% against other currencies.

Something else has to be happening. Perhaps the strongest updraft is a commodity boom that has taken every metal skyward. It’s always been recognized in the bullion markets that silver is an industrial commodity as well as a store of value, and demand for any metal is strong right now. On the supply-side, silver is everybody’s byproduct — with the implication today that tight supply in base metals has to translate into tight supply in silver as well.

But the silver market doesn’t give up its secrets that easily. Silver manufacturing demand has exceeded silver supply since 1990 — and the period when the market was in deepest deficit produced a mighty rally from US$3.50 up to US$5 per oz. Moreover, that deficit has narrowed steadily since 1997, and market observers CPM Group have predicted it will go into surplus — 48 million oz. — beginning this year (column, p. 4).

That is not to say that fundamentals don’t move the market. But they move it modestly and gradually, if history is any guide.

And traditionally the investment tail wagged the industrial dog, and the evidence is that it’s happening again. There is a new ingredient — a silver fund — in this year’s brew. Barclays Global Investors, that one-stop shop for all your exchange-tradable fund needs, listed its iShares Silver Trust on the American Stock Exchange at the end of the month. The trust will hold 10 oz. silver for every share it issues, which to many had the timbre of a giant sucking sound. Nobody knew how much silver the iShares trust was likely to need; only that even a modest demand for units would take a large bite out of existing above-ground stocks.

Barclay’s undeniably successful Comex Gold Trust and the London-listed Gold Bullion Securities now hold almost US$10 billion in gold, so predictions made the rounds that a silver fund could easily attract a tenth of that amount from investors wanting a tradable silver share. A US$1-billion silver fund would hold, at present prices, about 70 million oz. silver — coincidentally, about the size of the whole silver-futures market on the New York Mercantile Exchange at the beginning of the year.

The iShares fund is now a quarter of the way to that level, and its final prospectus put the planned offering at 13 million shares, or 130 million oz. silver, which would be a US$1.8-billion fund at present silver prices. If that silver were to be taken up by the fund, it would easily wipe out any surplus in an already tight market.

The forces that might work against that are released silver stockpiles, scrap, and increased mine production. But unlike 1981, 1984, or 1998, there’s very little hanging over the silver market today. The only large official-sector holder is the Indian government, and it has already announced its plans for an orderly sale in 2006 (a figure CPM factored into its surplus prediction). Scrap supplies from the industrialized world may not be as large as they were in the days when ordinary people were carrying boxes of cutlery and bags of coins to silver buyers.

That leaves mine production, forecast to increase by about 15 million oz. About 3 million oz. each is expected to come from Mexico and Peru, the world’s two largest silver-producing countries. Some will come from China. But a large part is supposed to be coming from Bolivia, where all bets are off following the election of Evo Morales and the MAS.

If nationalization is in the cards in Bolivia, silver might go through the roof.