In the last eight years the silver price has increased close to five-fold, from US$6 / ounce to US$29 / ounce.
It hasn’t been an easy ride for investors.
The price crashes intermittently when the trade gets overcrowded. With just $50 billion of silver bullion above ground, it is a very small market and gets crowded easily. The Silver price has had four major crashes in the last ten years but has still increased five-fold.
In the first half of 2004 it fell by 36%.
Then during the first half of 2006 the silver price fell 38%.
In 2008 it fell for most of the year with the peak to trough fall a colossal 61%.
Then in 2011, from its April peak to its low point in late December, silver lost 48% in price.
But between these savage dips, silver has surged.
The net result is, if you invested US$10,000 in silver at the start of 2004, it would now be worth US$48,309.
Last year left a bad taste in the mouth for many silver investors. The 48% correction was brutal. And now there’s a lot of negative sentiment around silver.
But – believe it or not – when negative sentiment builds to this point it is often the best time to invest. As Warren Buffet says, “be greedy when others are fearful and fearful when others are greedy.”
There are also some clear signs this latest correction is now finished.
The main sign comes from the silver futures market.
It is now cheaper to buy a silver futures contract than real, physical silver. Silver rallied more than 60% the last time we saw this happen towards the end of 2010. As I write this, physical silver is US$28.98 / ounce. A silver futures contract is $28.93 / ounce.
This 5-cent difference may sound like small bickies but it is very important. Futures contracts are usually higher than the price of the commodity. Not so much as a price predictor but more to reflect the cost of storing the commodity and the opportunity cost of the capital.
When the futures price dips below the commodity price like this, even by just 0.2%, it is a clear signal to expect higher prices. The market calls this ‘backwardation’.
The silver market went into backwardation a few weeks ago on 28 December 2011. The next day, silver started a three-day bounce that increased the silver price by 12%. This included silver’s biggest one-day move in over three years – a 6.6% jump.
Backwardation tends to happen when there is a shortage of a commodity. The result is a much higher commodity price, which encourages people to sell. Backwardation was in play during the last silver rally that drove the price from $25 / ounce to its peak of $49.50 / ounce.
This is a very exciting development for silver investors. It’s also good to put the silver market in some historical context to see what the next few months could bring.
Like gold, silver tends to set its low point for the year in the first six weeks of the year.
In six of the last 10 years, the low price for the year was set by 8 February.
With a significant correction behind us, and backwardation now in play, it’s easy to imagine we may see the 2012 low point for the silver price very soon. That’s if we haven’t seen it already.
Compared to its recent precedents, the 48% correction in 2011 was bigger than those in 2004 and 2006 and was only smaller than the 61% fall we saw in the GFC of 2008.
What would happen if silver fell further and matched the drop we saw in the GFC?
We would see it down at $19.50/ounce. It’s hard to imagine given the current set up, but anything can happen with silver. I’m a buyer of silver at current prices. But if silver fell this far I would buy even more! The silver price has more than tripled since its GFC drop.
Something I’ve written about in Diggers and Drillers for a while is that you should watch for the cost of buying silver through a bullion dealer to break away from the spot price. The tangible, physical stuff should command a premium. Buying physical silver is very different to buying ‘paper silver’ through a commodities exchange. There is a lot of doubt that silver bought this way is backed by the real stuff. Since the collapse of MF Global, investors have woken up to this.
One way to measure what premium physical silver should be trading at is to watch the price of the Sprott Physical Silver Trust (PSLV) against the spot price of silver. The market believes that Sprott’s fund carries the silver it claims and isn’t a bad proxy for the real value of silver.
So it’s interesting to see Sprott’s silver trust surge in value against the silver price recently. The chart below shows just that. I’ve divided the value of a unit of the Sprott Physical Silver Trust by the silver spot price; my ‘Sprott-to-spot’ index. Since the start of December, the relative value has increased by more than 20%.
What does this actually tell you? Investors struggle to buy large amounts of silver, and are prepared to pay above the market price for physical if they trust you have it.
For the average investor, we may find that buying bullion from dealers may start coming with extra costs, which reflects its true value above the spot price.
2012 also brings the likelihood of more money printing from the Fed, and possibly the ECB. This is not something you can bank on. But either would be bullish for precious metals prices. As the money supply of the major currencies of the world increases, the price of hard assets, such as gold and silver, rise to reflect their value.
So the stars seem to be aligning for a big year. Silver normally bottoms out at this time of year, the correction looks finished, the metal has gone into backwardation, and physical metal is now priced at a premium.
I expected big things from silver last year based on the fundamentals. All those fundamentals are still in place, and now we have everything you have just read about today on top of that as well.
With a painful correction now out of the way – and the price knocked back down – the silver market looks ready to explode again.
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January 10th, 2012 at 4:02 pm
“What does this actually tell you? Investors struggle to buy large amounts of silver, and are prepared to pay above the market price for physical if they trust you have it.”
What that chart tells us is that PSLV is a closed end fund with some possible tax advantages with good marketing, hence the premium. In the real physical wholesale silver market which is not constrained by a limited number of shares, Perth Mint is not having any problem acquiring, or selling, silver at spot.
January 10th, 2012 at 9:52 pm
Silver premiums on physical silver have been pushed extraordinarly high over the last 3 years. When we started BullionSupermarket.com to compare premiums on physical Gold and Silver products 10 ounce silver bars were changing hands on auction sites and at dealers for as low as 5% premium. However at times of high demand and tight supply, tight supply seemingly all the time these days, premiums have risen significantly over time. We see some branded bars at the 10 ounce level bid up to 25% +.
Even an experiment where we had minted our own brand 1 ounce bars yielded far headier premiums on a brand of Silver bar never before marketed.
Premiums do fluctuate a lot in at the small physical bar and coin end of the market. A good premium tool such as ours can help alot to spot the bargains and the stuff priced in cloud-cookoo-land .
January 11th, 2012 at 9:58 am
BullionSupermarket – won’t that premium disappear in a puff when demand falters?
January 11th, 2012 at 1:22 pm
Even with this analysis, the question everyone keeps asking is when can I buy silver, and the answer is not that simple.