THE HISTORY OF SILVER
Besides gold, silver is probably the metal that comes to mind most readily when we think about wealth or money. This is easy to understand when we learn that silver was one of the earliest metals known to man. Because it was ductile, very malleable and capable of a high degree of polish, silver was fashioned into ornaments as early as 4000 B.C.
In due course the metal became a medium of exchange. It met the logical criteria of virtual indestructibility and portability and it could easily be divided, as could the other metals which served as money: gold, copper and bronze. Yet silver established itself as the most popular currency, because, unlike gold, it could be found in greater abundance and was distributed over the then known world more equally. In addition, the majority of commercial transactions were too small in value to be paid for in gold, which was very rare and very expensive, and too large to be settled in copper or bronze, both of which were suitable for only very small purchases.
As more silver was mined, more of the metal was accumulated by the rich and powerful. Silver, along with other precious metals, motivated wars and conquests. When Alexander the Great marched upon Persia, he did so not only for its gold but also for its silver. In the ancient world, most silver came from what is today’s Turkey as well as from Macedonia and Thrace. Only in the sixteenth century were larger silver deposits found. This time these were in the Americas, where Spanish and Portuguese explorers had discovered them.
The first statistical records of silver go back to the 11th century, when William the Conqueror placed the Mint in the Tower of London and introduced the “Tower pound” as a unit of weight for the white metal.
Through trade, a considerable amount of this silver found its way to England where, under Elizabeth I, an effective silver standard had already been established. Because the country’s East India company had to finance immense imports of teas, coffees, spices and textiles, all of which had to be paid for in silver bullion, demand from England was consistently high. The relationship between silver and Asian trade became so obvious that whenever the company prepared a ship for sail, it had an immediate impact on the bullion price! But while large quantities of silver were leaving England, substantial gold imports were occurring at the same time. This was because most of the nation’s trading partners in continental Europe paid for British goods in gold. Sir Isaac Newton, then the Master of the Mint, recognized that silver would soon be in shorter and shorter supply and that the price between the two metals was being totally distorted. What evolved was an effective gold standard, although it was not called that until 1816.
In the meantime, sizeable discoveries of silver had been made in the United States. And because the u.s. was also the major producer of gold, a bimetallic monetary standard was chosen in 1792. But the American experience was no better than what the British had gone through: it found itself plagued by massive shifts in international trade which constantly affected bullion prices. Gradually, the U.S. also shifted towards a gold standard, proclaimed in 1900 as the “Gold Standard Act”.
As it became clear that more and more nations were switching to the gold standard, substantial quantities of silver began to flow from official holdings onto the free market. Previously, people had been able to come to the Mint and have their silver turned into legal tender, free of charge. In other words, bullion could freely be exchanged into coinage bearing a face value, which gave the white metal a fixed price. The removal of this right to free coinage depressed the price of silver because no one wanted the metal any longer.
Silver production, meanwhile, was sharply on the increase: from about 40 million ounces per year in the 1860’s, output rose to 170 million ounces thirty years later. This over-supply was felt the most keenly in the United States which, by then, had become the world’s largest silver producing nation. In 1878 the Bland Allison Silver Purchase Act directed the u Treasury to purchase four million dollars worth of silver per month and to coin it into silver dollars. But the pressures discussed earlier led to further price deterioration: having been traded at $1.29 in 1874, silver was now selling at 92 cents. By 1890, the u.s. was flooded with silver dollars and new legislation, the Sherman Silver Purchase Act, directed the Treasury to increase purchases of the white metal to $4.5 million per month.
Three years later, the government was virtually bankrupt and had to suspend all such purchases. Silver was still dropping. By 1902 the silver price was at 47 cents.
Silver recovered somewhat in the years following World War I, but was then pushed even lower by the deflationary pressures of the Great Depression. From 50 cents in 1929, the metal fell to an all time low of 25 cents in 1933. Nevertheless, with the passing of the Silver Purchase Act of 1934, the Treasury was instructed to buy silver until the traditional Mint price of $1.29 was reached again. A wild speculation to accumulate silver ensued in the open market. Soon the price was back to 80 cents and the government officials expressed surprise and outrage at the profits which were amassed by some market operators. It did not occur to them that they themselves had just created the basis for such speculation and that the original Mint price of $1.29, not seen since the 1870’s, had absolutely no relation to reality. At any rate, by the beginning of World War II, the u.s. Government held almost three billion ounces of silver in its coffers!
All along, silver producers and industrial users had been the largest beneficiaries of the Government’s interventionist policy. While the Treasury had been busy buying silver at prices higher than market value, industry had been quietly purchasing their supplies from abroad, at cheaper rates. In the mid-l950’s, the market price started to exceed the price posted by the Treasury, but the principle that the Government should lose on its silver transactions remained intact: silver users now simply purchased their supplies from the Treasury.
In the 1890’s the u.s. Government went nearly bankrupt trying to keep the silver price high. In the 1960’s billions were spent in an attempt to keep the price low. Both efforts failed miserably.
During the Sixties, the world economy grew at a tremendous pace, and demand for silver along with it. Eventually, the Treasury’s selling price of $1.29 was broken and the market had, all by itself, accomplished what the Government had been trying to do for a quarter century!
One would think that this would have been cause for rejoicing, but now politicians suddenly realized that vast amounts of silver dollars were in circulation, each one of which was valued at $1.29. If they wanted to keep this money in circulation, they had to keep the price of silver do% or people would simply start to hoard their coins. Thus, a disastrous attempt to keep the price of silver from rising unfolded. It dragged on throughout the Sixties and culminated in the final withdrawal of all silver coinage in 1968. It also left the Government’s stockpile of silver nearly depleted: from three billion ounces at the beginning of World War II, the silver stock had shrunk to below 200 million ounces all sold at below market prices!
ironically, it was the demonetization of silver and the end of government attempts to manipulate its price in 1968, which led to the most spectacular private market intervention in the metal’s long history. This occurred in 1979 when the Hunt family of Texas began aggressively adding to its already sizeable silver futures positions. Along with other factors, the Hunts’ purchases caused a significant rise in the price of silver, from around $6 at the beginning of the year to $11 by early September.
We now know that several of the trading firms represented on the New York and Chicago Commodities Exchanges then held short positions in the silver market and were counting on the price of silver going down. But, to their chagrin, the Hunts continued to buy and several other private investors, acting through American brokers and Swiss banks, jumped on the bandwagon. In early December, the March 1980 contract, around which most trading actively centered, crossed the $20 mark. By year end, March silver was trading at almost $30 and exchange officials were in a panic. They had 30,000 short contracts and they had just been forced to put up additional margin of at least $1.5 billion, in one month alone! Besides, the danger of a “squeeze” on March delivery was growing daily more alarming. If the Hunts continued to purchase and the trading firms were forced to add to their short positions, how on earth were they going to deliver all the silver they had sold? Since they obviously could not, it became clear to more and more traders that, unless the price collapsed, they would have to liquidate their short contracts by buying silver from the Hunts!
Exchange officials were now determined to zero in on the Hunts and other investors. They did this by making several substantial changes in the trading rules. To start with, the number of contracts an individual could own in any one month was limited to 500. Secondly, no more than 2,000 contracts could be held in all delivery months combined and, thirdly, any account with more than 100 contracts was made a “reportable account”. These new rules had only one purpose: to force the sale of existing long contracts.
In spite of all this, silver continued to climb. The Hunts and other large investors were now transferring their business to London. On January 17, the price reached $48.80 and the large trading firms were being forced to deposit more than $100 million in margin every single day!
The final bust came on the subsequent trading day, Monday, January 21. The COMEX board actually did what no one thought an exchange could do: they prohibited the buying of silver by anybody — anybody, that is, except those who already held short contracts! Thus, the Hunts could only sell their silver to the same firms which controlled the short contracts. Moreover, they had to sell to them at the prices they bid, when they bid.
Obviously, this was the beginning of the end. The Hunts owned 192 million ounces of silver, bought at an average price of around $10, for a total of $1.92 billion. As of January 17, it was worth $9.2
billion which, if they could have sold it, would have meant a profit of $7.3 billion, or 380 percent. But it also meant that from January 21 on, the Hunts were to lose $192 million for every decline of one dollar in the price of silver!
Roughly two months later, on March 27, silver reached its 1980 low of $10.80. The day was named “Silver Thursday”. The Hunts had liquidated some of their silver, but their u.s. and London positions still amounted to 141 million ounces, valued now at $1.52 billion. There is no doubt that if the Hunts had been forced to liquidate their remaining silver, the price of the white metal would have plunged to far lower levels.
Still, the price had not reached its cyclical bottom. The global recession gained momentum throughout 1981 and the silver price reflected this. In June 1982, the white metal briefly touched the $5 mark, the lowest price since the days before the Hunt debacle. At such depressed levels, new buying interest set in and silver quickly returned to the more realistic $10 level. And once the first signs of an economic recovery set in, the white metal advanced further. Like gold, silver had entered a new bull market.
The Hunt brothers lost more money in the silver market than even the u.s. Government had lost: in less than three months, their fortune shrank by $7.7 billion!
THE FUNCTION OF SILVER
Silver, like gold, has a dual function in today’s world. To some people the white metal is a refuge to which they can turn when they feel threatened by monetary or economic instability. Others praise it for its incomparable industrial applications. However, there is a difference. The gold price is primarily influenced by investor thinking, while industrial demand is secondary. With silver, it is the other way around. Although most people associate silver with coinage, tableware, decorative objects or photography, more recent applications have taken over. The exploding electronics and computer industries, for instance, use silver because of its high thermal and electrical conductivity, and its ability to reflect light. Small amounts of the white metal are contained in almost any article you use in everyday life. Whether it is a watch, a washing machine, a standing lamp or a video screen, there is likely to be a silver rivet, a silver-coated plate, or fine silver wire somewhere in it. This evolution is gradually having an immense impact on the price outlook for silver, which will be discussed later.
Just as most people say that gold has no place in our industrialized modern world, so they wonder how silver can provide investors with insurance against political, economic and social uncertainty. The answer to this is quite straightforward: the desire for protection always stems from suspicion. And when people become suspicious about their money, they inevitably turn to something which is more limited in supply than paper currency. Although less precious and rare than gold, silver is still relatively rare and has therefore managed to protect people’s assets over a period of time.
To be sure, many will argue that silver recently did just the opposite: did not millions of people who purchased silver in 1980 at record prices of around $50 lose a fortune? And does this not prove that silver is just the opposite of a protective vehicle, namely a highly dangerous and speculative commodity?
Such questions should serve to remind us that it is only by studying the long term relationship between a precious metal and the pattern of inflation that we can determine its real value. Consider, for instance, the case of someone who purchased silver fifteen years ago, when the price was $1.30, and now looks back on his investment when prices are around $10. On the one hand, our investor has to conclude that he has more than stayed ahead of inflation, but on the other hand he probably wishes he had sold his silver at $50 for an even more spectacular profit.
This example contains a crucial lesson. If speculation is not what you are after, you should strictly follow longer term strategies. But, if you are interested in speculation, then silver will offer you all the volatility you’ll ever want — and then some!
Take a look at what happened during the 1979/ 1980 run-up in prices, when the white metal advanced from below $7 to above $50, thus posting a gain of more than 600 percent. Gold, by comparison, moved from $220 to $850, gaining less than half of that. And when the panic markets of early 1980 collapsed, it was the same all over again. By mid-1982 gold had declined to $280, losing 67 percent of its record value. Silver fell to below $5, giving up more than 90 percent of its peak price!
THE PRICE OF SILVER
Silver and the Economic Cycle
Silver’s volatility is easily explained, however, when we look at it in the context of the rollercoaster economic cycle we have been riding for the past fifteen years. Every time inflation needed to be curbed, the cycle was brought to an end through a sharp rise in interest rates. And every time the pressures of recession moved into the foreground and unemployment became the issue of the day, enough debt and money was created to get the economy moving again. At the beginning of each cycle, investors foresaw that industrial demand would sharply increase, but they also sensed that it was just a matter of time before inflation was back in the headlines. Silver catered to those investors in two fundamental ways: not only did the metal benefit from the industrial pick-up but, along with gold, it also promised to protect one’s purchasing power. The reverse is true when the economic cycle comes to its peak. Price inflation tends to jack up interest rates which, eventually, stifle economic growth. When that happens, the gold price correctly anticipates an improvement in the inflation outlook and starts to drop. Silver does the same, but it also has to take into account a significant slowdown in the industrial process. Reacting to two such major factors simultaneously, silver invariably drops faster than the yellow metal.
Silver and Market Manipulation
The price of silver has been manipulated more often, and on a greater scale, than the price of any other major commodity. In our section on the metal’s history, we explored the frequent interventions by the U.S. Government and, more recently, by the Hunt family. Unfortunately, these were only two of the many cases in which the silver price has been influenced by some particular interest, albeit the two most important ones. In other instances, Eastman Kodak, one of the largest silver users, has affected silver and at other times professional commodity traders have pushed the price up or down.
The reason for all this manipulation is really the white metal’s inadequate distribution. It is this factor which tempts so many into trying to corner the market. But, as we have seen, things are improving since both the American government and the Hunts have been chastened and since the photographic industry is gradually losing its overwhelming importance as the main source of demand.
Still, the white metal has a long way to go before it is a distributed as gold.
Silver and the Asian Hoard
During the 17th and 18th centuries, immense amounts of silver left Europe for Asia in order to pay for spices, cloth and tea. And to this day the white metal is still regarded there as a store of wealth. You have to realize that most countries in Asia have a “closed” economy with foreign exchange controls and few means of accumulating capital. Silver fits Asian needs beautifully. Particularly in India and Pakistan, the hoarding of precious metals, either in jewelry or in bullion form, is one of the most accepted ways of saving.
During the Seventies, an average of about 45 million ounces of silver were smuggled out of Asia every year. At the beginning and at the end of the decade the amounts were larger, while at the mid-point supplies showed a drop. This illustrates that hoarders in Asia tend to dispose of their holdings when prices are high and reduce their sales when they are low. Although we don’t have reliable figures for the early Eighties yet, I am reasonably certain that they will prove to be much lower due to the collapse in the silver price. For the time being supplies from Asia should stay relatively subdued because the silver cycle is one of several years duration and selling is not likely to pick up until we move towards a new top. But, always remember, overhanging any bull silver market, is the huge hoard of the white metal in Asia.
Silver in Exchange Warehouses
Another overhang analysts frequently point to is the vast amount of privately owned silver in the approved warehouses of the American futures exchanges. But what many analysts forget is that these holdings do not belong to the exchanges. Rather, they are largely the property of private and corporate investors who held futures contracts and who then took delivery. Instead of having the metals shipped to them, they simply instructed their brokers to take delivery at an exchange warehouse and have had a receipt issued.
To speak of this hoard as an “overhang” would be a mistake. After all, many of these investors bought their silver at far higher prices than are now available and will want to wait for a price recovery before they even consider selling. The long term trend for private dishoarding of bullion in free markets is exactly the same as in the black markets of Asia. Higher prices cause private investors to dishoard while low prices attract new investment. This was best illustrated when tens of thousands of people lined up to sell their tableware, their tea sets or whatever silver jewelry they could find when silver reached the $50 mark in early 1980. Shortly after this event I went to inspect one of Canada’s largest precious metals refineries and what I saw illustrated this point perfectly. A storage room about one quarter the size of a football field was literally filled with drums stacked to the ceiling each drum packed with cutlery, bracelets and heirlooms waiting to be melted down.
Private supplies held in official exchange warehouses react in accordance with this pattern. They tend to go up moderately during the first part of a bull cycle, then grow at a very quick rate and, following the peak, fall substantially. (The dishoarding follows the peak because most investors miss it.) Thus, the danger of renewed sales from this source is over for the time being. In fact, as the silver price starts to appreciate again, warehouse stocks should go up with it thus increasing not the supply of silver, but the demand.
Silver and Soybeans
You may wonder what soybeans have to do with the price of silver and, on many occasions, I have marveled at this curious link myself. Throughout the Seventies, however, there was a relationship between these two commodities.
The reason was more logical and simple than you might think. The whole thing started when a few Chicago grain speculators acquired the habit of converting their profits into silver contracts. When soybeans moved down, they liquidated their silver positions again in order to raise cash to meet their margin requirements. This trend spread and, as soon as an advance in grain prices took place, silver would move up in anticipation of higher prices as well.
Since the early Eighties, though, this pattern has not been reliable. The fall in the price of silver discouraged professional grain dealers from using it as a “parking spot”.
Silver Producer Cartels
When the silver price dropped to below $5 in mid-1982 several silver producing nations made strong noises about the necessity of forming a cartel. This was understandable because a prolonged period of such low prices would certainly have forced sharp cutbacks in output and even the closing down of production facilities.
Even so, a silver cartel is a very unlikely affair, either now or in the future. There are many different silver ores in the world, but most of the metal is produced as a by-product of one of the base metals. While some producers mine a particular ore solely for its silver content, to others the white metal is just a windfall by-product. Moreover, production Costs vary largely as a result of the different economic structures which exist in today’s silver producing nations. The Soviet Union’s per ounce cost is quite different from that of the United States, Australia or Canada. And developing nations, such as Mexico, Peru or Chile have foreign exchange earnings to make — even at a loss. In other words, the world’s largest producers have different economic objectives, if silver became subject to another selloff, Peru, Chile and Bolivia might very well unite to formulate a policy of their own, but this would be meaningless. As the table of leading producing countries shows, they would control a reasonable portion of the market but other nations such as Australia, Canada or the United States could break their cartel because, together, they command still greater influence, Industrial producing nations may, however, resort to other measures of price stabilization. In times of depressed prices, demand can be created by the manufacture of coinage or, more simply, by stockpiling. After all, governments have the power to withdraw coinage from circulation and can resell stockpiles again when prices recover.
Industrial Demand for Silver
In the section on gold we saw how various political and economic events can affect investor demand for bullion and, in the first section of this section, we found that silver reacts to the inflation cycle the same way gold does, except that its movements are more pronounced. It is now time to examine what will happen on the industrial side when an economic recovery gets underway.
This is a rather intriguing subject because, since the late 1950’s, silver consumption has exceeded total production in every single year. Most of the silver which made up for this shortfall came of course from the gigantic u.s. Government stockpile which, between World War I and the late Sixties, declined from three billion ounces to less than 200 million ounces. Throughout the Seventies, a lot of private dishoarding took place as prices reached levels which were attractive to even the most demanding investors. And after that, as a result of their confrontation with the American exchanges, the Hunts were forced to sell a portion of their holdings.
But what about the future? Now that the United States Government doesn’t have that much silver left, now that we have seen as much private dishoarding as we will see for a while, and now that the Hunts have consolidated their financial position, where will the silver come from? The answer is startling. If we get any kind of an economic upturn, there will simply not be enough of the white metal to satisfy industrial demand!
Photographic materials, by the way, still represent the largest demand factor for silver. Electrical and electronic products are second, while the more conventional applications in jewelry, mirrors and sterling ware are third. As already mentioned, more and more of the world’s silver is used in the form of very small, but very vital components of much larger machines. For example, the u.s. military uses more than 5,000 different items containing silver, among them 150 different kinds of bearings. Sizeable amounts of the white metal are used in rockets, torpedoes, jet aircraft, ships, submarines and tanks, while minute quantities can be found in points, starters, gears, valves, batteries, etc.
The amount of silver used in these things is usually worth no more than a few pennies and this means that silver has considerable protection on the upside. Even if the price doubled, tripled or quadrupled, it would have very little impact on the overall unit cost of the many appliances and devices in which it is contained.
But, you may ask, could not the producing nations simply increase supply? Remarkably, the production of silver is extremely inflexible. Remember, the white metal is mined predominantly as a by-product of copper, nickel, lead, zinc and other base metals. The price of silver would have to hit astonishing heights before going after it deliberately would be practical.
To generate as much foreign exchange earnings as possible, low cost producers in the Third World are currently selling all the silver they can. But if you take a look at our table above, you will see that all these supplies can be easily consumed, even though we are only at the beginning of a global recovery. In fact, there is still a hand some shortfall of 57 million ounces which has to be covered from the existing supplies in industrial and private inventories!
Finally, as our figures show, total world consumption for the white metal is again on the rise. If this trend continues, silver will outperform gold in the near future.