-- Posted 22 August, 2005 | | Source: SilverSeek.com
California gasoline sales leveled off early this year, probably because people drove less to save money as gas prices shot up.
And that was before the average price climbed another 25 cents a gallon, sending the price to more than $3 at some Sacramento stations for the first time.
-- MSNBC 8/21/05
Having logged over 5000 road miles in the past month, from Missouri to Maine to Minnesota, I have noticed a common concern on the lips of many Americans: the price of gas. This latest price push, from abound $2.50 a gallon to near $3 in places, seemed to occur in a matter of days, with prices at local stations jumping nickels and dimes at a time. It seems that no matter the promises or machinations of politicians, supply and demand will win out every time, and even those who love to blame high prices on “greedy oil companies” have come to realize that as we move into an era of static supply, prices must rise unless demand is somehow capped.
But why is the supply static? Aren’t high prices supposed to bring more gas to the market? Not necessarily, because there are number of physical factors (limited refining capacity, an aging transport fleet, maybe even Peak Oil) that make it difficult – some would say impossible – to drop the price significantly, at least in the short term.
Demand, however, is not static. Though prices are having an effect on individual buyers in certain places, world demand continues to rise, finally outrunning world refinery capacity near the end of last year. China and India, flush with dollars and modernizing their economies at a frantic pace, are more than eating up the savings created by a few California car pools.
Inelastic supply combined with rising demand points to higher prices for the years to come.
But it’s not just true in the oil market: the silver market may be an even better example of inelastic supply in the face of rising demand, and with the price of silver holding near $7 an ounce, it’s a good idea to look at the silver supply and demand equation.
According to the Silver Institute, world supply of silver in 2004 was about 880 million ounces, within 10% of the supply from every year going back to 1996. In fact, as prices rose from less than $5 at the end of 2000 to $6.65 in 2004, supply dropped marginally and has been unchanged since 2001. That’s inelastic supply, and it comes about because silver is a byproduct metal. 85% of silver from mines is a byproduct of other metals. Recycling is a byproduct of photography. Government sales are a byproduct of previous savings.
The face of demand, while similarly inelastic in places, has the potential for change. Demand is composed of four elements: photography, jewelry, industrial applications, and investment, with the last being all but forgotten as the price languished below $5 an ounce. Because silver makes up a small proportion of the cost of many products it is a part of (like photographic film, antibiotic creams, even some jewelry) higher prices do not always tamp industrial demand. However, in 3 of the past 4 years (as opposed to none of the previous 6) investment demand has been a net positive. In fact, implied net investment, when combined with sales of coins and medals, made up a full 10% of demand in 2004.
Isn’t it supposed to work the other way? While high gas prices in California have the effect of tamping retail demand, why do higher silver prices cause more and more silver to be sold to those who don’t “use” silver rather than to industry?
The answer is that investment stands the supply/demand curve on its head. Investment, unlike consumption, is not discouraged by high prices; in fact, it’s not until prices rise that investment – what one might call “saving” – creates any demand at all. When stocks are low, no one wants them. When silver is low, no one wants it. When baseball cards or beanie babies or other collectibles are out of the news, no one wants a garage full of them. But let prices rise and suddenly no one can get enough of them.
So there are two major factors in the silver supply and demand numbers that offer the potential for an oil-like movement in the price of silver.
The first is on the supply side. A significant portion of the current supply (more than 10% in 2003) comes from government sales. These are one-time injections into the market (e.g. the US government can only sell its hoard one time – and it has done so). Most mines are not going to produce more silver when it is a byproduct of their main target, whether gold or copper. That means silver supply, like oil supply, can be expected to remain fairly steady and has the potential to fall. Think “Peak Silver.”
But the second factor is on the demand side. No, it’s not photography demand (since the vast majority of photographic silver is recycled, it’s a net wash in the market). That factor is investment demand, which will continue to rise as prices rise. And if a number of analysts are correct about the amount of short silver that must be returned some day in physical form, that demand could escalate very quickly is it becomes generally accepted that physical silver is in short supply. Investment demand, rising from zero, has the potential to be to the silver market what China is to oil: that one buyer who does not care about price and has an almost insatiable demand.
Static supply, higher demand; just like in oil. And the result is likely to be the same.
But there are two other interesting numbers to consider. According to Eric Hommelberg, the historic gold/oil ratio, now near an all-time low, is 15.8 barrels of oil to an ounce of gold. For most cultures that have used both gold and silver over the past thousands years, the price ratio has been around 16 ounces of silver to one ounce of gold. So plying a little fuzzy math gives us the potential for one ounce of silver to be priced the same as one barrel of oil.
Oil is currently north of $65 a barrel. Silver trades about $7 an ounce. Something is dreadfully overvalued or something else is wonderfully undervalued. Invest accordingly.
Bill Hoyt, August 22, 2005
Bill Hoyt is investor relations manager of Timberline Resources Corp (TBLC). Views expressed herein are purely his own, but he invites you to share them if you wish. Visit his web log, El Borak’s Myopia, for daily commentary and responses to reader email.
-- Posted 22 August, 2005 | |
