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Will Arabian investors do a Hunt to silver?

By: Peter J. Cooper

-- Posted 7 July, 2008 | | Discuss This Article - Comments:

The best-read article on this blog is about the selling of Hunt Petroleum for $4.2 billion recently and the possibility that some of this vast sum might be invested in the silver market, in some kind of a re-run of the Hunt Brothers’ silver pool of the later 1970s. That is pure speculation, but there is nothing speculative about the outlook for silver.

If gold has bright prospects due to inflation over the next couple of years, then silver shines even brighter. For in previous periods of financial turmoil and high inflation silver has always out performed gold by a factor of more than two. It is only the volatility of silver prices which puts investors off. But that is increasingly seen as a small price to pay for out performance.

In modern Arabia silver is often mixed with gold to create an alloy known as white gold, with a 25 per cent silver content, that is popular in local jewelry. Purer silver is used in traditional handicrafts such as Omani daggers and jewelry boxes. But the fact that silver costs less then one-fiftieth of the price of gold means that it is not often treated as a store of value or a financial instrument.

The silver futures contract on the Dubai Gold & Commodities Exchange is one of the least traded contracts, and physical imports of Dubai totaling some $250 million are dwarfed by the 20 per cent of world gold production now believed to pass through the City of Gold as Dubai is known.

However, silver is about to have its moment of glory. Worldwide inflation is mounting. The Chinese have just agreed an 85 per cent rise in iron ore. Oil prices are double their level a year ago. Food prices have soared. Consumer price inflation is up wherever you look.

Investors and speculators are finding that the value of assets like real estate, company shares and bonds are all under pressure from inflation. House prices started from an inflated high and are now deflating as inflation drives mortgage costs up and disposable income down. Inflation hits company profits and therefore their share prices. Bonds provide fixed income and negative returns after allowing for inflation.

In inflationary scenarios investors need an asset class with relatively fixed supply that will at least increase with inflation and is likely to attract speculative demand as a consequence. Precious metals fulfill this role with low annual production in relation to total supply, and become monetized as fiat currencies lose their value.

But why should silver out perform gold in this environment? From a technical point of view there is a very large outstanding short position in the Comex futures pit. That means a sustained rise in the price of silver will be amplified by the shorts running for cover, and having to buy silver at whatever the price.

There is also a more fundamental reason to be confident about silver: the market is considerably smaller than gold. The gold market is estimated to be worth something north of $4 trillion while the whole silver market is reckoned to be valued at between $16-25 billion. Therefore, it takes considerably less money to move the silver price higher than it does gold, and that is one reason for silver’s price volatility.

Over time the long term silver to gold ratio is 15, that is to say gold is worth 15 times more than silver. Except not at the moment, the silver to gold ratio is 52, which means historic undervaluation. If you throw in the oil to gold ratio, which shows gold to be historically undervalued as well, then silver looks even cheaper. But silver has been catching up with gold and is up 283 per cent over the past five years, ahead of gold’s 156 per cent rise. It still looks cheap.

In March a 1,000 ounce gold bar would have set you back more than $1 million, while the same amount of silver could be had for a mere $22,000. Silver has still not crossed its all-time high of $54 reached long ago in 1980 or even the average selling price of $24 an ounce 28 years ago. It is the most undervalued of all the commodities.

Yet silver is actually consumed in vast quantities by many industrial processes and a vital material for electronic devices like mobile phones and personal computers.

In fact, one of the most amazing facts about silver is that supply has outstripped demand for the past 18 years. Annual silver supply deficits have run at between 70 million and 200 million ounces. And it is because silver is consumed by industry that available stocks are just a tiny fraction of gold reserves which just pile up in bank vaults.

A scarce resource with unique properties as a conductor of electricity and a traditional unit of currency, silver has a double hedge against inflation as both an industrial commodity and a precious metal. It ought to rise in value now for both reasons.

Perhaps it is the history of the silver crash and the Hunt brothers pooling of the silver market in the 1970s that still hangs over the price of silver. But as investors becoming increasingly desperate to find an effective hedge against inflation there is surely going to come a tipping point when that Comex short position is challenged and a price surge creates a buying momentum of its own. Intriguingly the Hunt family recently sold their oil business for $4.2 billion, leading to speculation that they might planning to repurchase the family silver.

You do not get many opportunities to make a fortune in a lifetime but buying and holding silver at these price levels over the next few years is almost guaranteed to be one of them. All it takes is a little imagination to see that all that glitters does not have to be gold.

Peter J. Cooper

-- Posted 7 July, 2008 | | Discuss This Article - Comments:

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