-- Posted 22 October, 2008 | | Discuss This Article - Comments:

As the price of silver pulled back under $10 an ounce recently, I started loading up on the white metal. Or, I should say, I tried to load up. While I was easily able to buy silver coins with numismatic value, my first attempts to buy silver bullion coins met with frustration.

I think this says a lot about the silver market right now. On paper, it’s cheap. But in the real, physical market, silver is getting very precious indeed.

In fact, if you can buy silver bullion for under $10 an ounce, I recommend you grab it and run!

Hi-yo, Silver!

Maybe you have your own stories of the silver rush to share. Here’s how things are going for me.

First, my success. I was able to buy some 1921 Morgan Silver Dollars from Eastern Numismatics (http://www.uscoins.com) at a pretty good price. I say that because I checked eBay, where 1921 Morgan Silver Dollars for VF and AU (very fine and almost uncirculated quality) were selling for higher prices.

But with silver under $10, I knew that while numismatics (rare) coins were good, this was an even better time to buy bullion.

So, I checked a couple of my local favorite gold/silver shops. At the first one, I was told that silver bullion coins (I asked for silver Eagles) were unavailable. At the second one, I was told they were available, but “not at any price you’ll want to pay.”

How much was that? Oh, about 60% more than I expected to pay.

“That’s outrageous!” I sputtered.

“Call me next week,” the dealer told me. “Maybe we’ll have more then.”

So then I turned to the Internet. I decided to buy some bullion coins straight from Pan American Silver (PAAS). This company has mines in Peru, Mexico and Bolivia, and development projects all over the place. It also sells its coins and bars, minted at the Northwest Territorial Mint (http://www.nwtmint.com). While its coins may not be as well known as silver Eagles or Maple Leafs, I think most gold/silver dealers would recognize them pretty easily.

I called a couple of times, but couldn’t connect with anyone but a recorded message that said the mint was overwhelmed with call volume so no one was answering the phone. In frustration, last Friday, I wrote an email to the Northwest Territorial Mint, asking how I could buy 1-ounce silver rounds (coins) from them immediately.

Later that day, the mint wrote back. The message said, in part:

“We have been experiencing an unprecedented volume of sales, and we have been unable to answer each call in person as we would prefer. We are adding to our bullion sales and customer service staff and upgrading our telephone systems to better respond to customer inquiries.

“When you reach one of our bullion sales representatives by phone, you can lock in your purchase at the current market price. However, please note that most of the precious metal bullion products we produce currently have a 12-to-16-week lead time before delivery.”

The email went on to say …

“Because the United States Mint and the Royal Canadian Mint have significantly curtailed distribution of their bullion products until 2009, we are quoting delivery of new orders for American Eagle coins and Canadian Maple Leaf coins into March 2009.”

A 12-to-16 week lead time for delivery? Un - freaking - real. And while that may sound crazy, it pales compared to the lunacy of not being able to get American Eagles and Canadian Maple Leaf coins until March of next year! And it’s not like it’s the mint’s fault — they’re working as hard as they can and adding staff.

Tell me again about the surplus of silver. That’s a good one.

Physical Silver versus Paper Silver

Of course, there is a difference between minted silver rounds and 1- or 10-ounce bars on the one hand, and silver you can buy with a futures contract on the COMEX on the other hand. A silver futures contract is for 5,000 ounces, or 1,000 ounces for a mini-contract. While you can take delivery of a futures contract, who the heck would want to do that?

Well, David Morgan, that’s who. He’s an independent precious metals analyst and the founder of silver-investor.com. He also writes a blog at http://silverblogspot.blogspot.com.

Silver coins and smaller bars may be harder to find right now, but certain forces are at work that may soon affect prices and availablility.

Morgan and I met on a tour of mines belonging to Endeavour Silver and Great Panther in Mexico, and I found him extremely knowledgeable about silver, its history and trends. So, I called him up and asked him what he was seeing in the physical market. And it turns out that what he’s seeing is making him more bullish — so bullish, he bought a 1,000-ounce mini silver future contract and took delivery.

Morgan says he’s not the only one doing arbitrage between the paper and physical silver markets. He said entrepreneurs could “take advantage of the discrepancy between physical and paper silver — these people could take gold and silver off the exchanges at the spot price and turn it into gold and silver coins and reap the large premium now available.”

Maybe that will ease the pressure in the physical silver market, and make coins and smaller bars readily available again.

The Bulls and the Bears

There are both bullish and bearish forces at work in the silver market right now. The interesting thing is that the bearish forces seem to be at work in the paper (futures) market, and the bullish forces are at work in the physical market.

Let’s sum up some of those forces …

Bearish Forces …

1) Fear of a global slowdown. Silver is an industrial metal as well as a precious metal. And while the global economy was hot, silver demand soared. Last year, industrial demand for silver jumped 7.2% to a record of 455.3 million ounces.

But the global economy is slowing into recession, and that slowdown could last well into next year. The International Monetary Fund forecasts a reduction in global growth to 3% in 2009 from 5% in 2007.

If there is any single force that can send the price of silver lower, an economic slowdown is probably the one.

2) Mine production. Before the global economy started to slump, global silver production was expected to grow by 6.5% in 2008, faster than last year’s increase of between 3.6% and 4.1%.

But that was then. Now, thanks to the slowing global economy, mines are closing. You see, two-thirds of the world’s silver is produced as a byproduct of other metals. For example, Oz Minerals is cutting zinc production at its Golden Grove Mine Australia by 35%. But that mine also produced over 3.1 million ounces of silver in 2007.

So, if the global economy worsens, we’re likely to see silver production go down, and perhaps sharply lower.

3) Selling by big funds. As the global markets careen into the mother of all financial crises, hedge funds have been imploding one after another like overheated Christmas bulbs. And it’s not just hedge funds — whole trading desks have disappeared. This has removed a lot of the paper demand for silver.

And liquidation in silver futures has been a drag on prices. On the bright side, hedge fund liquidation won’t go on forever. Silver will find a new base, and use that to head higher.

Now let’s look at some bullish forces …

Bullish Forces

1) Supply/Demand Squeeze. Did I say there was an increase in silver mine supply? Well, that’s true. But there’s also an increase in demand. Goldfields Mineral Services recently estimated that current world silver bullion stocks of coins and silverware stand at a mere 400 million ounces. That’s down from more than 2 billion ounces in the late 1980s.

2) Investor Demand is accelerating. The iShares Silver Trust has already seen a massive increase of silver accumulation since 2006 — over 220 million ounces. Take a look at this chart …

This and other silver ETFs in London and Zurich have made it easy for investors to move in and out of silver.

3) Silver is cheap compared to gold. The price of gold recently traded at 82 times the price of silver. This is about 36% higher than the ratio over the past eight years, and looking back over history, the ratio is closer to 20 to 1. If we return closer to historical ratio, the price of gold would have to go way down, or silver would have to go way, way up.

Why is the gold-silver ratio out of historical whack? It goes back to silver as an industrial metal: Investors are terrified that a global economic slowdown will dampen demand for silver in batteries, superconductors and other electronic components, so they’ve dumped silver futures overboard.

But that conflicts with silver as a precious metal — the global economic crisis is causing more investors (like me) to buy physical silver as a refuge of safety.

After all, Central Banks around the world are flooding the financial system with trillions of dollars — a money deluge worthy of Noah — to try and douse the four-alarm financial fire that is the credit crisis. Give them their due; they’ve actually blunted the worst of the immediate threat. The problem is this threat is ongoing, and it could get much worse from here. And that makes physical gold AND silver look even better to me.

These two worlds — the paper world and the physical world — are going to collide. While I think the shortage of physical silver coins and bars will ease down the road, I think the most bullish forces in silver are yet to come. I think the physical world will win out over the paper world … and silver could go much higher.

The Best of Both Worlds

Don’t worry about my quest for physical silver; by the time you read this, I’ll have more locked up. As for your own portfolio and investment needs, I think a little physical silver never hurts.

And there’s an investment that combines the best of physical and paper silver — the iShares Silver Trust (SLV). It owns physical silver and issues shares against its treasure hoard. Sure, in this volatile market, it could go lower. But if, like me, you think the price of silver is going higher in the longer term, then the SLV looks cheap right now.

Yours for trading profits,

Sean

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