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Silver’s Liquidity Risk

By: Dr. Jeffrey Lewis

-- Posted 6 September, 2011 | | Discuss This Article - Comments:

It’s unlikely that any silver stockpile will go without a buyer.  As more and more investors place a portion of their tangible assets in gold and silver, the market for metal grows.  However, just like in high finance or even in personal finance equations, liquidity risk is a concern that investors should have on the mind.


In terms of finance, liquidity risk is the risk that over-leveraging may create a default on debt service.  A company may borrow capital to invest in the business and essentially lend money by offering 30-day payment terms to customers.  Should the company keep a high level of leverage while maintaining few current assets (cash and accounts receivables) the company runs liquidity risk.


Liquidity Risk in Silver


There are obviously many people who buy silver.  However, there are also many people who buy $100,000 luxury cars.  The real question is how many people buy silver or $100,000 luxury cars.  Even those we consider poor could come up with $1 to buy a luxury automobile.   Pawn shops will buy any quantity of silver at $1 per ounce. 


But how close can investors get to spot?


On the retail level, bullion dealers represent a source of liquidity.  A dealer often pays a few points under spot to purchase silver ounces before marking them up above spot to create a profitable spread.  Liquidity providers like bullion dealers do help ensure a viable market exists for your silver, but to what end is this dealer your friend?


Premiums and Purity


At the .999 fine thresholds, silver buyers are predominately bullion dealers, who buy and sell investment grade silver.  Sure, recyclers and refiners will purchase .999 silver, but few offer a spread that competes with an investment-grade dealer.  Silver .999 pure simply isn’t in the part of the market a refiner wants to service.


At 90% pure—“junk” US coins being an example—prices begin to reach equilibrium.  Investment-grade dealers offer significantly lower bids on 90% grade silver than they do for .999 silver, as it may take weeks or months to sell.  Additionally, if the dealer needs liquidity of his or her own, he or she will have to sell the silver quickly.  On the other hand, a refiner sees 90% silver as the best possible silver for his or her market.  Top-quality .999 silver doesn’t need refining; 90% silver needs only a little work.


Portfolio Purity


In thinking how to best structure a bullion portfolio, it would make sense to accumulate assets with a total weighted purity level.  For example, a portfolio of 90 ounces pure silver and 10 ounces 90% silver is essentially .99 pure.  Should hard times come, the 90 ounces of nearly-pure silver are liquidated with ease at prices close to spot. The cost of liquidity, in this case, is fairly inexpensive, as there are ample buyers for .999 pure silver.  If the same buyer were to have accumulated junk silver at a discount, he or she would still stand to lose as the market for junk silver simply isn’t as liquid.


Investors should mind the liquidity risk in their portfolio, opting for .999 pure when possible, while chasing some junk silver for a value investment.


Dr. Jeffrey Lewis

-- Posted 6 September, 2011 | | Discuss This Article - Comments:

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