Silver is used for everything from industrial purposes to decoration to photography to medicine. Its unique combination of strength, malleability and conductivity makes it a major force in the commodity market. Along with its more well-known brother gold, investors should know what affects the price of silver, what types of investments can be made and the methods in which it is traded before making any investment decisions.
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Silver is a unique commodity in that it is widely used for both industrial and investment purposes. Gold's price is primarily driven by investment demand, with only about 11% driven by industrial use. Silver's industrial demand consists of over half of the total demand. According to The Silver Institute in April 2011, silver's world industrial use is forecasted to increase about 36% between 2011 and 2015, from 487.4 million ounces (ozs.) to 665.9 million ozs. From this 2011 demand, silver's industrial use comprised about 50% of the usage, with jewelry and physical silver demand consisting of about 31%. The remaining demand is divided between photography and silverware.
This growth in silver's industrial use in 2007-2010 is quite remarkable considering that in 1990 industrial demand only comprised of 39% of its use. As of 2010, the majority of worldwide demand for silver comes from the industrialized world, with the United States, Europe and Japan accounting for over half of that demand. However, developing countries, like India and especially China, have increased their demand for silver and this trend is expected to continue as their economies grow.
As a result of industrial demand making up over half of silver's use, a recession or weakening of industrial demand would have an impact upon silver prices. The economic outlook of the world economy drives a lot of the silver price speculation. During 2007-2010, emerging markets such as India and China played a larger role with their appetite for silver. This demand is likely to increase further as the list of the core uses for silver increases in electronics, the automobile industry and the solar industry. Looking at its elasticity, silver demand is largely price inelastic in the short term as its substitution for other metals is limited.
Silver is produced all over the world, with over half of worldwide production coming from five countries: Mexico, Peru, China, Australia and Chile. The world's largest silver mine is based out of Australia, and as of 2010 this mine produced 38.6 million ounces of silver per year; the mine is owned by BHP Billiton.
Bars or bullion can be bought typically in 10 oz. bars, 1 kilogram bars, 100 troy ounce bars and 1,000 oz. bars. A disadvantage is that they must be stored physically and yield no interest to the investor.
Buying silver coins is another popular method of physically owning silver. However, they usually sell for a premium over bullion bar prices, and like silver bars they do not yield interest.
Certificates allow investors to buy and sell silver without actually physically owning it, making certificates more convenient.
Futures/Forward and Options Contracts
In the U.S., silver futures are traded on the commodity exchange, which is a part of the New York Mercantile Exchange. Investors and/or companies can use the contracts to hedge, invest or speculate on the price of silver.
Exchange-Traded Funds (ETFs)
Silver ETFs are another method investors can gain exposure to silver. These can directly hold silver or invest in derivatives that track the price of silver.
Mutual funds can be a great way to gain diversification among silver mining companies. However, they may require a larger investment than small silver purchases.
Silver Miner Stocks
Investing in silver miners requires knowledge of the equity markets. However, these companies do offer leverage to silver prices and may pay a dividend as well.
Importance of the Gold/Silver Ratio
Compared to gold, silver is very volatile. This is due to silver having a smaller overall market and the fluctuations between industrial and investment demand for silver. As an example, from 2007 to 2012, silver went from about $14 an oz. to almost $50 an oz., and settled at close to $35 an oz. as of February 2012. With this volatility, one of the most watched indicators by traders and investors is the gold/silver ratio. This ratio has varied widely across time, ranging from 12.5 in Roman times to over 100 in the early '90s. The average is a topic of controversy depending on the time period that is looked at, but over the past 35 years it has averaged about 55 ozs. of silver per oz. of gold. The lower the ratio the more expensive silver is compared to gold, and vice versa. As we can see in the chart below, the gold/silver ratio can widely differ from year to year.
There are a few key drivers that will fuel silver demand moving forward. This includes gross domestic product (GDP), solar demand and government regulation that may affect the solar industry.
As GDP growth recovers from the depths of the 2008 credit crisis, silver demand should increase as well. This will be from the rise of consumer electronics, consumer goods and an increased use in the automobile and solar industries. It is important to note that as the price of oil increases, the use of solar power as an alternative energy source is expected to go up and so will the demand. Also, carbon legislation may force the price of power higher, leveling the field for solar energy. However, use of other renewable energy may limit the solar industry's rise to fame, which as of 2011 produces one-fifth of the world's renewable energy. Emerging economies are expected to increase their silver demand, outpacing industrialized nations.
The Bottom Line
When investing in any commodity, investors should do their due diligence before committing any capital. Silver has been used throughout history as a symbol of wealth, and has now found its way into industrial production. This trend is likely to continue as silver finds its way into more and more industries, including solar. For investors, there are a number of different ways to gain exposure, from owning silver physically, to investing in the stock of silver miners. Whichever method an investor chooses, they should be sure to keep an eye on the gold/silver ratio, and be advised, it is a wild ride.