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September 26, 2009

One Unique Silver Fundamental
by Silver Analyst

I am looking for the USP of silver, it's Unique Selling Proposition. Does it exist and do we even need one?

In silver, you have the technicals and you have the fundamentals. Admittedly, during my lengthening experience with silver I have paid more attention to the technical analysis of the element rather than the fundamental analysis. However, over the years I have read various articles on why certain events are bullish for silver and lo and behold silver has risen by almost five fold in that time. But has silver risen since 2003 because of certain given silver fundamentals?

For me, the truth of the matter is that no uniquely silver fundamental has driven silver from $4.50 to $21.30. In fact, I would venture to suggest that nothing you ever read about silver's natural or economic properties is the main reason for driving silver higher and higher. We shall look for that unique silver fundamental but what about the fundamentals of this decade?

There is one main fundamental that has driven silver higher but it has nothing uniquely to do with silver and it is the US Dollar. Back in 1999 the dollar was riding high on low inflation, economic growth and a general optimism about the future. That was about as good as it got for the dollar and then the fundamental event that proved decisive for the dollar happened and that was 9/11.

The dollar was overbought anyway by that time but when the Twin Towers fell the USA entered into war and war as we know is inflationary. Dollar holders and traders increasingly began to see what Iraq and Afghanistan added up to and that was increasing budget deficits and national debt. As a result, investment flowed out of and past the dollar to other major currencies, precious metals and commodities as hedges against a possible dollar collapse.

Silver benefitted but so did gold, platinum, palladium, the Euro, Pound and oil and so on. Good for silver but not a silver bull market based on pure silver fundamentals. Nevertheless, silver enjoyed the "benefits" of a dropping dollar and readers have no doubt profited from that to varying degrees. However, in terms of riding this bull, technicals have proven almost as important as fundamentals.

It was back at the beginning of that bull that I bought my first silver bars but it was also when I wrote my first silver article entitled "The End of the Silver Bear Market". The date was 13th March 2003 and silver was at a bargain $4.54. My conclusion at the end of the article proved to be true:

"My only reservation with that is that this is not the lowest price of the 22-year bear market. However, if this interpretation is true, then a move beyond $5.00 will be a confirmation and you should waste no time getting on board. So, good luck and good investing in this watershed year for silver!"

Four months later silver closed above $5 and another nine months after that silver was spiking to $8.50. The bull market was underway but I was not concerned about any silver USP at that point.

Fast forward five years to March 31st 2008 and I was issuing a warning to subscribers that I was exiting all my stock positions as I believed silver was about to undergo a major period of correction (I remained out the rest of that year). The US dollar fundamental kicked in and the USD was about to rally and that meant silver was going down. If I had kept my silver mining stock positions I would have taken an 80% haircut. Remember half the battle of investing is to preserve as well as grow capital.

Finding the bottom to silver in the ensuing credit crunch was a trickier matter. Standard technical analysis at first suggested around the 200 day moving average at $15 but this was no standard correction and silver sliced through that line (though the 200 day line had proven more reliable in the past and does so today). You may be familiar with the "Catch a falling knife" phrase but after some analysis I suggested in my newsletter that silver would either bottom at $6.60 or $8.15. It hit a bottom at $8.47 a few weeks later in October.

While I am on the technicals of price projection, it is a theoretical possibility these prices may be hit again but I am more inclined towards a price of $13.20 (I will explain this in my newsletter). So watch out for that price in the months ahead! Coincidentally, silver is now about $2.50 above the 200 day moving average ($13.50) and this chimes nicely with the $13.20 price.

But if we go back to that silver USP - what would one class as a unique fundamental? Let me give some real life examples of a commodity with unique fundamentals. The palladium bull of the late 1990s was unique to palladium due to constrictions in the Russian stockpile supply. As a result palladium dectupled in price in three years. Another is uranium and its nuclear fuel properties which have seen it rocket in price this decade.

But what unique properties does silver have? Naturally silver is the best conductor, reflector and biocide. You could almost class these as unique by degree but I do not think any of these are big enough to drive a real bull market.

What about silver's almost unique monetary property? Now I believe silver is money. Whether the market believes that and has driven silver based on that proposition is another matter. In fact, it is pretty hard to tell whether silver has been bought in recent years primarily as a "hard asset" or as "money". Both these modes are perceived as stores of value but an asset can be bought as a store of value without it being perceived as money. Platinum and palladium were bought as hard assets but not as money. Gold I am sure was bought mainly as money but I am not sure what the mix was for silver - money or hard asset? I think the jury is out on that one.

One other possible USP is silver's leverage over gold. Silver often leverages gold but this is not a unique feature of silver. Over the 2001-2008 gold bull, silver leveraged gold by 1.5 to 1 but platinum did 1.66 to 1 (palladium did only 1.1 but was still suffering from its late 1990s bull bubble).

So where is that unique fundamental we seek in silver? Perhaps we don't need one, just ride the bull and make your profits! But there is one silver property that may be classed as unique and that is a geological property. To whit, there were various comments and articles going about on the Internet that silver would be the first geological resource to be "exhausted".

Now at The Silver Analyst we don't swallow every bullish argument for silver unquestioningly. In fact, we take a "Berean" attitude to these things. To be precise, one of our previous newsletters addressed the statement that silver would "run out" in 13 years. What we found out was that the United States Geological Survey (USGS) was stating a global economically mineable reserves base of 270,000 tonnes for silver and a 2007 global production of 20,500 tonnes. Divide these two and you get the RP ratio of 13.17 years.

Done deal then - silver will be gone by 2020 and silver holders will all become millionaires? Not quite as we "dug deeper". The astonishing fact was that on examining previous USGS publications since 1993, they were all saying the same thing. Global silver resources since 1994 were stated at either 270,000 or 280,000 tonnes! In other words, it appears that the USGS are not proactive in updating their numbers and can we place any trust in them? One thing we can do is to calculate said RP ratio for the various USGS reports from 1993-2007 and you get the graph below.

Note that the silver "lifetime" has been dropping since 1993. If we project this line towards the zero base line then the RP hits it at about 2023 or 2040. Now you have to realize that silver won't just keep producing 20,000 tonnes per annum until 2023-2040 when suddenly it drops to zero tonnes. Something will happen before then and silver output will begin to diminish. I can't say when that will be and since silver is a byproduct metal this confuses the picture even more. All we can say is that within our lifetimes silver production may irreversibly decline first in a "Peak Silver" event.

Is this our silver USP? If that happens then it won't matter what the dollar or gold is doing, it will be the equivalent or greater of palladium in the 1990s. But there are objections to this USP proposition.

Firstly, won't the price of silver just go up to make uneconomical silver deposits accessible? Yes it will and that is what we are depending on as silver investors! An increased price will bring more silver out of the mines but it won't change the thesis that silver will begin to deplete first and only delay the inevitable when silver will become so depleted it will come under government control.

Secondly, won't other metals experience this kind of event in a "Peak Everything" scenario? Not quite, using the USGS reports for gold we get an RP of 20 years, 175 years for Platinum Group Metals, 43 years for nickel, 35 years for copper and 20 years for lead. Also note that some of these metals have higher recycling efficiency than silver which pushes their "day" out further.

Thirdly, can we even trust these USGS numbers? Perhaps we can't, it may even be possible that the USGS is overstating reserves. But I read an excellent article by Bryant Blake which looked at the reserve base of the 20 largest undeveloped silver mines. Based on their numbers, the total reserve base of these mines was 2.52 billion ounces or 78,473 tonnes. He further projected that these mines would only hold back a problem for silver production until the next decade which would accelerate into the 2020s.

I also found another good site (www.goldminerpulse.com) which lists the reserves of the top TSX listed silver companies at about 6.8 billion ounces or 212,000 tonnes. But note that this total includes uneconomical resource base as well as the mineable reserve base. Once we factor in other non-Canadian listed companies such as mighty Fresnillo we get closer to that USGS number of 270,000 tonnes but it doesn't look like an agreement yet to me - further study is required.

World production of silver isn't going to drop yet but we await the day when the USGS will begin to drop that reserves number. When that happens, the world will perhaps begin to believe in silver's Unique Selling Proposition.

Further analysis of silver can be had by going to our silver blog at http://silveranalyst.blogspot.com where readers can obtain a free issue of The Silver Analyst and learn about subscription details. Comments and questions are also invited via email to silveranalysis@yahoo.co.uk.

Silver Analyst
http://silveranalyst.blogspot.com

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