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Published 9/17/05.
For all those readers who have slept through the last week, the Optimist
is excited to tell you that the price of gold has surged to $460, its highest
price in almost two decades. Speaking of sleeping, however, the price of
silver has been disappointingly dull compared to gold. Although everyone
knows that silver will more than double from its current price of $7.20, and
will eventually multiply by a factor with one or more zeros (i.e., 10, or
100, or 1,000, etc.), the key question everyone asks is when the explosion
will happen. It seems like most silver investors keep their bags packed for
the rocket trip, but they want to wait to purchase the ticket until just
before ignition and liftoff. The Optimist admits, of course, that his guesses
about a date are no better than those of the readers, but he hopes to provide
perspective for recognizing the ignition process so we can all enjoy the
liftoff which will soon follow.
When there is a shortage of real physical silver
The Optimist must confess that he thought the rocket was ignited 18 months
ago, and he briefly enjoyed illusions about what would be done with all the
profits from the silver explosion. That sweet dream was rudely terminated by
the subsequent market action, and the Optimist is now as cautious as everyone
else about shouting that there are visible flames at the base of the silver
rocket. In retrospect, it is now easy to see that throughout the rapid price
increase in April 2004 there was adequate physical silver for continued
manufacturing and for investment accumulation. That availability of real
physical silver enabled the banks and the Comex paper printers to flood the
market with paper silver and to drive the price lower. Note that the paper
silver didn't actually create any real physical silver. It only saturated the
investment demand for people who prefer to bet on the direction of silver
prices than to hold physical silver in their possession. The key concept is
that the paper silver operation would not have had any chance to drive the
price of silver lower if there was not enough real physical silver available
for consumption by manufacturers and for accumulation by some investors. The
answer to when the price of silver will explode is when there are problems
with industry and investors getting all the real physical silver that they
need or want. No amount of pretend paper silver will make a real physical
shortage go away.
So, when is that, exactly?
The next question readers will impatiently pose is exactly when will there
be an unsatisfied physical silver demand. Readers will not be surprised with
hearing yet another deficient answer. It isn't just that the Optimist doesn't
know the date. If anyone did know the date when demand for real physical
silver will overwhelm supply, they would be very unlikely to write about it
on the Internet. They would instead be much too busy raising all the cash
possible so they could purchase a maximum amount of real physical silver
before that explosive date. The Optimist hopes, however, that he can provide
a window on one of the key market dynamics that may help us to see when the
ignition process is underway. Before opening that window, a little more
background will be helpful.
The key is made of base metals
Readers are, no doubt, familiar with the ongoing silver supply-demand
deficit, and with the portion of mining production that derives from base
metals like copper, lead, and zinc. Approximately 60% of the amount of silver
mined is a byproduct from these base metals. During times when more base
metals are mined, the amount of byproduct silver which is dumped on the
market as additional physical supply is proportionately increased. As one
might guess from looking at a chart of energy prices, the world economy has
been intensely hungry for energy, and for base metals. The rising prices of
base metals over the past three years testify to the increasing worldwide
demand for more base metals. It should be no surprise to any reader that
rising prices of base metals cause mining companies to ramp up production to
keep up with the demand (and to multiply their profits in the process).
Consider the three charts (from InfoMine.Com) of lead, zinc and copper below,
and you can be sure that base metal production has increased substantially in
response to rapidly rising prices.
Silver shortage delayed
The increased production of base metals in response to rising prices
resulted in significantly greater production of byproduct silver. Base metal
miners don't care about managing the impact on the silver market, so they
just dump that excess silver production into the market. The increased amount
of byproduct silver meant that there was little risk of running out of real
physical silver over the last three years, so the banks and the Comex
creators of paper silver shorts could proceed without concern about being
tripped up by the physical market. By comparing the three charts above to the
comparable chart of silver below, it is easy to see that the rapidly rising
base metals prices have had a constrictive impact on the price of silver.
It looks like the sharp increases of zinc and copper prices from May to
September have contributed to the recent silver price doldrums even as gold
has thrust into new highs for this move.
Introducing the MoreCu Index
Another way to view the relationship between silver and base metal prices
is through a ratio. Everyone is familiar with the gold to silver ratio, even
if silver bulls continue to be depressed by the faster price escalation of
gold. Since silver is frequently thought of as more of an industrial metal
rather than as a precious metal, another useful ratio is the price of silver
divided by the price of copper. The Optimist calls this the MoreCu Index,
because it shows more about the impact of copper and base metals on the price
of silver. The rational for viewing this index as significant is that when
base metal prices are rising rapidly due to industrial demand for base
metals, then the additional byproduct silver produced will cause the price of
silver to fall in relation to the base metals. If the price rises were due
primarily to inflation, then one would expect the inflationary effects to be
comparable to both base metals and to silver, so the ratio would be
relatively little changed. Let's take a look at the Optimist's chart of the
MoreCu Index:
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