Hi ho silver

Subject: Hi ho silver Wed Mar 09, 2011 6:34 am

Hi ho silver

Mar 8th 2011, 11:18 by Buttonwood
SILVER reached its highest price since 1980 yesterday at $36.70 a troy ounce while gold managed a new (nominal) record of $1444.40. But the junior of the precious metals has been on a tear over the past year, easily outpacing gold (see chart).
Remarkably silver has even in backwardation - spot prices have been higher than future prices. Traditionally* the precious metals have showed the opposite pattern, with futures prices higher than spot. Hi ho silver 20110312_WOC313

There has been higher demand for silver coins at the US Mint (sales of American Eagle coins were 6.4 million in January, compared with 34.7 million in the whole of last year). Some blogs suggest the coins are not on sale because the Treasury has run out but Michael White of the Mint e-mailed me to say that
<BLOCKQUOTE>
We are still producing American Eagle Silver Bullion Coins. The traffic you are seeing is based on language that was on our web site all last year, when we did not produce American Eagle Silver Uncirculated Coins, a numismatic product. It is being updated.</BLOCKQUOTE>
For small private investors, the low nominal price of silver may have a penny stock effect, making it seem as if they get more for their money. By contrast, a Krugerrand, containing one ounce of gold, retails at around $1500, which could be a bit daunting.
What is the right ratio of gold to silver? Oddly enough, the gold standard resulted from a mistake by Sir Isaac Newton who, as head of the Royal Mint, sent the gold silver ratio at 15.5/1. By undervaluing silver (previously, the ratio was 12/1), silver coins dropped out of circulation. Britain's subsequent economic success made other countries follow its gold-based example, despite efforts by some (including the US) to flirt with bimetallism.
According to Deutsche Bank, silver is around 18.75 times more abundant in the earth's crust than gold; that suggests the current 40/1 price ratio is too high. But the comparison is complicated because silver has more industrial uses than gold; industrial demand is thus likely to have an impact on the price. Traditionally, photography was a big user of silver for prints, but digital cameras mean that demand has slipped from 146 million ounces in 2006 to an expected 65 million ounces this year. Luckily for silver bulls, this decline is now being offset by increased use of silver for solar energy and, in some cases, as a replacement for lithium batteries in laptops.
I can quite understand why investors are attracted to precious metals when none of the leading paper currencies look that appealing - the US because of QE, the euro because of the sovereign debt crisis, the yen because of a very high debt-to-GDP ratio. All three of them lack a decent yield. Would you rather own a zero-yielding asset where they can create lots more of it or a zero-yielding asset where the supply is limited?
Nevertheless, experience suggests caution when an asset price is up 80% over the last 12 months, as has been the case with silver. Suki Cooper of Barclays Capital points out that silver mine production has been at a record high for several years in succession and the recent surge in price is all down to investment demand. Those new investors could exit as easily as they entered.
It is also tricky to value a precious metal; Jim Grant has suggested that the value is simply the inverse of confidence in paper currency but that is not much use as a guideline. There is the "real high" argument which adjusts the $850 gold peak in 1980 for inflation to come up with $2500 an ounce. But that 1980 peak was very short-lived.
Clearly the precious metals bulls are anticipating very high inflation but it remains very low in the developed world (despite QE). Most economists would argue (see Free Exchange) that inflation isn't much of a threat because of the amount of spare capacity in the economy, the aftermath of the debt crisis, the impact of fiscal austerity and so on. Certainly, in Britain, higher oil prices seem just like a demand-reducing tax hike (wages are up just under 2%, headline inflation is 5% and we are losing real spending power).
My lingering doubts on this score reflect what might be called the question of "real inflation". David Ranson of Wainwright Economics points out that commodities such as gold and wheat are the best way of comparing prices across the ages since they have, in essence, remained unchanged. Services vary enormously; to take a small example, once people could post letters and have them arrive in London on the same day. Quite recently, the post arrived before I left for work; now I have to sort it out in the evening. Is that a fall in service standards or should we really be measuring communication costs, in which case e-mails are free and instantaneous? My computer is much more powerful than its 1980s equivalent but I spend most of the time using it to type stories (badly); have I really benefited from so-called hedonic improvements or am I just paying for capacity I won't use?
It would be nice if there were some other unchanged good to use as a comparison. Paul Tustain of BullionVault reckons that the guideline is a price of a good suit which is now around $850, suggesting a hefty overvaluation for gold. But textiles is an industry where costs have been really driven down by globalisation. What about a haircut? The price of a restaurant meal? Any suggestions welcome, particualrly if they can be plotted in a chart against the gold price.
* Keynes argued that backwardation might be a normal occurrence for commodities since producers have more incentive than consumers to hedge. Commodity investors could thus earn a premium, known as the roll yield, by buying the future and waiting until the price increased to meet the spot; this yield was the return for providing liquidity to the market. But gold has always been an investment metal with plenty of people happy to buy in the futures market so gold trades on contango.
http://www.economist.com/blogs/buttonwood/2011/03/commodities

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