Silver shortage in the forseeable future.

Previously, I mentioned that there is no more than 800 million ounces of investment grade, above ground silver. For perspective 800 million ounces is only 8% of the 10 billion ounces once held in world stockpiles and less than a years worth of demand. Further I have shown that current supply deficit is made up with government sales supplementing mine production and recycling to meet world silver demand. The question is how much long will the remaining 800 million ounces last?

Before we can estimate how long 800 million ounces will last we need to find the location and availability of this silver.

Locating all the worlds silver is impossible, there are numerous private hoards hidden in attics and safety deposit boxes, various investment bankers and bullion traders have supply, a few governments such as China likely have some silver left but China does not publish this kind of information. A quick scan of the web allowed me to identify approximately 42% of estimated 800 million ounces.

104 million ounces Barclay’s silver ETF
105 million ounces NYMEX (New York Mercantile exchange)
33 million ounces Central fund of Canada
96 million ounces - estimated remaining government stockpiles
338 million ounces total or 42.25%

The silver in the Barclay’s and Central fund of Canada is effectively off the market backing these investment vehicles for a reduction from 800 million, to 663 million ounces of silver available to industry and physical investment. That’s not to say that the principals of the ETF would not pull silver out of the fund if it suited their interests but for the time being and at this price and supply level there is no need.

NYMEX silver is available to the market but under conditions limiting the physical delivery per trader to 1.5 million ounces per month. This is in an effort to stop one big buyer from sweeping up all the silver in one fell swoop. Considering the small size of the silver market at this time and the low 1 billion dollar value of all remaining silver this is a real risk. There is also the fact that you can’t go up to NYMEX and buy 100 oz for your personal hoarding. NYMEX stocks are in nominal 1000 oz bars traded on future contracts of 5000 ounces. There is no way for a small investor to cash and carry from NYMEX; this is the playground of the industrials and big money.

So if 663 million ounces remain for purchase how long will this supply last?

First we have to assume the trend of deficits continue for the immediate future. A continued deficit is an easy assumption to make considering that projected demand is growing faster than projected supply at least for the next couple of years. The level of deficit is difficult to pin down as several methods seem to be used to calculate it. A leading silver miner Pan American states the 2005 silver deficit as being 35.5 million ounces by leaving out investment buying, while others estimate a 80-100 million ounce shortfall. Ted Butler of Investment rarities, who is the most prolific of the silver commentators, believes there is a 50 million ounce deficit which seems a reasonable number to accept that also fall in the average of other estimates.

On a simple calculation 663 million ounces divided by 50 million per year should give us a 13 year supply but this is very misleading. The Barclay’s silver ETF has applied to enlarge the fund by another 152 million ounces. If this amount was ever filled it would represent 35% of today’s silver. While I’m pretty certain they will not be able to source this much silver in a short period of time without driving the price to the brink, some silver will certainly be bought and this new demand will remove million of ounces from the market place. This new demand will keep prices rising slowly and attracting attention to the silver market and silver fundamentals.

Also it’s quite likely that depleted government holdings will end the practice of government selling into the market. The average government sales for the last 10 years have been 55 million ounces per year. The removal of this supply will double the rate of depletion and shorten the timeline by half.

Technologies are being announced everyday that will strengthen silver demand, silver/zinc matrix batteries, anti bacterial/fungal fabrics using silver, silver embedded plastic storage containers for fresher food. Asian growth in demand for cell phones, washing machines, computers all add demand for silver. In India a trend towards substitution of silver jewellery for gold allows women to have more pieces and more variety for the same investment dollar. Indians are also turning towards bullion rather than jewellery as an investment. Bullion’s much lower price premium over jewellery allows the purchase of more gold or silver for the same expenditure, increasing demand.

The devaluation of fiat currencies vs. the value of bullion gold or silver is very evident over the last 5 years. Despite being considered an industrial metal, silver still retains some of the spill over from its monetary history and is still considered the poor man’s gold. This monetary connection is obvious upon seeing the increasing investment demand in both bullion and coinage. Add to this the movement to remonetize silver though the use of the Mexican Libertad and it’s obvious that demand for a safe haven from paper money is growing.

The biggest factor that will bring shortages and huge profits for the enlightened is fear and panic. Industries that require silver to operate their day to day operations cannot and will not let themselves be cut off from their supply. When the fear of shortages makes its way to industries, panic will set in and purchasing and hording will take place. In the modern just in time delivery system companies may only buy a week or a month’s supply of silver at one time, however with the chance of shortages companies will step up their purchases and could try to purchase their whole years supply while they can. The first ones in will get the best price and bid up the value of the remaining silver and shrink the supply. Other industries will see the price hike and supply drop and a new wave of panic will take place, this panic could quickly gobble up all physical supplies. Even a shift from an average of 1 month supply to a 2 month supply would take 70 million ounces off the market and be well on the way to cleaning NYMEX out.

Rather than the possible 13 years a simple division of the supply vs. the deficit would give us, I believe a 4 year or less timeline is more appropriate. With or without the second filing by Barclay’s, the silver ETF will reach 130 million ounces by early 2007 pulling 26 million more ounces off the market. I believe that the amount of silver diverted to investments will increase significantly this year as will the coinage allotment; this trend will continue increasing the yearly deficit speeding the future shortage.

This shortage will happen it’s just a matter of when. The two factors that could start a run on silver and shortages early are risk tolerance by silver users and fiscal instability. The tolerance of companies to the risk of material shortage cannot be known, each company will decide at some point that it fears for its own production and will step up its buying schedule. Companies might come in dribs and drabs to the market buying extra stocks of silver, or they might see others moving and stampede the market in a very short time. Financial instability could also start a run on silver, and gold too for that matter. The U.S. dollar is in a very precarious situation having lost a great deal of it’s value in the last few years, should Asian creditors pull the plug on new credit or begin selling off U.S. debt the dollar will fall and a great deal of money will run to hide in bullion in an attempt to maintain its value. Eventually all fiat money has failed but bullion throughout history has never been worthless.

With electronic trading and the big money available in the market, very little silver will be available for the small investor if this kind of shortage develops quickly. If you don’t have it before panic sets in you won’t ever have it. Don’t mortgage your house or sell your car or do anything else rash, rather consider diverting $1500 from your RRSP this year, forgo buying a bond or taking that cruise and buy 100 ounces for a start. I truly believe that a 500-700 percent profit is not only possible but probable. Even if it takes 5 years, where else are you going to get 100% per year growth?