Many of our clients have asked that we publish more about the silver markets. In the precious metals world, gold tends to get most of the attention. After all, when was the last time you saw a morning silver report on Fox Business? It’s probably been a while, as they don’t have one! It’s no mystery that gold continues to make headlines as it has more than doubled in value in the last couple years. What is a bit puzzling is how little we tend to hear about silver. So we’ll take a couple minutes and lay down some framework for understanding some silver market basics.

First, let’s look to physical demand and performance, and we’ll start with a little about our own physical silver sales to demonstrate the point. Between the years of 2000-2005, silver accounted for less than 5% of our total sales. It’s not that we didn’t stock it and make it available. There just wasn’t all that much interest. This all started to change in the latter part of the last decade. By 2008, serious concerns about the availability of physical silver began to come to light, and demand increased significantly. That trend is still developing, and we have had several months in the last year where silver sales have actually been higher than gold! Needless to say, demand for physical silver has increased dramatically in the last several years.

It’s pretty easy to see why silver has been so popular for individual investors. First off, gold has tacked on more than 225% in gains since the beginning of 2009. While stock and debt markets have stagnated at best, gold has been soaring and attracting attention from investors of every type. Then there is silver, which has gone up by a staggering 387% over the same timeframe! During the best two and a half years on record for gold, silver has actually outperformed its yellow cousin by nearly double.

There is, however, a flip side to the silver coin so to speak. While silver has enjoyed much stronger overall performance, it has also shown even more price instability than gold. Any bull market such as the one currently seen in precious metals is going to have swings. Silver has experienced more severe corrections over the last several years than gold. During the first 4 months of 2011, silver experienced a trading range of more than 83%, selling as low as $26.68 and as high as $48.70. The question then is why does silver behave the way it does when compared to gold, and what can we expect moving forward?

Gold is a relatively simple market to understand. There are only two major forms of demand, and those are jewelry and investment. Each year, production tends to be quite stable, and the relationship between the two demand fundamentals tends to be relatively predictable. Silver on the other hand, is a much more complicated issue. Major demand areas include industrial applications, photography, jewelry, flatware, coins, investment, and producer de-hedging. Of these demand areas, there are wide variances from year to year in how much of the total global demand each area encompasses. For example, in 2007, total industrial applications made up more than 54% of overall silver demand. In 2009, that dropped to only 43%. Though total silver demand has risen steadily over the last decade, the rise can be unpredictable.

The industrial demand portion of global silver usage is also a key factor in understanding how the market works. While a failing global economy can be extremely positive for long term gold prices, it’s much more of a mixed bag for silver. Since gold has almost no industrial demand component, it does not need booming global production demand to sustain higher prices. Silver on the other hand relies on industrial applications for nearly half of annual usage. Thus when the global economy stalls, it can hurt silver demand significantly. In this light one might expect the last three years to have been hard on silver, which is not the case. Don’t forget that just because the west is hurting, doesn’t mean China and India aren’t buying silver at a record pace. One other important consideration is that silver used in industrial applications tends to be destroyed. Unlike gold, which is often recycled and re-used, the hundreds of millions silver ounces used in industry each year are typically gone forever.

On the other hand, silver is also seen as a form of currency in the same way gold is used. This is a key factor for the long term picture. As gold becomes more and more expensive, individual investors are turning to silver in greater numbers as a storage for wealth and a tool for barter. The rising gold price also pulls silver higher, and many experts think silver is undervalued as compared to gold by more than 50%. Historically, silver should be trading near 1/16th the price of gold. That would put this silver price today at $114 per ounce.

If metals experience a meteoric rise during a coming currency crisis, there is one other incredibly strong argument for silver. Very simply, you can’t really use a gold coin for barter purposes if the value of an ounce of gold is upward of $5000. That would be a very expensive loaf of bread. Thus many silver buyers are becoming more interested in silver as a precautionary asset. Don’t forget also that many of the massive naked short positions that held silver prices down over the last decade have come unwound over the last 12 months. All in all, silver has some extremely strong fundamentals for higher prices. Though there may be more swings along the way, the long term picture looks pretty strong.