A number of states are now considering remonetizing both gold and silver (see States seek currencies made of silver and gold and Colorado looking at gold, silver currency). Understand that the Constitution bans states from printing their own paper money or issuing their own currency. But it allows the states to make “gold and silver Coin a Tender in Payment of Debts” (Article 1, Section 10). Given the concern over the U.S. dollar’s stability, the states will likely run with this idea at some point in the not too distant future. Therefore, we should consider adding a third demand curve to the silver price equation.
Presently, the price of silver is driven by the convergence of just two demand curves: industrial and investment. The third, yet future, demand curve is monetary.
- Industrial demand. About 50% of the demand for silver is industrial. This demand has steadily and consistently increased over the years, even in recessionary times, and there is no expectation that it will change. For most manufacturers, the price is inelastic, meaning that a change in price does not affect the demand. This is because silver is used in such small quantities that the manufacturers typically absorb the price fluctuations.
- Investment demand. Investment demand includes paper (i.e. futures and stock) assets as well as real physical metal in the form of coins and bars. Investment demand has followed a more explosive path. For example, up until 2008, demand for American Silver Eagles was rather flat at around 10 million coins a year (e.g. 8.5, 8.9, 8.9, 10.7, and 9.9 million for the years 2003 through 2007, respectively). Then, in 2008, demand doubled to 19.6 million coins and continued to increase each year to the point where Silver Eagles are now selling at four times the number they sold prior to 2008. And this is with a nearly fourfold increase in the price of silver. Yet another inelastic price curve. This explosive demand for silver has also occurred in other countries around the world.
- Monetary demand. Although silver is today no longer used as money anywhere in the world, its history as a monetary metal is well established. In fact, it is even better than that of gold. In the words of Milton Friedman, “The major monetary metal in history is silver, not gold” (Nobel Laureate Milton Friedman in an interview with James Blanchard at the New Orleans Investment Conference. November 7, 1993). The reemergence of silver as legal tender will come soon enough given the interest shown by the various states in this country.
The remonetization of silver in the United States will be incredibly bullish. To get some perspective on the supply/demand dynamics: If every American (that’s 350 million) were to purchase just two silver coins (or about seventy-dollars worth), the ENTIRE year’s supply of mined silver all over the world (i.e. 750 million ounces) would vanish. That’s if all the mined silver were turned into coins. But that’s impossible, since half of it is used in industry and another big chunk is used in jewelry. So monetary demand would have to go after the above ground silver inventory of approximately 2 billion ounces.
But it gets better. If the United States monetizes silver, then other nations will likely follow. We know it is already being entertained in Mexico, for example (see Mexico Mulls Silver Lining Against Currency Crash). Once the nations of the world get on board, then the above ground inventory of 2 billion ounces itself would go poof!
A major reappraisal of silver would then follow.
In order to come up with shorter-term price projections, I used StockCharts‘ free charting services to produce the following 5-year silver, spot, weekly chart.
Given the trend line convergence (around the red oval) near $32 on September, 2012, and the Fibonacci Time Zones for May, 2012 and June, 2013, I suggest the following optimistic view:
- Major price resolution by September, 2012. The contracting symmetrical triangle forming since September, 2010 (on the breakout over $20) will continue and resolve on (or shortly before) September, 2012.
- Resolution will be to the upside. The resolution will be to the upside, with a resumption of the long-term uptrend (above the blue line since 2009 and above the orange line since 2002).
- A steep climb into June, 2013. The uptrend will follow the green arrow to the price objective of $52, and any pullbacks will not break below the ascending blue trend line through June, 2013.
- Shorter-term, meaningful pullback between May and September of 2012. Shorter term, I’m looking for a May, 2012 high around $36-$37 (at Fibonacci Time Zone 34) followed by a meaningful pullback to the $31-$32 area by September, 2012. This sets the stage for the steep climb into June, 2013 described previously.
The pessimistic view suggests a breakdown below both the orange and blue trend lines on or shortly after May, 2012, then a bounce that approaches the September, 2012 convergence area, followed by further weakness in the ensuing months.
I availed myself of netdania‘s convenient (and free) charting services to produce the 10-year silver spot, monthly chart shown below. It is scaled logarithmically in order to equalize percentage changes in price—i.e. a 100% move of $1 to $2 displays on the same scale as a move from $5 to $10.
Consider the peaks in 2002, 2004, 2006, 2008, and 2011 (referenced by the yellow arrows). Notice that for the first 6 years from 2002 to 2008, silver was producing price cycles every 2 years. Also, notice that from the trough (bottom) to the peak in each cycle the difference was generally a double. That is, from the 2003 trough of $4-ish to the peak in 2004 of $8-ish it’s a double, then from the 2005 trough of $7-ish to the peak in 2006 of $14-ish it’s another double, finally from the 2006-2007 trough of $10-ish to the peak in 2008 of $20-ish it’s once again a double.
Had this pattern continued in the 2008 through 2010 period, we would have gotten a peak at around $34-$36 from a $17 to $18-ish trough for another double. However, the 2008 financial crisis came and cost silver a lot of upward momentum. It took all of 2009 and 2010 to regain it and then produce another peak in 2011. By then, a year late in arrival, the peak was higher at $48-ish.
Given these observations, what can we project going forward? I will suggest two possible scenarios.
- Optimistic. If the low of $26-ish in December of 2011 is not exceeded, silver produces a pattern similar to 2008-2011, where a double from $26-ish to the $52 level is achieved in late 2012 or early 2013, then a pullback no worse than $42 (i.e. a 38% Fibonacci retracement), and finally a sustained run begins in late 2013 resulting in another peak in early 2014 at around $84 (i.e. a double from $42) to match the peak trend going all the way back to 2002 (i.e. the trend line hitting the peaks in 2002, 2004, 2006, 2008, and 2011 as shown in the above chart).
- Pessimistic. A Lehman-style financial crisis occurs this year which crashes silver below $20 and it takes a full year to recover the momentum back to the mid-$30s. A run over $50 would not occur until the first half of 2014, if at all. In technical terms, this view suggests a broken major trend and a reversion to a longer term mean beyond the last 10 years.
The $50 price level has huge technical significance, since it was the all-time high in 1980 and it became resistance in 2011, followed by major pullbacks on both occasions. The next time we get there, the $50 price level will offer a lot less resistance and the pullback will not be as extreme. If it occurs in early 2013, then we’ll see a spike over $50 to the $52-ish target price and then trade below $50 for several months before resuming the climb. But, if it happens in late 2013 or early 2014, then the run over $50 will be explosive, similar to what occurred in late 2010 to early 2011.