Physical Silver Shortages Growing, Premiums Rising

In my Numismaster column (http://www.numismaster.com/ta/numis/Article.jsp?ad=article&ArticleId=24149) earlier this week, I discussed some facts about what led to the sudden sharp drop in gold and silver prices, then speculated on some possible events that might be occurring behind the scenes.  I concluded that the drop in prices represented a bargain buying opportunity instead of being an indication that the gold and silver markets were past their peak.

The last sentence of the column noted that delivery times on physical silver were backing up.  In the two days since, there has been a significant slowdown in deliveries.  Further, premiums are on the rise.  The reason for these trends is that virtually everyone is a buyer of physical silver and not a seller at this week’s lower prices.  Not only are people buying, but they are buying right away rather than taking time to “think about it.”

The product experiencing the longest delay right now is Johnson Matthey 100 Ounce silver bars.  Buyers will have to wait for new product to be fabricated.  The end of the line, as I type this in the early afternoon on September 29, is about 7 weeks delay.  By the time this is published, the delay will almost certainly be longer.

For most sizes of silver ingots, US American Silver Eagles, and Canadian Silver Maple Leafs, you can still receive delivery within two weeks from the time you pay for it.  But, I expect these delivery times to quickly extend further into the future.  Even if you can still purchase ingots at the same dollars and cents premium above spot price than two weeks ago, the lower silver spot price means that the percentage premium has risen.  A $1.00 per ounce premium at $40.00 spot is only 2.5% whereas it would be a 3.3% premium at $30.00 silver spot.

US 90% Silver Coin, a physical silver product that has not been in production since 1964, is no longer available on the wholesale market at prices below the intrinsic value of the silver.  In fact, it seems like the premium is trickling up literally almost every hour right now.  I expect that the premium will continue to rise.  For now, supplies are plentiful, but that could change within days.

The fact that US 90% Junk Silver Coin is now worth more than intrinsic value on the wholesale market could result in quickly rising spot prices.  When 90% Silver Coin is trading wholesale for 1-2% below silver value, refiners can profitably melt down the coins and refine the silver.  This effectively expands the supply of available physical silver.  Now that refiners no longer have this source of supply available, because the 90% Silver Coin is costing them more for the silver than the price at which they are selling their refined products, you could see a rapid physical supply squeeze.  If the current physical silver buying surge continues, you could see a significant recovery in the spot price.

By the way, though buyer demand has been overwhelmingly for silver rather than gold in the past few days, there has also been a surge in demand for physical gold bullion-priced coins and bars.  One primary distributor in the US has stopped accepting any orders for the South African Krugerrand, even though this coin is still in production!  Premiums have increased slightly for the Krugerrand and also the Canada Gold Maple Leaf.  I would not be surprised to see more delivery delays and premium increases for physical gold, though not to the extent it is already occurring for physical silver.

For much of the past few years, when the gold/silver ratio was 55 and higher, I skewed my recommended allocation between gold and silver to be about 2/3 silver and 1/3 gold.  When the price of silver neared $50 toward the end of April this year, the gold/silver ratio fell into the 30s.  At that level, I shifted to advocate that about 50% of the value of your precious metals holdings be in gold and 50% in silver.  Now that they gold/silver ratio has jumped above 50 again, I am returning to my recommendation that about 2/3 of the total value be in silver and 1/3 in gold.  The physical silver market is much smaller than gold.  When prices rise or fall, silver tends to move by a greater percentage—in both directions.

I have recently been asked, more frequently than usual, if or when I would ever recommend selling one’s gold or silver holdings.  This answer needs to be broken down into two parts.  First, the basic reason for someone to own precious metals is for insurance against potential calamities with the value of paper assets.  In quiet markets in years past, I suggested that 5-10% of one’s net worth or investment portfolio be held as this insurance position.

For the past couple of years, I have recommended 10-20% for an insurance position.  I made this change because I perceived a growing risk that the US dollar would decline in value and other financial problems around the globe would become worse.  In my mind, the insurance portion of gold and silver is intended to be held indefinitely, no matter what the financial markets do.  The reason for never selling this core position is the same purpose as buying various other insurance policies.  However, it is theoretically possible that financial markets could return to stability and normalcy, in which case I may again reduce my core position back to 5-10% of one’s net worth or investment portfolio.

My recommendation to own an insurance position in gold and silver applies no matter what the spot prices are at the time you make your purchase.  I regard it as more prudent to make sure you have your position established soon than trying to wait for a sizable dip.

Second, any precious metals holdings above that considered as insurance should be thought of as a trading position.  If someone is looking for an expert to advise them for extremely short-term trading of gold and silver, I am not their guru.  My perspective is the medium to long term.  I have had prospective customers (including some of my own staff) ask if they should park some temporarily available funds into gold or silver knowing that they would need cash out to pay for an expense nine to twelve months in the future.  Even though I thought and now think the prospects look bright for that time frame, I have always recommended against making a gold or silver purchase because there is some risk that prices could be down by that deadline.

For those looking to trade gold and silver in amounts beyond what they are holding for insurance purposes, I recommend being willing to commit to at least a three year holding period.  If your metals reach your selling target within six months, fine.  But what if it takes 30 months to reach your target?  You need flexibility to be able to reach your goals.  You also need to pay attention to what is really going on in the financial and political world and compare it to comparable eras in history.  Unfortunately, following only one or two indicators or one or two so-called experts is not sufficient.  There are an incredible number of factors that affect supply and demand and, ultimately, the value of any investment.

Keep in mind that markets are cyclical.  My company generally warned customers away from owning bullion silver for much of the 1980s other than as part of an insurance holding, which proved to be profitable advice.  Be mature enough to accept that you will lose money or make just a small profit on a number of your investment decisions.  Establish long-term goals that can be achieved despite these bumps along the way.  From my experience, those who think they have a sure fire “system” to make sure they never lose money will end up with some of the worst long-term results.

It is also financially prudent to have a diversity of investments.  Even for my most aggressive customers, the highest percentage of their net worth or investment portfolio that I suggest they hold in precious metals is one-third (and I include mining company shares and all the other paper forms of investing in gold and silver in this limit).  If you concentrate your investments too much, you are increasing your risk with only a small chance of a significantly better than average return.  (P.S.  Don’t ask me where to invest the balance as I am not an expert at other investment categories.)

To get back to the main thesis of this column, though, I believe that right now is a great opportunity to acquire physical gold and silver.  But I urge relatively prompt action as I expect prices to generally rise, supply shortages to develop, and premiums to rise.  I expect that those who do so will be well pleased in the medium to long term.

Patrick A. Heller owns Liberty Coin Service in Lansing, Michigan and writes “Liberty’s Outlook,” a monthly newsletter covering rare coins and precious metals. Past issues can be found online at http://www.libertycoinservice.com/ Pat Heller is also the gold market commentator for Numismatic News. Past columns online at http://numismaster.com/ under “News & Articles”. His bimonthly columns on collectibles can also be read at http://www.lansingbusinessmonthly.com under “Articles” and “Department Columns.”His radio show “Things You ‘Know’ That Just Aren’t So, And Important News You Need To Know” can be heard at 8:45 AM Wednesday mornings on 1320-AM WILS in Lansing (which streams live and becomes part of the audio and text archives posted at http://www.1320wils.com.