Monetary Digest, May 1998
Warren Buffett is acclaimed as the most successful investor of our times, having become — according to Fortune magazine — the country’s second wealthiest man via his investment acumen. Starting 42 years ago with $100,000, Buffett is now worth more than $21 billion. His share of Berkshire Hathaway, the company he heads, makes up the bulk of his wealth. Berkshire’s net assets exceed $31 billion; it was through Berkshire that Buffett bought 129,710,000 ounces of silver.
Normally, Berkshire would have revealed its silver acquisition in its annual report; however, amid accusations that silver prices were being manipulated and a CFTC announcement that it was looking into the accusations, Berkshire issued a press release on February 3 disclosing the purchase.
Additionally, on January 28 a class action lawsuit was filed against the commodities firms that had been buying the silver. The lawsuit maintained the price of silver was being manipulated because the price of silver was rising as gold was going down, an “unprecedented” occurrence.
Asserting that gold and silver cannot move in opposite directions ignores the law of supply and demand. Due to central bank sales, gold is perceived to be in abundance, while silver is clearly in short supply. For their prices not to diverge under these conditions would be anomalous.
It is true that gold and silver prices generally have trended together. Their prices respond to monetary developments, rising during periods of inflation and falling during periods of disinflation. (Disinflation means declining rates of inflation.) And, both rise during financial crises. However, when one of the metals becomes abundant, or appears to be, its price falls.
During the late 1800s and the early part of this century, government policies (mostly silver purchase acts) resulted in huge quantities of silver being mined. When the government stopped buying silver, its price fell, clearly responding to an oversupply.
Now, silver is in short supply, and it is reasonable to expect silver’s price to rise to a level that will balance supply and demand. And, that’s exactly what Berkshire stated in its press release: that “equilibrium between supply and demand will only likely be established by a somewhat higher price.” At cost, the silver position makes up less than 2% of Berkshire’s investment portfolio.
Monetary Digest has for years maintained that silver offers better upside price potential than either gold or platinum. We take this position not just because of silver’s positive supply/demand fundamentals but also due to a phenomenon most silver analysts overlook.
Since the beginning of time, silver has served as money alongside gold. The Old Testament is replete with references of silver as money. Genesis tells of Abraham paying “four hundred shekels of silver, current money with the merchant,” for a burial place for his wife Sarah. And, everyone knows of the thirty infamous pieces Judas Iscariot took for betraying Jesus.
The New Testament also mentions Greek silver drachmas and staters. The thirty pieces Judas Iscariot received were probably staters. The King James Version translates the Roman silver denarius as “penny,” and today its initial, d, is the English symbol for penny, or pence.
Secular history credits Lydia, a country that is now Turkey, with producing the first coins in the 600s B.C. These coins, made of a natural alloy of gold and silver, were called staters and were the forerunners of the Greek staters. Seagoing merchants brought these coins to Greece, and by the mid-500s B.C. Greek silver staters were used in every area where the Greeks had colonies.
The Romans began making coins during the 300s B.C. and in about 269 B.C. issued the first silver denarius with the introduction of a new silver currency. As staters had spread to Greek colonies, denarius coins saw wide use in countries the Romans conquered.
Shortly after the birth of the United States, Congress put the new country on a bimetallic standard with the Coinage Act of 1792, which called for the minting of silver and gold coins at the fixed ratio of 15 to one, a ratio accepted worldwide at that time for the exchange of silver and gold. Silver coins as defined by the Act of 1792 remained part of our monetary system until 1965 when the U.S. Mint began producing the nickel-clad slugs we use today.
Not only has silver been used as money along with gold, but it has been more accepted by the masses. When the average person thinks of investing in precious metals, he generally gravitates toward silver because he gets more metal for his money.
Although the average person has significantly less money than the wealthy, in the aggregate the middle class has much more money than do the wealthy. In India, where silver is valued culturally, the middle class is larger than the population of the United States.
So, when the world faces another round of inflation or a financial crisis, the world’s middle class will pour their collective billions and trillions of dollars into silver while the wealthy opt for gold. Because the middle class has more money than the wealthy, their buying will push silver higher than gold on a percentage basis.
Right now, though, gold is trading near 18-year lows, and silver recently bounced of an eight-year high. Both are responding to supply/demand fundamentals.
Investors perceive gold to be in abundance. One or two smaller central banks have been regular sellers this decade. Additionally, gold producers and hedge funds have been selling forward for years, artificially inflating the supply. With price inflation at its lowest level in years and the Asian collapse being perceived as “manageable,” investors have turned away from gold.
Silver, however, is another story. But, before returning to why Warren Buffet invested some $680 million in silver, it should be pointed out that the events that have driven gold to 18-year lows have positive sides to them.
First, more gold is consumed than is mined. The shortfall is being met by central bank sales and by forward sales by gold producers and hedge funds. (Forward sellers borrow the gold they sell, usually from central banks.)
A financial crisis could cause central banks to reverse their attitude toward gold. If the Southeast Asian crisis has proven anything, nations need to back their currencies with gold. The price of gold in Southeast Asian currencies soared as the conflagration spread.
As their currencies collapsed, Thailand and South Korea mounted door-to-door campaigns to get their citizens to donate gold in any form — trinkets, jewelry, even pure ingots — to exchange for “hard” currencies to be used to meet their international commitments. Although the Thai baht and the South Korean won became pariahs on the world’s monetary markets, the donated gold was eagerly snapped up after being refined.
Someday, gold producers and hedge funds will stop selling forward. Then, the supply of gold will shrink for two reasons. First, the forward selling will stop. Second, the forward sellers will have to replace the gold previously sold forward. This gold will come out of production, thereby further reducing the supply of gold available to meet demand. As for the hedge funds which are selling forward, they will have to buy their gold, increasing the demand.
All this will produce an exciting rise in the price of gold sometime in the future, probably sooner than most expect. Meanwhile, the supply/demand fundamentals for silver grow increasingly positive by the day.