Silver has been used since the dawn of time as money and has always retained its purchasing power. The relatively tiny silver market is ripe for a huge move higher. Silver’s fundamentals couldn’t be any stronger in 2015.

In 2011, the price for silver neared $50/oz (an ounce) and was ready to break to new highs; however, it was quickly brought down by a series of brash market interventions through selling pressure in the paper markets and many margin increases on the CME. It had the intended impact and the price dropped rapidly and kept falling since, settling to where it is today at $16.

(5 Year silver price chart)

I’m not going to harangue about the manipulation in the paper markets; I’ve done plenty of that in my previous articles on oil and gold in the past. I would like to state a few simple imbalances though: nearing $50/oz silver was trading over a billion ounces a day in paper contracts, when the total global mine production that year was only 800 million ounces. That’s well over a years’ worth of supply, traded in a single trading day! The paper markets once again trade on nothing more than an agenda set forth by large banks. There is no real price discovery in the markets, while fundamentals count for very little.

I detailed in my previous article about gold, which focused on inflationary scenarios for precious metals when people really give up on fiat currency as a store of wealth. Central banks have destroyed their balance sheets and kept interest rates negative, which has taken away the self-correcting forces of the market. These doom scenarios are extremely bullish for silver as well as gold. The world has lost faith in central banks and the fall out is taking place now.

Marc Faber recently said: “The only way to short central banks is to own gold.” I couldn’t agree more, but I might add silver or any other physical asset to the list.

In this article, I’m going to focus more on supply and demand. Demand for silver breaks down into three important categories: silver in industry, investment, and silver jewelry & décor. More than half of the annual supply goes to industry, which leaves a small amount for jewelry and investment. The huge upside will come from silver as an investment more than anything else.

Silver Ratio facts to give deeper perspective.

The in ground ratio of silver to gold is estimated to be around 17:1. In Roman times, the price ratio was set at 12:1, which meant that 12 ounces of silver could be exchanged for 1 ounce of gold. In 1792, the ratio was fixed by law in the United States at 15:1. However, the average price ratio during the 20th century was 47:1. The ratio has narrowed at times, notably in 1980, to 17:1, when the Hunt brothers famously tried to corner the silver market and the price surged higher until regulators stepped in and consequently crushed them. Also in 2011, the ratio came down to 30:1, which is when silver re tested its historical high of $50/oz before being smacked back down to where it sits today.

In 2013, the total amount of mined silver was just over 800 million ounces, while gold was at 100 million. This represents an 8:1 ratio of production. Current silver prices around $16 and gold at $1200/oz give a ratio of 75:1. I expect the ratio to revert back to 30:1; but, if inflation picks up, it could narrow as much as 15:1, as silver usually outperforms. With a conservative estimate of gold over the next decade at $3000/oz, we could see silver at well over $100/oz.

The general consensus among the primary silver miners is that under $20/oz isn’t very profitable to produce silver. The mining costs of companies vary greatly in the industry, as silver is usually produced as a byproduct of other metals. Nonetheless, I think it’s safe to say companies are getting squeezed in this environment. Companies that have survived have delayed capital expenditure and held back supplies when the price has dropped too much in the short term, while some have even called for other large producers to form a cartel with them. This was the case with First Majestic last year, as their CEO tried to take on manipulation and hopefully speed up real price discovery in the markets.

According to ‘The Silver Institute’, in 2013, which is the last full year of data available, there was a global supply deficit of 100 million ounces of silver, which I expect carried into 2014. How the price dropped throughout this period is counterintuitive to anyone following supply and demand.

Precious metals supplies are more elastic than other commodities such as oil and grains over the short term, as there are greater investment options, also excess stockpiles stored through ETF’s and central banks available. All of these stockpiles can be covertly released to mask strong demand, as silver has previously shown. All commodities eventually follow the same supply and demand metrics; if the price remains below cost for too long, then supply will dry up, causing a huge constraint on supply and a price surge to the upside.

Resource investing is very cyclical and it can take a while for supply and demand to balance out. As Rick Rule likes to say: “The cure for low prices is low prices.” The day is fast approaching when the damage done by keeping silver prices low will cause huge supply constraints.

The whole annual supply of the silver market could be bought up for around $16 billion dollars at current prices. With half of the global supply going into industrial uses, the number shrinks even further; down to less than $8 billion dollars worth of silver for global jewelry, silverware and primarily investing.

China and Russia are both large producers of silver as well as gold. Both countries are net importers of gold and I suspect the majority of their silver production never leaves their borders either; that would roughly take an additional 15% of annual supply offline. This is a very tiny and tight market, which could be bought up entirely by a few large funds or investors, not forgetting a country like Russia or China with healthy cash reserves if they wished to do so.

Another way to put the size of the silver market into perspective: take annual global silver supply and divide by the worlds population. Global silver supply including scrap is about 1 billion ounces, more than half of that is used for industrial. That leaves roughly 400 million ounces to be divided by over 7 billion people, meaning 0.057 of an ounce per person on the earth, which is less than $1 of silver at today’s prices. You might think why would everyone on the planet wish to buy silver? Good question. Why don’t we take just North America with over 500 million people and we get 0.8 an ounce of silver or $13 per person. India and China, both huge consumers of precious metals, with combined populations of close to 40% of the world, would not get any silver for investment. This is a tiny market!

India has had gold import bans over the last few years; as a result of this, the Indians quickly turned to silver purchases as a store of value and their imports skyrocketed. Russia and China are net importers of precious metals as stated above. Mints across North America are posting record sales and we have seen delayed shipments on various products.

Prices are starting to diverge from the paper market. Small premiums are starting to pop up in the physical market; notably in China, which has the world’s largest physical metals exchange. Thanks to Koos Jansen, who has helped bring light to China’s insatiable demand for precious metals; I expect price discovery to continue to head east.

As in the gold market, when fundamentals reassert themselves in the silver market in the near future, the turn will be abrupt and sudden. Those who don’t have exposure already will be chasing a quickly rising market and have trouble locating any physical silver.

As in all commodity plays, marginal producers offer the most upside potential. This is because they are leveraged to the price of silver and have the most to gain when the price rises. As with any form of leverage though, it is a double edged sword. The marginal producers stock prices have been battered since 2011; therefore, one must tread carefully as some of the marginal producer’s might not make it out of this bear market if debt can’t be refinanced. Such a scenario is especially true if the paper price drops further over the short term and further squeezes them. Look for solid balance sheets if dealing with marginal producers. I think silver will rise dramatically from current levels, so I don’t see a need to further speculate with junior miners. On the contrary, I’m avoiding them altogether and looking at companies already in production with proven track records.

Currently at around $16/oz, I’m expecting outsized returns over the next decade. It wouldn’t surprise me to see $100/oz silver, which would equate to a 600% rise from early 2015 levels.

I’m holding some physical silver for protection and silver miner’s for wealth creation. The perfect storm is setting up to make silver one of the most exciting investments of this decade.

By Nolan James Fyfe