Silver’s value is far from a sure thing

Silver or gold can serve as a hedge against inflation, but be wary if anyone tells you they are sure-fire investments.

The problem is that anything, whether bread, a haircut or a house, has value only because it meets peoples’ needs or wants. It has no absolute value in itself. The same is true for gold and silver, even though these often are described as having “intrinsic value.”

Because they are scarce and durable, gold and silver can perform the classic functions of money as “a medium of exchange and a store of value.” Yet, these metals’ “values” are not given from on high. They depend on relative scarcity, which varies over time, and on people’s preferences. Their prices yo-yo relative to each other and to quantities of various sets of goods and services.

All this is prompted by inept personal finance advice I saw over the weekend in the “Everyday Cheapskate” column by Mary Hunt under the headline, “Reader learns lesson about inflation.” A reader asked, “If you had $500 for investing, what would you do with the money? Should I buy gold?”

The columnist responded that because gold was so expensive, silver might be a better option. She also asserted, “If you would have purchased one U.S. silver dollar in 1963, it would have cost you $1. Today, you need $33 to buy that same silver dollar. Silver did not become more valuable; dollar bills lost their value. We have every reason to believe silver will continue to increase in cost, which is just another way of saying the U.S. dollar will continue to slide.”

This is breathtaking in its ignorance of economics and of how silver and gold prices have varied over time. The value of silver has, in fact, fluctuated greatly by a wide range of measures, both up and down.

The issue is not whether silver is a good investment in January 2012 but whether changes in the number of dollars per ounce of silver over the past half-century actually have been even and continuous, as implied. They have not been, and there have been many times when buying silver turned out to be a terrible investment.

Suppose that in 1979, you took $500 and bought silver at $21.79 an ounce, the average for that year. If you sold it 20 years later at the1999 price, you would have gotten $122.01 back, for a loss before inflation of 76 percent. But consumer prices also increased by a factor of 2.3 in dollar terms over those two decades, so you would have traded $500 in 1979 buying power for $52.30. Just putting those allegedly ever-declining dollar bills under your mattress would have left you with 80 percent more purchasing power than buying silver.

Those familiar with U.S. history will know that 1979, the starting year I chose, was a year of the highest silver prices ever, because of market manipulation by the Hunt brothers. (Prices peaked at $49.45 in January 1980 but fell to $11 two months later.)

Of course, other time spans would produce different outcomes.

If you had purchased $500 in silver at the 2001 average price and sold it at the 2011 average, you would have increased your investment eightfold, to $4,013. In retrospect, this was a great investment, and this is why silver is now touted so highly.

If, however, you bought silver in 1986 and held it to 2004, your return would have been 1.3 percent per year. My very conservative retirement fund returned 8.5 percent over the same interval.

Silver has risen sharply in recent years because precious metals can be a hedge against inflation. But they are so only if purchased at a low enough price. The later someone buys into a rising market like this, the greater the likelihood the investment will be a bad one. Silver can protect some individuals against inflation, but if everyone piles in, it cannot protect everyone.

In the two decades from 1984 to 2004, silver prices averaged $8.44 in today’s dollars. Yet, large quantities of silver were produced each of those years. Costs of silver production continue to fall in real terms. Why would one want to buy a substance for $28, today’s price, if miners have demonstrated they are willing to produce it for a third of that sum?

Enthusiasts may retort that the fact that silver is rising faster than the cost of production shows it is a great investment. But the price is rising only because mining is highly capital-intensive and it takes years to open a new mine or make major production increases at existing ones. And mining companies are hesitant to commit too much to new mines when experience tells them that prevailing high prices are not likely to last long enough to amortize a new mine.

All these fluctuations mean that silver – or gold, for that matter – is a problematic investment. It also means a return to a gold and silver standard, as advocated by some politicians, is fraught with ore dangers than people think. But that is something for another day.

© 2012 Edward Lotterman
Chanarambie Consulting, Inc.