The holidays are coming up, and with that the opportunity to review our financials. Moreover, you have probably noticed that gold and silver prices have experienced a correction over the past two years. Given the lower demand for silver, which usually benefits from positive gold sentiment, silver prices dropped even more than gold. The price of gold decreased from €1,379/oz to €871/oz last year: a decline of 37% (currently €985/oz). Silver dropped from an initial high of €32.71/oz to a low of €12.39/oz last month: a decline of 62%. This resulted in an increase of the gold/silver ratio from 32:1 to 75:1. Past June, when the ratio was at 60:1, I wrote that I expected a further rise in the gold/silver ratio. Should you now exchange your gold for silver?

You may remember that in August 2010, the silver price started an upward trend, starting from a price of €14/oz. Around Christmas, silver had already risen by 64%, to €23/oz. The bull market euphoria had not yet ended though. In the first months of 2011, silver went parabolic. Investors couldn’t believe their luck. In a matter of weeks, the price rose to over €32/oz; a 100% increase in less than a year.

History repeats itself. Many investors buy at the wrong time. They bought silver at a time of enormous price increases, which were a clear warning sign for investors on the alert. I too held silver in 2010 and 2011, but decided to sell right after witnessing the parabolic move up. From that point onwards, the silver price underwent a long-awaited correction. At this moment, silver is down by 62%, which is not unusual for a commodity.

What can be said about the silver price? What is value of silver? And how can we actually know how much silver is worth?

800 million ounces of silver are produced each year. That may seem a lot, but it is only a bar of merely 470 cubic feet. With this in mind, we are able to realize how scarce silver really is. Silver is rightly called a precious metal. In addition, a lot of silver is recycled. This recycling adds about 200 million ounces to the annual supply.

The industrial demand is an unknown factor. The major markets for silver seem satiated, especially given the declining economic activity in many parts of the world (Japan, Europe and China in particular).

For example, the role of silver in photography will continue to decline. In addition, a major part of the demand for silver consists of its use in electronics and batteries (somewhat less than 300 million ounces). Electronics sales in Western markets fail to meet expectations though. Moreover, technology continually endeavors to decrease the size of components which, on the long run, negatively affects the silver demand. If corporate investments do not increase, sales of electronics may remain disappointing for a longer period of time.

We have better news from the jewelry industry. The Indian silver import reached a record high in October. The substitution effect from gold to silver is still very much alive in India; a subject that we discussed before. Also, silver coin sales at the US mint will reach record highs this year with over 40 million ounces.

We may take a look at the marginal costs of silver mining. The ‘all-in cost’ of, for example, Coeur Mining (which has silver mines in the U.S., Canada, Mexico and Bolivia) is around $17.50/oz, which is higher than the current silver price of $17.10.

However, a major argument can be raised against this point of view. That is, we are considering marginal silver producers and we can safely assume that we’ll be able find silver producers that are unprofitable at current prices. In other words, mines whose marginal costs of production are higher than the current silver price. However you cannot conclude that the silver price will have to increase in short run.

On the contrary, mines can actually remain operative even if the market price is below margin costs. The reasons are that (i) silver is often a by-product and (ii) closing a mine is a very expensive measure.

These statistics mainly tell us which mining stocks we absolutely need to avoid. These companies may run into financial problems when the silver prices remains low for a longer period, or when they drop even further. These marginal producers will disappear from the market. Given thecurrent state of affairs, this is not likely to happen yet. However, many producers remain that have (much) lower mining costs.

Given the end of the year, this is a good question to reflect on. Historically, the correlation between silver and gold is high. Given the correction of the past two years, silver currently seems to be cheaper than gold. The opportunity to exchange gold for silver seems to be ahead.

I am taking into account the possibility of declining gold and silver prices. In such a scenario, the gold/silver ratio may increase again, perhaps even to levels comparable to those we observed during the 2008 stock market crash. At that time, the gold/silver ratio peaked at 80:1.

The low price of silver is not the result of an enormous production surplus that first needs to be eliminated. On the contrary, we are currently consuming existing silver supplies. That, combined with the favorable gold/silver ratio, may make it attractive to exchange gold for silver in the coming time period.

Summarizing, if the holidays are also a period for you to reflect on the past year, then seriously consider exchanging gold for silver in the upcoming year.