The Story of Silver

by William L. Silber

  FIGURE 20. Warren Buffett gives investments the taste test.

  The CEO of Berkshire Hathaway gave silver a reprieve because the metal is a cross between precious and industrial, a store of wealth for millions, and productive in photography and electronics. It was also good to him early in his career, making his commitment personal as with Dairy Queen: “Thirty years ago [1967], I bought silver because I anticipated its demonetization … [and] ever since I have followed the metal’s fundamentals but not owned it.”19 He had been watching silver longer than Bunker Hunt and made it sound like a homecoming when disclosing this “non-traditional investment” in his 1997 letter to Berkshire Hathaway shareholders: “In a way, this is a return to the past for me.”

  Buffett’s return began on Friday, July 25, 1997, when silver was $4.33 an ounce, and he proudly reported that by the end of the year the “position produced a pre-tax gain of $97.4 million.”20 He explained his reasons for the investment, which totaled about 2% of Berkshire Hathaway’s portfolio: “Charlie and I concluded that a higher price would be needed to establish equilibrium between supply and demand.” Buffett liked silver because annual consumption by industry outpaced mine production, the same fundamentals attracting the Hunts to silver rather than gold, but he quickly distanced himself from the fallen billionaires: “Inflation expectations … play no part in our calculation of silver’s value.” To just about everyone else, however, the price jump in the white metal brought back memories of a squeeze and inevitable comparisons to Bunker Hunt.

  The day after Berkshire Hathaway disclosed its purchases the Washington Post told its readers that “Buffett has amassed the biggest silver position any single individual has accumulated since the Hunt brothers were accused of trying to corner the silver market in 1980.”21 The New York Times drew a distinction:22 “When the Hunts were accumulating their position, they and many investors believed that there was no way that rampant inflation could be checked. … Now, the opposite consensus prevails, with inflation deemed to be quiet and likely to stay that way.” But the Times then turned Warren Buffett into a Bunker Hunt look-alike by making the technical observation that “silver has recently traded in what is called backwardation.” The word “backwardation” means that silver for immediate delivery sells for a higher price than silver for delivery in the future, which is very unusual for a precious metal that incurs storage costs. The Times then explained that this strange phenomenon “reflects concerns about a possible squeeze on current supplies, and is an indication … that huge quantities of silver have been accumulated.” The Times should have reminded readers that the CFTC had used backwardation and related concepts to charge the Hunts with manipulation.23

  Buffett tried to soften the squeeze by saying in the original press release: “If any seller should have trouble making timely delivery, Berkshire is willing to defer delivery for a reasonable period upon payment of a modest fee.”24 Looking back he claims that Berkshire Hathaway “intentionally avoided buying an amount beyond what was easily available for delivery” but the contemporaneous backwardation in silver indicates otherwise.25 Buffett owned a large stake in the Travelers Insurance Company and had used its commodities trading subsidiary, Phibro, to accumulate the white metal in London, draining Comex warehouses and adding to the perceived shortage.26 The Guardian explained:27 “Silver was heading for London to meet Mr. Buffett’s order and once there, it disappeared behind a veil of secrecy because London publishes no figures for the bullion in its vaults.” Switzerland had been the silent refuge for Hunt silver.

  The Berkshire Hathaway press release of February 3, 1998, ended the CFTC’s investigation almost before it began, a testament to Buffett’s reputation for integrity and the slippery definition of manipulation.28 The commission’s annual report never mentioned Warren Buffett by name and summarized the incident like the weather bureau on a tropical disturbance: “Silver prices rose sharply from $4 to over $7 per ounce between July 1997 and February 1998. … The most significant concern was the demand for silver by the holder of a sizable position in London. … Subsequently, prices fell and spreads loosened as the market was able to provide sufficient supplies.”29 Christopher Lovell, the New York attorney who had sued Phibro for carrying out the manipulation, joined the CFTC on the sidelines and withdrew the complaint.30

  The subjective nature of manipulation, which requires the intent to distort prices, eased Buffett’s treatment. Dennis A. Klejna, a lawyer who ran the CFTC’s Division of Enforcement when the agency prosecuted the Hunts, said, ‘‘It is very difficult to establish manipulation under the law, because there are very legitimate reasons for people to purchase large amounts of commodity futures contracts or large amounts of physical commodities.’’31 Buffett’s accumulation squeezed the silver market but proving manipulation by an individual investor requires testimony by a mind reader. The jury convicted the Hunts because they conspired with other traders, a violation of the antitrust laws, while Warren Buffett’s approach to investment abhors collusion. His success comes from being a contrarian, buying when everyone is selling, as explained in his 1997 letter to Berkshire Hathaway shareholders:32 “You pay a very high price … for a cheery consensus … pessimism drives down prices to truly attractive levels.” Buffett’s investment in silver fits this profile.

  Berkshire Hathaway never disclosed the average cost per ounce of its white metal but the pretax profit of $97.4 million reported for 1997 permits an estimate of $5.05 for 111.2 million ounces bought in 1997.33 The remaining 18.5 million cost about $5.50.34 Buffett had bought a bargain and paid cash, so he could have held forever, as with his Coca Cola stock.35 But he became impatient and would scold himself: “I bought it very early and sold it very early.”36 Buffett missed the explosive advance that would soon challenge the Hunt era record of $50 an ounce.

  *Warren Buffett refused to be interviewed for this discussion. He responded to one question by e-mail through his administrative assistant, as described in an endnote below.

  CHAPTER 22

  * * *

  MESSAGE FROM OMAHA

  THE NEW MILLENNIUM DULLED SILVER’S LUSTER. PRECIOUS METALS gain during economic and political chaos, but the Great Moderation that began in the mid-1980s—declining inflation, stable economic growth, and lower interest rates—made the world look as calm as a desert mirage. During the first week of September 2001 the price of the white metal averaged $4.17 an ounce, so Warren Buffet’s $97.4-million paper profit of 1997 turned into a paper loss of almost $100 million, small change for Berkshire Hathaway but a disappointment to the CEO.1

  And then came September 11.

  The tragic day cost more American lives than Pearl Harbor, brought New York City to a standstill, and destroyed America’s comfort zone forever. Speculators from London to Tokyo should have embraced the white metal the way Americans did when the Ayatollah Khomeini made his triumphant return to Iran. Instead they did almost nothing. Silver rose a paltry 4¢ an ounce to $4.22 in the London bullion market on September 12, about the same as a normal day’s volatility, while gold increased a significant 3% to $279.50 in response to the shock.2 By year’s end neither metal deserved its reputation as a safety net. Silver closed at $4.62 an ounce on December 31, 2001, a slight increase over its pre-9/11 level, and gold settled at $279, little changed from before the terror.3 The long slide in precious metals that began when the bubble burst in January 1980 continued to torture investors who had bought at the top. Gold had declined to less than one-third its peak and silver to under a tenth, a miserable performance over twenty years that made the precious metals market resemble West Virginia’s coal country.

  Warren Buffett remained undeterred. He had bought after prices had shriveled and could afford to wait for his silver seeds to flower. Buffett believed in the white metal because economic fundamentals would drive the price higher and not because silver had become a rock-hard asset after it had been demonetized. He viewed silver as an industrial commodity like copper or oil and relied on supply and deman
d to turn a profit. He recalled that in 1997 “silver was out of balance,” with annual demand for photography, jewelry, electronics, and other uses exceeding by almost 200 million ounces mine production plus reclamation from old scrap.4 Baby boomers melted silver cuff links and hair clips inherited from their grandparents to close the gap. Buffett expected the annual shortfall to continue, putting upward pressure on prices, because “there are few pure silver mines—most silver is produced as a byproduct from other mining—so it’s not easy to bring on added production.”5 The Berkshire Hathaway CEO also understood the power of patience, having told his stockholders when he first bought Coca Cola stock in 1988, “Our favorite holding period is forever.”6 So he waited.

  By the middle of 2005 Buffett’s staying power paid off. An expanding U.S. economy spurred silver prices and the New York Times celebrated the white metal’s resurgence on Sunday, May 29, 2005, with the headline “Gold Sleeps While Silver Rocks.”7 The Times reported, “Silver ended last week at $7.31 an ounce, up 7.4 percent for the year,” compared with gold that was “down 4.2 percent in 2005,” and explained the white metal’s superior performance as though it were dictated in Omaha: “Silver is more of an industrial commodity, while gold still has its monetary and safe-harbor allure. That means economic growth is good for silver.” A new bull market was underway, just as Warren Buffett had predicted.

  A year later, on Friday, May 5, 2006, a day before Berkshire Hathaway’s annual meeting, silver traded at $14.15 an ounce, almost doubling over twelve months and confirming the Oracle of Omaha’s wisdom.8 The price advance had been slow and persistent, like a steamroller, unlike the sharp spikes of the Hunt era when prices doubled over two months (twice) only to crater when speculators ran out of cash.9 Berkshire shareholders had much to anticipate.

  The capacity crowd at the annual meeting in the twenty-thousand-seat Quest Arena and Convention Center in downtown Omaha on Saturday morning, May 6, 2006, resembled fans gathered for a rock concert.10 To his stockholders, Warren Buffett dwarfed Bruce Springsteen in popularity. The meeting began at 8:30 a.m. with the latest Berkshire Hathaway comedy movie, a one-hour clip featuring Buffett and his partner Charlie Munger, six years older than Warren with a similar ruddy complexion, riffing with actress Jamie Lee Curtis about their investment strategies.11 A five-hour question-and-answer session followed the movie and both Buffett and Munger responded, although Munger often contributed his favorite line, “I have nothing further to add.”12 They answered questions on Berkshire’s cash balance—“$37 billion”—and on the danger of a nuclear attack in the United States—“It will happen someday.”13 Both of those were shocking responses, but the real surprise came in the discussion of commodity bubbles. Buffett worried about speculation in copper, where prices had increased fivefold between 2001 and 2005, from 70¢ a pound to $3.50. He profiled copper’s behavior as “driven by fundamentals” at the outset and then “speculation takes over.” He added his favorite refrain, “What the wise man does in the beginning, fools do in the end.” And then he dropped the bombshell, “We had a lot of silver at one time, but we don’t have it now.”

  Buffett sounded apologetic: “I bought it very early and sold it very early. We made a few dollars.”14 Rumors circulated that Berkshire Hathaway had sold at $7.50 an ounce in mid-2005, soon after the New York Times sang silver’s praises.15 Buffett never confirmed those details, but the timing made sense. The Times article would have brought unhealthy follow-on speculation, making Buffett cringe, and by 2005 the excess demand by industry over mine supply, which had attracted Buffett, had declined to one-third its earlier level.16 Berkshire Hathaway earned about $275 million on the investment of $560 million in 1997, about a 5% compound annual return over the eight years, less than they would have earned investing in U.S. Treasury bonds.17 Charlie Munger deadpanned, “I think we’ve demonstrated our expertise in commodities, if you look at our activities in silver.”18 Buffett concurred: “We’re not good at figuring out when a speculative game will end.”

  He did not realize it was about to begin.

  Buffett’s view of silver as an industrial commodity gained credibility after the May 2006 Berkshire Hathaway annual meeting. Fabrication demand for the white metal fell by almost 100 million ounces between 2006 and 2008, a drop of 10%, primarily because digital photography thinned the need for conventional film.19 An excess supply of the white metal drove down the price by more than 20% between Friday, May 5, 2006, and Friday, September 12, 2008.20 Silver resembled copper, which dropped by 11% over the same time and suffered compared with gold, which increased in value by 12%.21 The $10.87 price of the white metal on September 12, 2008, still embarrassed Buffett’s sale at $7.50 but confirmed his idea that silver belonged with the base metals rather than the nobles. Then came the Great Recession.

  The Chapter 11 filing of Lehman Brothers, the largest bankruptcy in American history, on Monday, September 15, 2008, turned a mild recession into the worst financial crisis since the Great Depression. The failure destroyed trust in financial assets, triggered panicked withdrawals from money market mutual funds, until then considered the equivalent of cash, and forced the U.S. Treasury to guarantee their safety. The expanded government insurance program prevented old-fashioned bank runs like those that had robbed the life savings of millions during the 1930s, but risky assets like equities remained vulnerable. Investor selling drove down U.S. stock prices by 46% in the six months after Lehman, a decline that rivaled the worst bear markets in history.22 Shares of General Electric, a diversified multinational company founded more than one hundred years earlier by inventor Thomas Edison, fell 70%, from $26.75 on September 12, 2008, the Friday before Lehman’s bankruptcy, to $7.41 on March 9, 2009, the stock market’s low point.23 A discouraged Wall Street octogenarian explained in unfashionable terms: “When they raid the brothel they take all the girls … even the pretty ones.”24

  The weak economy also destroyed raw material prices during those six months of economic turmoil. Crude oil dropped by more than 50% and copper lost 49%.25 Investors turned to U.S. government bonds, where rising prices lowered yields, and bought the timeless stores of value, gold and silver, which increased in value by 20%.26 The rise in gold surprised no one, but Buffett’s industrial label for silver suggested it would decline like copper and oil. Instead, investors polished silver’s twenty-first-century image to reflect its noble history.27 Silver correlates more with gold than with copper.28

  Aggressive government bailouts by the U.S. Treasury of General Motors, Chrysler, and insurance giant AIG, and the Federal Reserve’s zero-interest rate policy, helped America weather Lehman’s default, but Europe was not so lucky.29 By the end of 2009 U.S. stock prices recovered more than three-quarters of their losses just as international lenders began to doubt the creditworthiness of Greece, Ireland, and Portugal, with Italy and Spain not far behind.30 The European sovereign debt crisis turned the jump in gold and silver that greeted the Lehman bankruptcy into a bonanza not seen since the days of Nelson Bunker Hunt. The exploding financial chaos sparked gold prices to an all-time record $1,900 an ounce on September 5, 2011, an increase of 250% in the three years since Lehman’s collapse.31 Silver closed at $42.92 that same day, for a 400% increase, almost twice the move in gold, confirming silver’s reputation for volatility.

  The evidence that silver outperformed gold during the Great Recession came too late to help exonerate the Hunts, who had been blamed for manipulating that result during the last speculative boom, but it certainly taught Warren Buffett a lesson. He had been right to view silver as vulnerable to industrial forces, which is probably why it never breached the $50 record set in 1980, while gold, at $1900, more than doubled its 1980 peak. But Buffett forgot that the white metal is like a switch hitter in baseball, an industrial batter but also comfortable from the precious side of the plate. His uncharacteristic impatience cost more than he admitted. Had Buffett sold at $42.92 on September 5, 2011, well below the $48 crisis peak, he would have made $4.2 billion on his
investment of $560 million.32 His fourteen-year silver speculation would have earned a respectable 16.5% compound annual return.

  No one expects to sell at the top, so precious metals belong in every investor’s portfolio forever, including Warren Buffett’s, just like Coca Cola. His allocation of 2% to silver makes sense—not too much to cause insomnia, but enough to provide for food, clothing, and an iPhone during the next crisis. The evidence suggests that people have learned from the three catastrophes that tested investors during the last one hundred years: the Great Depression of the 1930s; the Great Inflation of the 1970s; and the Great Recession of the new millennium. During the last two episodes investors bought gold and silver without government interference, driving up prices to dizzying heights only to watch them decline when the chaos passed. But crises will not always end in a smile, and investors understand that three tests are too few to extrapolate. In 2017, as the Great Recession faded, silver declined to about $17 an ounce, one-third its 2011 peak but three times higher than the price Buffett paid twenty years earlier. Silver has earned its reputation as a rock-hard asset in a world of fiat currency, and investors enjoy its protective shield.

  FIGURE 21. A very pretty American eagle silver dollar.

  The U.S. Treasury issues the American silver eagle, a dollar coin containing one troy ounce of 99.9% pure silver, sold at a friendly markup above intrinsic value since the program began in 1986.33 The shiny white coin is as pretty as Nelson Bunker Hunt’s Athenian decadrachm, with Lady Liberty etched into the front and the back engraved with an eagle and shield like the Great Seal of the United States. Between 1986 and 2007 the U.S. Mint sold an average of 7.1 million coins a year, and from 2008 through 2016 annual sales jumped fivefold to an average of 37.3 million.34 The combined sales of silver coins by the United States, Canada, Australia, and others increased from an annual average of 30 million to 115.5 million ounces.35 The jump in sales since 2008 suggests at least some people expect silver to make a comeback as a medium of exchange. Utah offered them hope with the Legal Tender Act of 2011 that made American silver eagles acceptable in payments at their intrinsic value within the state, but legislation elsewhere failed to pass, including Congressman Ron Paul’s effort to restore both gold and silver as monetary metals.36 Las Vegas bookmakers would place low odds on the remonetization of silver in the United States, perhaps the same line as on the richest man in the world being forced into bankruptcy, which could never happen again.