Back in 1979 the infamous Hunt brothers largely cornered the market on silver, driving the price from $6 per ounce to an all-time high of $48.70. Their scheme unraveled when the COMEX intervened, and silver rapidly shrank back down to more accustomed prices.
But here we are in 2011, and silver prices are once again whipsawing – trading at prices well north of $40, and then dropping $10 in less than a week down to $37 or so. But our current situation is different from conditions back in 1979, and while no one knows for sure, it seems possible that silver may have enduring higher prices going forward.
Back in December, I wrote an article on this blog when silver crossed the $30 mark. It took only four more months for silver to pass the $40 per troy ounce mark. And it’s not just silver. Have you noticed what’s going on with diamond prices? Tin? Copper? Yikes, it seems like 2011 is turning into the “Year of the Price Increase”.
So what’s a jeweler to do? One very important thing is to know is what your replacement costs will be. I recently read a report in a national jewelry trade magazine that made me wince. A retail jeweler was explaining that he wasn’t raising prices on his diamond jewelry inventory, and that his customers were appreciating that. While his heart is in the right place, will he be prepared to buy new stock when the time comes? Some diamonds, especially small 1 and 2 pointers have risen as much as 50% recently. Being prepared to buy your replacement inventory is a must! Here’s a little parable I heard recently here at Rio:
There once was a gas station in a remote corner of New Mexico. It was the only gas station for 45 miles. Gasoline prices started to go higher and higher. The station owner thought he should sell his gas based upon what he PAID for the gas. Weeks later, when it came time to refill his tanks, he did not have enough money to fill the tanks at the current prices. He was forced to close his station and now the locals in that village have to drive 90 miles round trip to buy gas. He thought he was doing them a favor, but in the long run his decision cost him his business and cost all his customers more time and money to get their cars gassed up.
So the lesson here is – base your current prices on your anticipated replacement costs. I read recently with interest a great blog post by Maureen Brusa Zappellini of Tucson, AZ on her blog. Maureen gives her personal account of how she is coping with these high markets and discusses how she considers replacement costs. It’s worth a read, so check it out!
Another strategy that we employ here at Rio is to constantly replace our inventory. Rather than make one big buy that might last for most of a year, we prefer to buy frequently. In fact, when it comes to silver and gold, each day we attempt to buy the same number of ounces that we sell. As an example, if we were to sell 1,000 ounces of silver on a given day, we would buy 1,000 ounces either that same day or the next business day. In this way we can recognize the cost of owning that 1,000 ounces of silver, and calculate any profit margins apart from the value of the metal.
While daily replacement may not be practical for every jeweler, frequent replenishment is a strategy that you should consider. Perhaps a strategy of replacing your silver/gold supplies would fit a weekly or bi-weekly schedule? The shorter the time period the closer you can follow the current replacement costs, and input them into your pricing on current inventory. Another advantage of this approach is you will realize steady margins. If you put off buying until you can afford a big buy, you will sometimes be operating at a net loss for a while, hoping you climb out of that hole before your next re-buy.
Here’s a simple comparison:
This is a very simple example, just to illustrate a point. You sell a unit that has a cost of $3.33, and you retail it for $10.00. You expect to sell 100 units each month. Plan 1 shows an example where you buy your entire inventory up front. While you make a nice profit by year’s end, you suffer through three to four months of negative cash flow. With Plan 2, you buy just what you need each month. You end up with the same profits, but you have much smoother cash flow all year long.
Sadly, retailing isn’t this easy. You never have steady demand, and as we know, the cost of replenishing silver and gold just keeps getting more expensive. But by following the principles behind Plan 2, you will ease your cash flow, and avoid horrible surprises that others will experience when they go to replace silver and gold which was purchased months ago.
Let’s explore how rising costs affect your margins. With the current reality, a 5% rise per month doesn’t appear to be farfetched. For the retailer who bought a year’s supply and set the price for the year, a dreadful surprise is waiting. Instead of buying an additional year’s inventory for $3,996, their replacement inventory is going to cost $6,840 ($5.70 per unit X 1200 units). That’s a nearly $3,000 hit that they did NOT see coming!
But for the retailer who adopted “Plan 2” above, they have visibility to the rising price, and can adjust prices accordingly. Consider:
In this scenario, assuming demand were steady, the retailer would actually make more money, maintain expected margins, and would have brought his customers along with constant small price increases.
No doubt about it, this silver market is causing a lot of trouble. Here at Rio Grande, we believe in sharing some of our coping strategies with you. We’re all in this together, and I encourage everyone to share their strategies by commenting below, so all of us can benefit from your experiences.