With silver having drawn quite a bit of investor interest of late, we thought it might be timely to consider taking a detailed look under the market's "hood" in order to better understand this metal's own supply/demand dynamics. The findings are not unfamiliar to those who have followed these drivers as they shape up in today's gold market. There are, however, certain notable differences (notably in the risk/reward equations) to consider when contemplating the silver proposition. Without further ado:
Total silver supply reached 26,700 tonnes (858.0 million ounces) last year. This tonnage was up 2.4% from 2008 levels and it also constituted a record volume of silver supply. A further 2.5%-5% increase in total silver supplies is projected for 2010. The largest increase in total supply last year was from a 4% bump recorded by global silver mine production. Around 22,100 tonnes or 709.6 million ounces of silver were estimated to have been mined in the world in 2009.
Transitional economy silver mining also recorded strong gains last year, with Chinese production for example showing an 8% gain and placing the country in third place on the global silver mine production list. In 2010, global silver mine supply may gain by more than 1,100 tonnes and silver sales by governments, while largely unpredictable, are expected to remain at low levels.
Such sizeable additions to global mine supplies are being achieved at an average cash cost of very near $5.25 per ounce of silver produced. Mine production accounts for nearly 70% of silver's total supply. While such costs may indeed have nearly doubled from just five years ago, they have started to show a tendency to flatten out and decline somewhat in recent quarters. The silver mining community is indeed, a very happy one.
Thus, the silver market this year will remain in "substantial surplus" even as the metal is still being "absorbed" by investors, said GFMS last month at a conference held in Beijing.
On the secondary supply front, rising amount of scrap silver amounted to around 8,500 tonnes or 272.2 million ounces that were estimated to have been reclaimed from old scrapped jewelry, silverware, photographic materials, electronics, chemical catalysts, and batteries last year.
This source of supply was up sharply from 2008 levels, reflecting heavy selling to take advantage of the high silver prices. Consumers in India, the Middle East, and certain Asian nations took advantage of high silver prices and sold significantly higher amounts of old jewelry and silverware to scrap refiners.
Tertiary silver supplies, as embodied in official sector silver sales declined to a one-decade low of about 426 tonnes or 13.7 million ounces. The majority of the decline in government sales came from Russia but there was also a notable absence of sales by the US and Indian governments. In general, government silver stockpiles have been dwindling at a fast clip since the early 1980's.
This dishoarding process is reflecting the ever-diminishing monetary role of silver in the modern global monetary reserve system. Thus, the world's central banks have gone from hoarding 11,200 tonnes of silver forty years ago, to just about 1,700 tonnes of it at present. Practically no further sales have taken place in the past 36 months, and the US, India, and Mexico account for virtually all (81%) of the official silver being held by such owners.
Total silver fabrication demand fell by a not insubstantial 11.9% in 2009. The total demand of this type amounted to about 19,000 tonnes (or 610 million ounces) - but this represented a 17-year low in demand for the metal and it also made for the seventh out of the past eleven years during which silver demand for fabrication purposes experienced a contraction and one during which the metal's demand fell across the entire spectrum of its usage types.
The bulk of the declines in the offtake of silver came from industrial users. For them, the global 2008/2009 recession has meant a more than 20% decline in demand, to a six-year low of about 11,000 tonnes. Even amid such conditions however, the industrial component of silver's overall demand remains a hefty 60% of the total figure. One cannot talk about bright future prospects for the white metal unless one also expects a significant recovery in industrial demand for it.
As was expected, the most notable decline in silver demand came from the still-shrinking photographic applications sector. In an almost perfect counter-trend curve, the demand for silver in photography has been fading away with the advent of the Internet, digital imaging, and non-film based information storage technologies. This sector experienced a 21% slump in demand for the white metal last year.
Investment Absorbing the Overhang
As is the case with the current gold market, the one pivotal type of demand that has come to play the lead role in shaping the price of silver last year as well as (especially) this year, has been that coming from the category labeled as "investment." The surpluses that the silver market has experienced since 2006 have been absorbed by investment demand.
GFMS estimates that implied net investment in 2009 was a very healthy 137 million ounces (or about 4,250 tonnes). While that sounds like a large amount of silver, it may all be relative. Recall that Warren Buffet made his now famous silver market play not that long ago by buying something on the order of 129 million ounces (that's 4,012 tonnes for one man, folks).
Clearly, some silver ETF investors are not long-term buy-and-hold style investors. And the fact remains that, for silver, the importance of the ETFs is far greater than that in gold; at least due to the percentage of apparent investment demand that they represent. At any rate, the vast majority of the demand for silver within the so-called 'investment' category can be attributed to ETF demand - a niche that, for example, 'consumed' 151 million ounces tonnes (nearly 4,700 tonnes) of silver in 2009. That is roughly 21% of fresh mine supply going into one single category that tends to be highly cyclical in nature and transitory in duration.
Arguably, the most recent (2007-2009) sharp rise in silver is primarily the result of hedge & momentum fund speculation and a falling U.S. dollar. Exchange-traded funds could play a critical role in determining the average silver price in coming years, especially if some of the holders of these vehicles have a change of heart and commence selling. Ditto the large speculative positions that are manifest in the futures and options niche.
Such selling could thereby unleash a large amount of physical metal onto a market in which, as we saw, overall traditional demand is relatively weak. We basically have no idea how significant the accelerative effect on falling silver prices a sizeable wave of redemptions from silver ETFs might become.
Our good friend, HSBC analyst James Steel, argues that, while industrial demand might warrant sustainable $15 or so silver, it cannot account for the push to 20 or 25 dollars. It is a smaller and less liquid market than that for gold, and is historically more susceptible to 'overshoots' (in either direction) than the yellow metal.
Thus, a serious "correction" in gold could spell "grave" declines in silver. Meanwhile, another long-time friend, Philip Klapwijk (he, the Chairman of GFMS) warns that: "We could see a fairly important correction across all the metals, and, with silver, it could be a bigger correction than with most."
As the investment performance data for various assets (shown in the above table) indicates, the one thing that is not absent from the silver playbook is volatility. If you take the nearly two decades that have just passed into the equation, a silver return of 9.54% - the highest in the group and indeed higher than that offered by gold during the same period - came with a disproportionately higher - in fact, the highest - level of risk; nearly double that of gold.
If, on the other hand, the quarter century period of from 1984 to 2009 is the metric, silver's return barely matched that yielded by gold, but its risk remained at the very top of the heap, and was again, nearly double that entailed by investing in gold. Extending the observed period to four decades only underscores the wide gap that exists between what silver returns on average versus the risk it brings with it. It is simply put, the riskiest of the tracked asset classes in question.
CPM Group projections made earlier this year indicated that although there is still a possibility of further price gains in silver ($30 has been mentioned lately), profit-taking in the wake of the recent run-up could bring the white metal quickly down to the $19-$22 range.
Prices above $25 could well attract increased retail investor interest, but they will also likely encourage increased secondary supply from scrappage, thrifting from primary fabricators and profit-taking from hedge fund investors who bought the metal at significantly lower levels. This could dampen the pace of potential increases in prices.
Jon Nadler is senior analyst with Kitco Bullion Dealers in Montreal.