This is somewhat old, but I think the fundamental story is still the same.
Resource Stocks Advisory - - - Report on Silver - - - January 1998
early subscription $149 cdn/year $119
THE CASE for the RAGING SILVER BULL
I have known for some time that the fundamentals of the silver market would lead to a dramatic increase in the price of silver. With this in mind I have been accumulating information on the silver market and various silver investments for over a year. This reports represents probably hundreds of hours of research on the silver market and silver related investments.
I compiled data on the silver market mostly from the Silver Institute, 202-835-0185. I gathered more data from various other sources such as the CPM Group, brokerage/analysts reports, company reports, the internet and a few other odds and ends.
What I want to do is explain to you the case for silver as simple as possible in layman terms, but give you ample detailed information. I then go on to analyze and compare more silver investment vehicles than you will be able to find anywhere.
To start, the case for rising silver prices is so simple it is really a no brainer and quite obvious to many in the market place. Demand has been outstripping supply for years which is resulting in a draw down of readily available above ground inventories. It is this anticipation in the market, that can, and is causing silver prices to act bullish a little prematurely than strictly what the supply/demand fundamentals alone would suggest.
In around October of 1997, I had noticed a signal that convinced me that silver was about to begin it's long awaited bull market. The Japanese industrial users of silver and some hedge funds had begun to buy up the metal in anticipation of higher prices. This is why in late fall of 1997 I began emphasizing the rise of silver and some of my favorite silver stocks. This was then confirmed as you can see on the chart with a break out above $6.00
The Japanese have recently began to use a lot of silver in their industry and they are notorious for buying commodities before significant prices rises. Toyota is using over 100 million ounces, Sharp and Casio use almost that much again and Fuji consumes around another 20 million. These numbers do not show up in Japanese consumption because of the amount of offshore manufacturing done by the Japanese. Why so much consumption? It is silver's unique properties, and there is just no way around significant consumption of the metal year after year. Lets have a look at what silver is used for or the demand side of the supply/demand equation.
DEMAND
Photography
Silver is mostly used in jewelry/silverware, photography and industry for manufacturing of various products. In most cases so little of the metal is used in each final product that if silver doubles or even triples in price it will have little effect on the price of the product. This is important because rising prices will not curtail demand very much. The exception to this is silver's decorative use, such as jewelry that could be acceptable to price increases.
Photography is now the smallest of these three categories taking up 27.8% of 1996 demand. You have probably heard a lot of talk about the digital camera replacing the silver film. While it is possible that this could have an impact some day we are many years away from this, because prices are going to have to come down a long way for the cameras and the quality improve to meet the superior quality of silver film. The digital use is increasing for industrial purposes but demand continues to grow for film usage in cameras within the developing nations, especially Russia and China who are still only using a fraction of what the U.S does on a Per capita basis. Technology has reduced the amount of silver used on each film and has offset the rising film demand. Consumption for photography use has remained around the same since 1990, fluctuating between 212 million ozs/year and 226 million. I expect this number to remain relatively flat.
Industrial Fabrication
Industrial use is the biggest demand segment at 36% in 1996. Most of this use is for electrical/electronics and brazing applications. Other uses include silver alloys for batteries, catalysts, mirrors and other coatings. GM and other manufactures use silver in windshields to improve reflecting ability.
The biggest new craze is silver for health reasons, especially in Japan. There is a good reason that silverware was made with silver. The properties of silver have been known for centuries. In ancient civilizations, the wealthy stored their water in silver vessels to keep bacteria from growing . Similarly, American settlers often put a silver dollar in milk containers to delay its spoilage. Silver has natural bactericidal properties that are not fully understood but are developing into a multi-billion market.
Today, silver is used by the Soviets to sterilize recycled water aboard the space stations. NASA selected a silver water system for the space shuttle. This is really taking off in Japan where Toyota last year announced that three of its popular car models will come equipped with antibacterial steering wheels and other interior parts. Sharp and Casio are selling antibacterial keyboards on their calculators. Pens, toothbrush handles, cutting boards and over 600 other silver based antibacterial products are available in Japan.
You can find numerous articles about Colloidal silver used as an antiseptic and germicide on the internet
better-health.com
Silver demand for industrial fabrication in the last 10 years has fluctuated between 257 million ozs to a high of 308 million ozs. in 1989 Industrial demand has shown modest steady increases from around the 260 million level in 1991/1992 to 293 ozs. million in 1996.
Silver is used in such tiny quantities as a total percentage of a finished product in most applications that price increases will have little over all effect to curtail demand. Demand here is mostly a reflection of the strength of global economies.
I expect 1997 will show another increase in the industrial use of silver. In 1998 and beyond, demand could be affected by the problems in Asia as it causes a slowdown in global economies. The Silver Institute reports the Far East Used 72.44 million ozs. in 1996 with 52.15M of this in Japan. If the Asian turmoil causes a global slowdown then we can expect a drop in industrial demand. This could be a drop back to the 260 million oz range that we seen in the 1991/92 slow period. It is also worth mentioning that a global slowdown will also affect base metals. This will cause a percentage of these mines to shut down. Silver production will drop also, perhaps off setting the drop in industrial use
Jewelry/Silverware
Silver possesses working qualities similar to gold but enjoys greater reflectivity and can achieve the most brilliant polish of any metal. Next to industrial use jewelry or decorative demand is the next highest at 32.3% of total demand. This sector is responsible for most of the increased demand with India being the driving force. India consumed 93.9 million ozs. in 1996 which is over twice as much as the nearest competitor, Italy at 40.5 million ozs. Outside of India, demand increased 3.5% in 1996. In 1997 this sector will once again show demand increases with India the main culprit.
Officially, India was a net exporter of silver in the late 1970s and early 80s. This trend changed in the mid 1980s and India is now the worlds largest user of both gold and silver. This is a result of import regulations being recently relaxed that gives the three existing importing agencies and eight newly licensed banks, rights to freely import precious metals. India has a traditional fascination with the metals and has a lack of efficient or competitive savings and investment vehicles.
This sector of demand in mostly India would be the most sensitive to price and could begin to be affected by prices above $6.00, the strength of the India economy and harvest conditions or success.
In the last 10 years this demand sector has seen all the growth, rising from 88.6 million ozs. in 1987 to 227 million ozs in 1995 and another 17%? increase to 263 million ozs. in 1996. In 1997 this sector will again show record demand, driven by India once again. India had already imported 95% of 1996 levels in the first 8 months of 1997. I expect this sector could see a drop in demand in 1998 because of higher prices. In any case even if demand drops in half or by about 130 million ozs. it would still not come close to solving the supply/demand imbalance
Coinage/Investment
This sector has represented a very small amount of total demand between 2% and 5%. In the last 10 years coinage demand has fluctuated between 17.8M ozs. in 1988 and 42.9M ozs in 1994 with 20.8M ozs in 1996. These low numbers reflect the little interest shown by investors. Long ago silver was the major monetary metal in the world and most coins were made of silver. In 1871, 80% of the world's population had currencies redeemable in silver and another 15% had a bi-metallic choice (silver/gold). This was gradually replaced by gold as well as silver being phased out in coins because of it's high price, relative to the face value of coins.
I remember well the old Canadian silver dollar which became extinct in 1968. The coin is so big and heavy it is more likely to be confiscated today as lethal weapon if propelled within 100 feet from a good arm. The draw back is each toss would cost you about $10cdn.
Today silver coins are minted as special issues for collectors and investors. Most of these are minted in North America and Europe, where Germany had two main issues of coins, struck last year to consume 3.89M ozs. The U.S. accounted for 6.1M ozs. in 1996 down 25% from previous years. Mexican coin production has plummeted since the 1992-94 level of 30M ozs. with the devaluation of the Mexican peso.
The real story on Investment demand is really dis-investment which accounted for 149M ozs. in 1996 or 18% of total silver supply. This comes from a number of sources including: liquidation of long positions on the world's futures exchanges and over-the-counter market, direct physical selling of bullion bars and coins by the public and unrecorded sales out of other inventories.
Investment demand can have a very large swing or turnaround as interest increases as the price of silver rises. This began to show up in late 1997 with silver been accumulated by some investment funds. I expect this sector to have the biggest increase on the demand side. As silver prices rise we could easily see coinage multiply a number of times over. The silver market is quite small with annual demand around $4.2 billion (10% of the gold market) and implied inventories of around $3 billion or less. This means increased investment demand or speculative activity can greatly influence the market and will lead to a lot of volatility in prices.
SUPPLY
The majority of silver supply, approx. 73% is from mine production with old silver scrap and recycling making up about 23% and hedging and official monetary sales being a very small percentage of 6% or less. The supply required to fulfill the supply deficit from higher demand comes from consumption of above ground silver inventories. Lets look at mining supply first.
Mining
The most important thing to understand about this source of supply is that approx. 80% (1996 83%) of silver mine supply is a by product of another metal such as lead, zinc, copper and gold. Mines with silver as the major metal make up a small percentage currently around 17%. Therefore the prices of other metals has more effect on mine supply than the actual price of silver itself.
Increased exploration in recent years has resulted in a number of new mines being discovered that could come into production soon. These include
•BHP's Cannington project in Australia (22M ozs/year) •TVX and Placer's Chimberos (30M ozs/year in 1998 only) •Barrick's Pierina (1998 9M ozs/year) •Barrick's Pascua (1999 3-4Mozs/year) •Metallica and Cambior's Cerro San Pedro (1999 3-4Moz/year) •Bolivia (2001 14+Mozs/year) •TVX's Cassandra (2001 4Mozs/year) •Sunshine's Pirquitas (2000? 9Mozs/year)
The large, recent declines in gold and copper prices could delay some of these as well as curtail production from existing mines.
The largest declines in mine supply come from the CIS where uneconomic production mines has reduced production by about 33% since 1990. It is possible for some increase to come here as well, such as the Dukat mine in Russia recently being acquired by Pan American. However, Russia and the Republics are politically and economically unstable so there is still room for surprises on the down side or long delays on increasing production.
Mine production has fluctuated between 440M ozs,1987 and 520M in 1990. Production was 492.6M ozs. in 1996 up from 478.9 in 1995. Most production comes from Mexico, some other big producers are:
•Mexico 81.27M ozs in 1996 •Peru 63.31M •U.S. 50.34M •CIS 47.93 •Canada 42.04
Estimates give 1997 mine production an increase between 5% and 10%. I expect this will be true and then we will see a falling off of mine production unless we have a significant rebound in gold and base metal prices. Off setting these declines could be increases in primary silver production as we see higher silver prices. The net effect in 1998 and beyond will likely be anywhere between decreases of 5% to increases of 10% depending on further price changes in gold and base metals and how high and fast silver prices rise.
There is far less hedging and forward sales activity in silver compared to gold. Since 1993 the amount of hedged production has been around 50M ozs. Hedging could increase with higher prices but I expect this will not be a major factor until silver prices are much higher and the old moth balled mines are brought into production with some hedging.
Scrap and Recycling
Silver is recycled quite efficiently with about 20% to 25% of annual supply being from scrap. Most of this is from recycling of photographic waste with melting of old silver coinage and jewelry also important contributors. Historically 17% to 20% of supply has been from scrap. The amount of scrap has fallen slightly as a proportion of total supply and represented 23% in 1996. With continued awareness on recycling and expected higher silver prices, I expect the amount of silver scrap to increase modestly in the next few years
Official Sector Sales
Unlike gold, official sales of silver make up a very small percent (around 5%) of the supply side of the equation. Most of the U.S official inventories have been sold. So have Russian inventories, like most of their other metals. Government official sales in the last 10 years have fluctuated between nil and 34.6M ozs in 1995, with 23.0M ozs. sold in 1996. The larger number in 1995 had a lot to do with India government sales from custom seizures of previous years. In 1995 total official sector holdings estimates reported by the Silver Institute were 175M ozs. with no significant amount in any one place. This number has likely declined some and in any case is not a significant factor on the supply side.
Inventories
The remaining supply to meet rising demand has come from depletion of above ground inventories. This amounted to 148.5M ozs. in 1996 and is expected to be closer to 200M ozs. in 1997. The quality of inventory coming onto the market is decreasing suggesting this supply is running out. I have more discussion on silver inventories further along in this report.
SUMMARY and CONCLUSIONS
The best way to grasp the supply demand picture is too look at the following table. This data comes from Gold Fields Mineral Services under contract to the Silver Institute. Prior to 1995 work was done by the CPM group and Gold Fields recalculated it's numbers from 1985. Prior years data is from the CPM group. There was some incompatible data but these numbers represent a pretty accurate picture that I confirmed from both sources. The exact numbers are not important but the overall trend and developments in the market place is what I want you to focus on.
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Rather than listing all the 1970s data I provided the total Supply deficit for this period. The 1997 data is an estimate. There has been estimates up to the 220 million oz mark, for a supply deficit in 1997. No doubt that there was record demand, but I have stuck with a more conservative number of 160 M ozs. Concentrate on the supply/demand numbers and Implied Investment and note the accumulated supply deficits and surpluses over the various periods. I will come back to the Inventories.
SILVER SUPPLY SURPLUSES/DEFICITS, Millions of Ounces
PERIODTOTAL SUPPLYTOTAL DEMANDIMPLIED INVESTMENTREPORTED INVENTORYIMPIED INVENTORY1978519.5628.2(108.7)488.9488.91979599.7604.8(5.1)476.9483.8Deficit 1972-1979(464.7)1980683.2471.5211.7491.6695.51981573.7446.5127.2471.9822.71982543.7507.436.3463.6859.01983620.8454.3166.5516.81,025.51984541.8482.958.9492.81,084.41985595.3513.481.9517.61,166.31986577.8569.18.7465.01,175.01987610.7569.541.2447.81,216.21988619.7593.726.0456.21,242.21989628.7625.53.2496.31,254.4Surplus 1980-1989761.61990654.6682.4(27.8)518.61,217.61991659.4680.8(21.4)511.71,196.21992632.2714.2(82.2)508.91,114.21993634.4776.6(142.2)481.9972.01994615.8768.9(153.1)486.2818.91995667.9768.8(100.9)652.0718.01996666.4814.9(148.5)562.0569.51997 Est.700.0860.0(160.0)-409.5Deficit 1990-1997(836.1)
The supply deficit in the 1970s led to the dramatic increase in silver prices in 1980 to a peak of around $50/oz. This peak was exaggerated by speculative activity mainly by the Hunt Brothers attempt to corner the silver market. Could this happen again? Yes, the entire annual global supply of silver is only about US$3.5 billion at US$5.00 silver. In today's global market with mobile funds for commodity speculators, large hedge funds etc. these $$ are a drop in the bucket. There has already been some rumors of Investment funds and banks acquiring large chunks of silver. This next speculative bullish phase could quite possibly surpass what we seen in 1980. This will create very volatile swings in silver price that could be drawn out for a period of 3 to 4 years given the current supply/demand situation.
The price binge of the early 1980s caused a dramatic increase of silver to come onto the market as silver hoards, melted coins, jewelry and art works were drawn out with high prices. The accumulated supply surplus from 1980 to 1989 was 761.1M ozs. far surpassing the deficit of 464.7M ozs in the 1970s. This caused a plunge in silver prices which eventually led to long time record lows in silver prices below $US4.00/oz. in the early to mid 1990s.
The record low silver prices caused most primary silver mines to shut down and curtailed exploration to develop new silver mines. The supply remained relatively flat as most supply came from mines where silver was a by-product. In the meantime, the technology/electronic era, new industrial silver uses, developing nations creating wealth and low prices led to increasing demand that had to be met with the excess inventory surpluses of the 1980s. The accumulated supply deficit, 836.1M ozs. of the 1990s has now exceeded the 761.6M oz. surplus built up in the 1980s and has caused a very tight silver market which will no doubt lead to another big increase in silver prices.
THE QUESTION of INVENTORIES
There is very good and reliable data on the supply and demand of silver. However reliable data on inventories is not available. London is the major center for silver trade and the European dealer inventories are the main factor in determining supply and prices. The only published data is the COMEX warehouse inventory. This paints a poor picture of the overall silver market. As you can see in the above chart, the reported inventories have not fluctuated very much with silver prices. Many times in the past, traders have artificially moved inventories out of COMEX warehouses only to move the metal back in again after profits.
Some analysts have taken the view that the 1979 spike in prices must have co-incided with a draw down and a low inventory of silver. I agree with this view and hence you see in the above chart that I have, the reported and implied inventory at 488.9M ozs. in 1978. We can then add or subtract the supply deficit or surplus each year to come up with an implied inventory number.
This has now resulted in the implied inventory number been drawn down to 409.5M ozs., well below the 488.9M ozs. in 1978/79 that led to the big increase in silver prices.
This is supported by the reported COMEX inventories that have been dropping to 12 year lows near the end of 1997. These inventories were down 31% on the year as of Oct/1997. The CPM group, as of Dec. 31 1996 has estimated unreported inventories are somewhere between a low of 102M ozs. and a high case scenario of 327M ozs. No matter how you look at things, inventories are getting dangerously low.
What really confirms the tight inventory situation is two fold. First is the drop in COMEX reported inventories which are likely going into European dealer inventories by being imported to the United Kingdom. Secondly is the high silver lease rates and forwards rates in the market. In the past 10 years these rates have been between 0.5% and 2%. Three month lease rates began climbing above 3% in 1997 and in the last few weeks have been around the 6% range and higher. This reflects the real shortage of inventory and professional short selling activity of silver with gold.
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There is little doubt that the silver bull market has begun with silver making it's first run to 8 1/2 year highs and totally decoupling from gold. Silver began moving up in October from the $4.80 level with a pretty steady rise to around $6.30 just before Christmas. Silver then had it's first good correction in the beginning of January, a typical and healthy market reaction. <‰æ‘œ> Many compare silver with gold and talk about the gold to silver ratio. While this is interesting, I believe there is little to compare between the two metals fundamentally and why silver can quite happily go on it's merry way with or without gold. This is exactly what happened lately as silver has been in a pretty steady rise from the $4.80 level at the end of October 1997 to it's recent 8 year high. This occurred while the gold market was getting hammered to new 18 year lows and illustrates what I have been telling you for months that silver is quite capable to move on its own.
You see silver does not have huge inventories held by central banks to dump on the market nor is it significant enough to mining companies to bother selling forward any significant amount.
HOW HIGH and WHEN will SILVER PRICES RISE ??
This is the only question for the current situation in the silver market. As I have pointed out in examining all the supply and demand sources, there is nothing that could change enough in the current situation to aleviate the imbalance in the market.
It is only a question of how high prices must go to increase supply and curtail demand to bring the market back into balance. The imbalance is now so high that it will likely take significantly higher prices. It will take $8.00 silver prices to stick around for awhile for miners to begin considering opening mothballed mines and step up exploration and development. These new sources of silver will take years to gradually come on stream. Therefore it is likely going to take higher prices to curtail demand from jewelry use and draw out the small remaining hoards of the metal.
I believe because of silver's heavy use in industrial processes and the lack of overhang of supply, even at higher prices, it will take new mine supply to eventually bring balance to the market. Failing that, a global recession would be needed to curtail demand in industry. When you add in the speculative and investment demand we will likely have several years of volatile price swings in a bull market. I believe $8 to $10 silver prices is a pretty sure bet in the next 3 to 18 months. The odds are very high, judging by past situations like this, in silver, that we could see much higher prices and lots of volatility in a good long bull market. |
