Article bullish on Silver:
The Silver Market
On November 12, 1996 we issued a report on silver to our clients as it was making a two year low. In that report (
which you may read below ) we elucidated the very bullish supply/demand situation and that a substantial price
move to the upside would have to occur to ration future, diminishing supplies. We issued repeated bullish
commentary to our clients during 1997 and have included a recent commentary for you to look over.
For those of you that have an interest in silver we send out periodic reports to our clients via the Gold Watch Fax
Service.
Gold Watch, November 12,1996
Are There Exceedingly Large Shorts in Silver?
The Silver Market
Last week Scotia Capital Markets held a conference on silver. It featured speakers from numerous silver
companies as well as Philip Klapwijk who represented Gold Field's Mineral Services (GFMS) and the annual
World Silver Survey which they conduct for the Silver Institute. The GFMS silver survey has reported an annual
supply/demand deficit in the silver market of roughly 150 million ounces (approximately 20% of annual global
demand) over the last several years.
All the speakers at the conference---Philip Klapwijk from GFMS, Ted Reeve and Felix Freeman from Scotia Capitol,
and many of the silver mining company speakers---all assumed that there was a very large deficit in the silver
market. Mr. Klapwijk reported that GFMS' preliminary work for 1996 pointed to a slightly larger deficit this year.
Because most silver is a by product of base metal production---particularly lead and zinc, both of which have low
secular rates of growth of global demand---GFMS projects a continued large annual deficit in the silver market if
prices stay at current levels. Although there are vast hoards of above ground silver stocks in the form of jewelry
and silverware, the quantity that is readily available in the principal depositories in the US and Europe has been
dwindling rapidly, with perhaps less than 500 million ounces---three years of the current annual market
deficit---left to be drawn down.
On the day of this conference, the silver price was plunging to almost a two-year low. The fact that virtually all
the participants at the conference believed a large deficit in the silver market exists, coupled with a plunging silver
price, posed the dilemma: either GFMS is very wrong about the silver market deficit or the market is very wrong
about the silver price. Philip Klapwijk, when asked about the weakness in the silver price this year, reported that
one very large physical holder (whose name he would not disclose) was a large liquidator of silver this summer.
We have heard rumors that the last of the large speculators, who put on large long silver positions three years
ago because the silver market was in an unsustainable deficit, threw in the towel this year. This is striking since
all the data on the silver market and silver depository stocks suggest that this bullish thesis embraced so widely
three years ago is largely correct and that we should now be seeing upside pressure on the silver price.
In this regard, we are inclined to agree with Ross Beaty of Pan American Silver. Ross stated at the conference that
in fact there is a large and unsustainable deficit in the silver market and that the current price is likely to look in
hindsight like a major low. As we suggested earlier in the year, the silver market is likely to act like the grain
markets in recent years. The grain markets went into deficits in the 1990's amid average global weather conditions.
In 1993, when heavy rains in the US caused significant but not severe global crop damage, stock to consumption
ratios went to near record lows. Speculators then took a run at the grain markets. However, aggressive producer
and consumer selling, despite low global stocks, followed by the best weather and crop yields in memory, forced
these speculators to sell. In 1995, as world weather conditions turned gradually adverse, global stock to
consumption ratios fell to new lows. Grains went into a major bull market that was quite unique in that grain prices
exploded without a severe weather induced supply shock. Pervasive bearish attitudes on commodities in general
encouraged economic agents to let grain stocks get so low that only a mild supply shortfall was needed to create
a major bull market. Our guess is that some day a further and gradual erosion of silver stocks will "mysteriously"
ignite a comparable bull move in silver.
Are There Exceedingly Large Commercial Shorts in Silver?
GFMS data show a cumulative volume of producer hedges in silver since 1990 of less than 60 million ounces. We
know that gold producers have established more than half of their outstanding hedges since 1990. If silver
producers have done the same, the GFMS data implies an outstanding volume of silver producer hedges of 100
million ounces or less. On the other hand, Ted Reeve does an annual hedge survey of North American silver
producers. He restricts his survey to North American based companies and only surveys primary silver and gold
producers. Silver and gold producers (as opposed to base metals producers) account for far less than half of
global silver production. North American primary gold and silver mining companies account for perhaps half of
global silver production by such primary. These two considerations would suggest that the universe he surveys
might encompass roughly a quarter of global silver production. Yet his survey shows that the outstanding
hedges of these companies exceed 80 million ounces. This would imply an outstanding global silver producer
hedge that far exceeds Gold Fields' estimate of 100 million ounces or less.
It has been our view that there are large outstanding silver consumer borrowings of silver as well. We asked
Philip Klapwijk about this possible understatement of silver producer and consumer hedges. He responded with
the following comments:
1.Gold Fields Mineral Services does not do an annual survey of producer hedges such as they do for gold.
Therefore, it is possible that they understate total hedges, but they probably do not understate this total
by a large amount.
2.Though base metal producers do account for the majority of global silver output, silver is a minor by
product source of revenue for them and he doubted that they contributed significantly to total producer
silver hedges.
3.Though there are undoubtedly some silver consumer hedges, GFMS has not focused on them and does
not believe they are significant.
We do not agree with Mr. Klapwijk on these points. First, if one compares Scotia McCleod's estimated aggregate
gold hedges by North American producers to estimates of gold hedges by producers domiciled elsewhere, it
appears that the North American's account for slightly more than half of estimated global gold producer hedges.
If one applies a similar ratio for silver hedges by the primary silver and gold producers that Scotia surveys, one
would arrive at aggregate silver hedges of 150 million ounces by this group alone.
Second, Philip is not correct in surmising that base metal miners ---the principal producers of silver---would not
hedge silver. We know from all the publicity directed at the recent gyrations in the copper market that copper
producers have been very aggressive hedgers of copper. They have hedged their copper output despite a
significant backwardation (or forward discount) in the copper market. With such evidence of a predisposition to
hedge output, would they not find the almost full contango in the silver forward market an incentive to hedge
their silver by product output as well? In the early 1990's I acted as a consultant to a major copper producer and
recollect that they hedged their by product precious metals output as a matter of course because of the high
contango in the precious metals forward market. At the Scotia conference, Fred Graybeal of ASARCO showed
that base metal mining companies account for approximately 70% of world silver production and that primary
silver and gold producers account for only 30% of total silver output. If base metal producers hedge their silver
by product output with less than half the intensity of primary silver and gold producers, aggregate global
producer hedges of silver might be on the order of 300 million ounces.
Third, we believe that consumer silver hedges are very significant. We understand that at least two chemical
companies have been running 8-10 million ounce silver lease positions for many years. One large US dealer
reported to us that the aggregate silver borrowings of the large US consumers he worked with approximated 50
million ounces. One must assume that consumers in the rest of the world (which accounts for roughly 80% of
global silver fabrication) borrow silver in some fashion as well. We understand that, in this year's bearish silver
environment, one or more new large silver consumer borrowings have occurred. We have no difficulty projecting
global silver consumer related borrowings of 100 million ounces and possibly much more.
Conclusion
We would not be at all surprised if outstanding producer and consumer related silver borrowings are on the order
of 400 million ounces. This is a large number in relation to silver demand (750 million ounces), the silver market
deficit (150 million ounces), and outstanding bullion stocks in the principal silver depositories (500 million
ounces). When the bull market in silver eventually occurs, some of these consumers and producers are going to
try to reduce their borrowings. If this silver bull market attracts large speculators who see the logic of taking
possession of the European silver stocks and refuse to lend silver (as happened, perhaps prematurely, in 1995),
silver lease rates could rise sharply, further encouraging reductions in silver borrowings by producers and
consumers. In a silver bull market, speculators will try to own the dwindling silver stocks remaining in the
principal depositories. At that point these stocks will have declined to a level that approximates outstanding
silver borrowings. The question arises: if producers and consumers attempt to repay outstanding silver loans but
the remaining available silver bullion stocks are low and are in firm hands, how will these loans get repaid?
In the short run, a serious physical squeeze and possibly a successful "corner" may develop in the silver market.
In the longer run, of course, the silver price will rise enough to induce a flow of silver from private hoards of
bullion, silverware, and jewelry which will clear the market. In the grain market, farmers and grain elevators
aggressively hedged all price rallies; when the grain bull market finally materialized, difficulties were experienced
by these commercial shorts and these difficulties helped fuel the bull move. It is our guess that something similar
is likely to occur eventually in the silver market.
Gold Watch, February 4,1998
Silver
HI HO SILVER!
Warren Buffet Rides Again!
It has been our position that:
The silver market has been in a large deficit.
The decline in Comex silver stocks was largely due to this deficit.
Silver would rise, progressively detaching itself from gold, as there are no central bank supplies of silver
as there are of gold.
There was one very large short side spec in silver.
So was Phibro, who has just been sued for market manipulation. This long side play has been criticized by Martin
Armstrong of Princeton Economics in reports which have been widely read on the Internet. Armstrong was the
reputed large short side spec in silver in 1997. Armstrong's complaints about manipulation in silver suggested to
some that he remained short.
If today's press reports are true, Warren Buffet is at least one of the long side speculators in silver. This is very
ironic. In 1995, Phibro purchased a huge silver position on the grounds that the market was in a large deficit.
Phibro eventually sold its position, with some reluctance. Now, two years later, Buffet has taken a similar position
with no doubt the same rationale.
The market's believe Buffet is god. Everyone may now try to buy silver. The Comex trend following funds are
already very long. Alas for Martin Armstrong, if he is still short. The existence of a large deficit in silver and the
inevitability of a significant rise in the silver price has been obvious since Phibro made its initial move in 1995. It
has been remarkable how long it took for "rational expectations" to take hold in this market. Now that Buffet has
taken a long position, the pendulum will probably swing; the markets will probably assume that what should have
been obvious years ago is now obvious and they will probably act accordingly.
Will the markets view Buffet's move as an isolated act or a move away from bonds and deflation toward real
assets and reflation? The latter interpretation could lead market participants to focus on gold's positive long run
supply/demand fundamentals rather than threats of global deflation and central bank selling and encourage a
renewed phase of short covering in gold.
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