The Curious Case For Silver
It has been a difficult year for silver investors with the metal falling by 36% year-to-date. While the Federal Reserve balance sheet continues to expand, ‘taper’ discussions by the Federal Open Market Committee have weighed heavily on the price performance of all the precious metals this year. By our calculations, over the last five years, silver has a beta to the gold price of 1.5x. This implies that price changes in gold are magnified in silver.
Combine this with an 80% correlation in the price action between gold and silver over the same time frame, and it is easy to see that, where the price of gold goes, the price of silver goes faster. As we break down the fundamentals for silver, market developments this year give rise to a curious conundrum - how can the case for silver be stronger while the price continues to languish? We begin with investor sentiment.
We use current ETF holdings and coin demand to gauge investor appetite for the metal. In both cases, demand has been robust. Last month, the US Mint confirmed a record year for sales of silver coins, and we still have four weeks to go.
Authorized purchasers of the coins ordered their full weekly allocation of 500,000 coins, bringing the total sales to date this year to a record 40.175 million ounces, the Mint said. That sales figure topped the previous annual record of 39.869 million ounces seen in 2011.1 Yes, the roughly 40 million ounces of silver only accounts for, maybe, 5% of overall demand, but it also represents a huge increase from a decade ago when it comes to investor interest in physical metal. In fact, globally, silver investment demand is up from essentially ZERO just 10 short years ago.2
Silver ETFs continue to add to holdings as well. According to Bloomberg, holdings across all silver ETFs have increased by 4% so far this year, and 6% over the last 12 months. Compare that to gold ETF holdings, which are down 30% so far in 2013 - a shocking contrast. Silver investors have added to their positions during this price decline. However, this is not even the biggest news in silver this year.
Last month, somewhat surprising news came out of India that roughly 130 million ounces of silver were imported into that country in just the first six months of the year. Recent data confirms that this trend is continuing. Data from Thomson Reuters GFMS shows that India has continued to be a massive new buyer in the market, with India’s silver imports rising to a three-month peak in October, putting them on track to hit a record this year. Buyers there are choosing silver over gold to meet high seasonal demand.
Silver imports jumped 40% to 338 tonnes in October from 241 tonnes in September, GFMS data showed. “By the end of the year, silver imports should be at 5,200-5,400 tonnes,” said Sudheesh Nambiath, an analyst with Thomson Reuters GFMS. This would be more than India’s record high purchases of 5,048 tonnes in 2008.3
For perspective, the world’s silver mines produce approximately 24,000 tonnes of silver, so this new buyer is purchasing approximately 22% of world silver production compared with almost zero last year. When you consider that approximately half the silver production is used for investment purposes, they are on track to buy 44% of the world’s mined silver available for investment. This phenomenon is unparalleled in the precious metal markets this year and represents a tectonic shift in silver market demand. One might expect a price reaction to this news, but none has been evident. In fact, silver has seen its biggest annual drop in at least three decades.
The price has fallen so fast that it has been difficult for most miners to adjust their costs appropriately and, in many cases, the price for silver has dropped below its marginal cost of production. In a note last month, Dundee Capital Markets revealed that the all-in cash costs of the silver producers it covers fell an average of 13%, to $20.08 per ounce, during the third quarter of this year.4
With silver languishing at approximately $19, most major miners are losing money on every ounce produced. We have already begun to see production increases curtailed in this new environment, which should give further support to the metal price in the future.
From looking at the chart of silver prices you would never know that such fundamental changes have taken place in the silver market. Investors have ignored doomsayers and continue to add to their physical and ETF positions. And why shouldn’t they?
If there is a full global economic recovery, industry will continue to consume half the silver mined in any given year, which will support prices. If there is no recovery, continued monetary support from the central banks will debase paper currencies, further supporting an allocation to the metal. With the addition of a massive new buyer to the market this year, it cannot be long before investment stocks of silver reflect this new reality. Further support to the price can be seen from the fact that it now costs more to produce an ounce than it is worth, providing investors an opportune entry point.
So, let us summarize to get this straight: if you believe in a global economic recovery - buy silver. If you believe that there is not going to be an economic recovery and that we will continue on ‘central bank’ life support - buy silver. A major new buyer has entered the market purchasing as much as 20% of the total world production this year for investment purposes - follow the money and add some silver.
To top it off, at the moment, it costs more to produce silver than to purchase it. Is it any wonder that investors continue to add to their positions and have driven coin demand to a new all-time high?
The most curious part of this fundamental case for silver is why the price is not higher.
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