Silver: A Supply-Demand Tightrope Act

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Silver is a special story. Without a doubt it’s a supply-and-demand tightrope act. There’s a limited supply, and it’s tied up in markets where demand could suddenly soar. As such, it’s a wild ride that tends to scare investors who don’t understand the whole story.

It’s not difficult to visualize how silver could go parabolic. Fundamentally, it’s a thin, small, emotionally charged market. The holders of silver tend to be true believers, who invest in a physical market dominated by paper futures contracts handled by shady bullion banksters, such HSBC and JP Morgan. The banksters lean (sell short) on the market to the tune of 125 days of silver production. As such, it’s the ultimate bet on trouble for the sistema and the demise of TBTF banksters.

For those who believe in the eventual triumph of classical economics, silver is a compelling asset to hold. Due to shorting and manipulation, it’s also one of the ultimate assets in the world for which price discovery has been completely destroyed. Without price discovery, distortions occur, and things become increasingly imbalanced.

One of those imbalances from false price signals causes silver not to be mined in sufficient quantity. Mining supply in silver is shockingly modest at about 800 million ounces a year — or a mere $18 billion a year, which is chump change along side bullion banksters and hedge funds.

There are currently 153,000 silver contracts of open interest on the Comex.  That’s 765 million ounces, or about a year’s silver production. This lends special meaning to Charles Kindleberger’s theory of “overtrading.” There was confirmed volume last Thursday of  84,526 contracts:  422.6 million ounces or 60.2% of annual silver production. Against this trading, there is 39.74 million ounces of registered silver in Comex warehouses.  There’s no other commodity quite like this in Paper Futures Land.

The all-in cost for mining silver is on average about $22. If silver dips lower than its current level, you will likely see production slip away. Silver is often produced as a byproduct of porphyry deposits, but those projects involve capex in the several billions and are currently in the penalty box.  Big gold (18.5 million oz.) and silver (526 million oz.) projects with considerable promise, like Metates in Mexico owned by Chesapeake  (CHPGF), sit neglected in the market. Mr. “Market” values this company at $212 million market cap and only $170 million enterprise value when working capital is subtracted.  Any value investor even modestly interested in silver should consider this name.

There’s little if any government stockpiles left in the world. China and the U.S. simply have none left. In 2001, China exported 100 million ounces, and in 2011 imported 100,000 ounces. Scrap prices are elastic, and some materialized in China when prices spiked two years ago. But there’s little scrap incentive at $23. Other than solar panels, industrial use gets consumed. There’s one gram of silver in laptops, 75 cents worth is hardly worth the trouble.

Investment demand for silver began to pick up during the big silver run up of 2011, and Chinese investors did some bargain hunting in 2012.  There are numerous reports, both anecdotal and in the news, that precious metal demand has spiked as a result of the April silver swoon. However, 20 million ounces shown on the Chinese retail chart below is modest compared to U.S. Mint sales. In 2012, 33.74 million ounces were sold from the Mint. Year-to-date sales in are running almost 60% higher still, with huge sales in April. Since the Mint reports sales regularly it should be a good tell on physical takedown.

Chart source: U.S. Mint

The estimate of commercial-grade investment silver that is above ground is about 2 billion ounces. In dollar terms, that is only $46 billion — a modest amount should an investment spike in silver occur. In the SLV ETF, 336 million ounces is held, and another 49.3 million ounces is at the Sprott Silver Trust (PSLV). The latter has been trading at a rare, slight discount, a represents a good opportunity. The draw down in the SLV was 13.3 million ounces during the swoon. Given the so-called “panic,” it’s in relatively strong hands.

In terms of mining supply and demand, there has been about 300 million ounces of silver available in excess of fabrication, minus coins and medals. Again, that’s only $7 billion, and it illustrates how little investment and speculative demand it would take to launch a bull market.

On the industrial demand side, it’s critical to recognize that silver is an antimicrobial and antibacterial cleansing agent. There has been spin about the commodity super-cycle ending because of a slow down in Chinese demand. I do believe a major slow down is getting underway in China and that some commodities will be affected.

But China is also an environmental cesspool, with extreme air pollution, thousands of animal carcasses floating in its waterways and a recent outbreak of deadly avian flu. Silver is one of the best antimicrobial protectors on the market. It’s also used in telephone receivers, door handles, bed rails, toilet seats, counter tops, children’s toys, socks, underwear, bed linen, towels, makeup, antibacterial soaps, water purification and autocatalysts. China is facing a national environmental and health emergency that is greatly underestimated and for which silver prices will not be elastic. This is one of the untold stories of silver.

In the same vein, China is committing to clean-energy photovoltaics (PV). One thick film (91% of installations) PV panel uses two-thirds of an ounce of silver. Reuters reports that China aims to add 10 gigawatts (GW) of installed solar power capacity this year, up from 7 GW at the end of last year, according to a Chinese government website (www.gov.cn). Its PV goals for 2013 will put China within easy reach of its stated target of 21 GW of installed solar power capacity by 2015.

The pause on solar panel growth shown on the next chart came from the end subsidies in the U.S. and Germany. However, Japan recently announced it’s offering 20-year, 53-cent-kwh power purchase agreements for solar developers — an amount that’s nearly three times higher than the cost of conventional fossil-fueled electricity production.  Therefore, I expect silver demand from China and Japan for PV systems to double over the next few years. Combined with an antimicrobial offense in China, the 200-300 million ounces left over for investment will be eliminated, leaving 2 billion ounces of investment grade silver to fight over.

On the question of whether a big elephant might jump in to juice the thin market and suddenly snatch up 100 million ounces (a couple billion dollars worth): Warren Buffet has done so in silver before and is one of the usual suspects. Buffet is secretive, but it suffices to say he is bullish enough on PV that he’s investing in the largest solar PV project in the world in California. Given his historical interest in silver, I wouldn’t be surprised if even he doesn’t connect all the dots.

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  • http://www.winteractionables.com Russ Winter

    Dowa Holdings Co. (5714), Japan’s biggest silver producer, will raise output 40 percent this year to meet solar-cell demand after the 2011 Fukushima disaster crippled a nuclear power plant and sent fossil fuel costs higher.

    The Tokyo-based company plans to produce 500 metric tons of silver in the year that began April 1 from 357 tons in the previous year, said Hiromitsu Takagi, manager of the strategic planning and public relations department at Dowa Holdings. That would be the most since 2006, the company said.

    Japan is expected to become the largest solar market after China this year, according to estimates by Bloomberg New Energy Finance, or BNEF. The forecast reflects the push by Japan to find alternative sources of energy following the earthquake and tsunami, which prompted the shutdown of all but two of the nation’s nuclear reactors. A rise in demand may support silver, which entered a bear market on April 2.

    http://www.bloomberg.com/news/2013-05-12/dowa-boosts-silver-output-to-meet-japan-post-quake-solar-demand.html

  • shinji
    • http://www.winteractionables.com Russ Winter

      Paying a 40% premium is nuts, they should just go with no premium PSLV.

  • http://www.winteractionables.com Russ Winter

    Andrew Maguire reports that gold into Shanghai has now topped 1000 tonnes of physical gold. This does not include 25 tonnes per day arriving into China through other ports.

    Harvey Organ reports:

    On Comex: The dealer inventory rests tonight at 2.280 million oz (70.9) tonnes of gold. The total of all gold at the comex rests at 8.781 million oz or 273.3 tonnes. The comex is slowly losing its gold both at the dealer end and the customer.

    The CME reported that we had 42 notices filed for 4200 oz of gold today. The total number of notices so far this month is thus 10,415 contracts x 100 oz per contract or 1,045,700 oz of gold. In order to establish what will be the total number of gold ounces standing, I take the OI for April (585) and subtract out Monday’s delivery notices (42) which leaves us with 543 contracts or 54,300 oz left to be served upon our longs.

    Thus we have the following gold ounces standing for metal:

    1,045,700 (served) + 54,300 oz (left to be served upon ) = 1,100,000 oz or 34.21 tonnes of gold.

    This is turning out to be a very big delivery month!1

  • http://www.winteractionables.com Russ Winter

    Kyle Bass at 42:00 discusses Comex gold “fractional reserve exchange”.

  • http://www.winteractionables.com Russ Winter

    9:13 AM A massive wave of Asian buying of precious metals is emptying dealer shelves across the region. “I haven’t seen this (kind of) gold rush for over 20 years,” says the head of the HK Gold & Silver Exchange, adding that old-timers haven’t seen anything like this for 50 years