Tuesday, May 1, 2012

Higher Silver Inventory Could Lead To Rising Prices

The content of this post  is something that has been playing on my mind for awhile, but I have not had a chance to easily put pen to paper (figuratively speaking) to write it (time constraints and struggled with an easy way to broach the topic). 

Luckily I noticed that Bron Suchecki has given me a succinct opening to get started.

This is an excerpt from Bron Suchecki's blog a couple of days ago:
If Sprott and Baker "are students first and foremost of the physical market" then they surely are aware that the one thing which makes gold different from all the other physical markets on earth is its huge above ground stocks relative to new mine supply - 170,000 tonnes versus 2800 tonnes.
This, I suggest, is a quite material fact and one which may be where "the gold is going to come from". Unlike "any other market", to which conventional supply/demand analysis can be applied, one cannot understand the gold market by just looking at annual supply/demand numbers when there is such a large overhang of stock.
What drives the gold price I would therefore argue, is not so much demand, but to what extent existing holders of the 170,000t will withhold it from the market. It is actually supply - the withholding of supply - that matters most. If even a small fraction of these holders decide to sell, then that supply "will soon overpower" the physical market, China or no China. This is not a negative statement. The decade long gold bull market is a message that the existing holders are requiring higher and higher gold prices to let go of their gold and that the new holders are more likely to withhold it. Gold Chat
In the above post Bron takes aim at an article from Eric Sprott and David Baker in which Sprott/Baker question where the Gold is going to come from given the increase in demand from China and other countries who are increasing their Gold reserves (such as Mexico, Turkey, Russia and Kazakhstan).

They come up with a poor comparison in the article, asking what would happen to oil if a similar increase in demand was to occur, given the supply limitations...
Could you imagine, for example, if the demand shifts described above were applied to the global oil market? What would happen if a single country came in from nowhere and increased its oil purchases by a factor equivalent to 30% of the world's annual oil supply?
The example provided in Sprott/Bakers article (oil) is a commodity which does not have significant above ground reserves. Wikipedia says there are 4.1 billion barrels of oil held in global strategic reserves:
Global strategic petroleum reserves ("GSPR") refer to crude oil inventories (or stockpiles) held by the government of a particular country, as well as private industry, for the purpose of providing economic and national security during an energy crisis. According to the United States Energy Information Administration, approximately 4.1 billion barrels (650,000,000 m3) of oil are held in strategic reserves, of which 1.4 billion is government-controlled. The remainder is held by private industry. Wikipedia
Barely enough to last a couple of months at current consumption levels.

As Bron points out on his blog, the above ground Gold reserves provide an abundant supply of Gold to those looking to increase their position at the right price (e.g. rather than mining supply vs new demand setting the price it's instead those who hoard the existing supply of Gold who do)

You're probably thinking "What about Silver? This article was supposed to be about Silver!"

Hold your horses, I'm getting there...

In an article last year I talked about how the price of Silver was in limbo with industrial demand waning which was pushing the price lower while the monetary (/speculative) demand was pulling the price higher (you can read the previous blog here). 

At the moment the pricing mechanism for Silver is positioned somewhere between Gold and Oil. It is both a consumable and an asset hoarded by those who think the price is set to rise.

A chart graphing data from CPM group shows that Silver inventories have been rising for the past 7 years:

Silver Inventories (above ground supply)

It's currently around a level which would provide 20 months supply for industrial purposes, which is significantly more reserves than 2 months worth of oil supply.

Most commentators have been fairly critical of this rising Silver inventory, but the truth is this overhang could push Silver toward a pricing system which is less reliant on consumption/industrial demand and would rather allow speculators and hoarders to control the price based on the price point they are prepared to sell at. 

What will this mean for the price of Silver?

As I have pointed out numerous times on this blog I am of the expectation that Gold and Silver will head into a bubble within the next couple of years (in a parabolic rise that will shock many). The change in Silvers pricing system will allow it to break free of the constraints that the previous supply/demand pricing system held over the metal and we will see Silver rise much more significantly than Gold (reducing the current Gold:Silver ration by half or more) as speculators pile into what will be considered the cheapest metal.

So I would suggest that increasing Silver inventories could have a positive influence on the price of Silver in the short to medium term, it is a sign that more participants are coming into the market or that those that are already holding Silver are increasing their positions.

But what will this mean for Silver over the longer term?

With the Silver hoarders now having a larger influence on the price they will be responsible for both the significant rise I expect we will see in the price of Silver as well as the crash that will undoubtedly follow as everyone panics out of their positions flooding the market with more physical than the industrial demand can make use of.

The below comments from Jeff Christian (comments section of Chris Martenson's site) point to some of the risks that Silver faces as a result of the stockpiling of Silver in ETFs and similar products:
I happen to believe that the Sprott silver investments may prove to be the downfall of silver. Remember: I am long silver, in contrast to all those inaccurate disparagements of me that have me an enemy of the metal. In fact, I was telling our clients back in the early 1990s that silver would rise sharply at some point in the distant future. But back to Sprott: Look at what his molybdenum specialty fund did to the molybdenum price, the equity prices of moly producers, and the investors in that fund, in 2008 and 2009. I think that is indicative of what could happen in silver. Sprott has amassed an enormous position in physical silver and in most Canadian listed silver mining companies. When investors grow tired of his funds and start to liquidate, Sprott will be in a mechanical position in which it will have to dump silver and silver stocks. This could trigger a massive liquidation. Link
And in another comment:
You asked about my comments on Sprott's fund being a hole in the armor of the silver market. I may be over-emphasizing his fund's size. I thought he had more metal. Regardless, he has other funds with too large of positions in silver mining shares to be easily liquidated, and Sprott as a company has shown itself to be like a rat on a sinking ship in other markets (and silver): They dump as soon as things look ugly.
Actually, the issue is more ETFs. I am on record for years as warning that the mechanical nature of physical metal ETFs management is a big risk to these markets. In fact, there was a commentary that we wrote presumably confidentially to the SEC when it was first considering permitting silver ETFs that somehow became public about some of the risks we saw. One was this.
Hedge funds, in contrast to public ETFs, have an orderly liquidation process. You have to signal your intention of redeeming shares typically 60 to 90 days in advance, to give the manager the opportunity to liquidate positions in an orderly fashion to match the upcoming redemptions. Physical ETFs do not have such management discretion. Investors go only and sell shares. If the sale is not met by ready purchase orders in the market, the market makers have to buy and hold them in the market. The market makers generally will redeem heavy sales flows (see what happened in the first half of May last year, and, on a smaller level, what happened in April last year). If investors say sell, or click the sell button on their computers, the managers of the ETFs have to sell at that time regardless of the price. So, prices could cascade downward in such an event. Obviously the SLV is the biggest worry, with 312MM oz, but the others could be worse, insofar as they may be sold in less liquid markets. PSLV has only 32 MM oz, so it is somewhat less worrisome, but I also am focusing on the silver mining shares held by other Sprott funds. Link
Of course the Silver held by the ETFs will only be a concern if you believe they truly hold the bars claimed and don't blow up trying to deliver the physical metal in the meantime (/tongue in cheek, I personally believe that they have the Silver they claim).

If I'm right then we're certainly in for a bumpy ride over the next couple of years, but at least we can rest easy that the Silver bull market can continue despite an increasing above ground inventories. Just make sure you're ready to exit before the rest of the hoarders decide to unleash their stockpile on the unsuspecting late comers to the bull market.


3 comments:

  1. but what would drive people to push up their silver inventory? Unlike Gold its not really a defacto monetary standard

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    Replies
    1. Silver has a long history as money, although it's end is not as recent as 1971 when the US completely abandoned the Gold standard. There is a good breakdown on The Daily Reckoning here:

      http://www.dailyreckoning.com.au/silver-a-brief-history-of-de-monetisation/2010/06/29/

      Silver has many of the same properties that Gold does, they are both a good store of wealth IMO.

      I think Silver's price point is what attracts the retail investor, it was certainly a draw card when I started and I had a lot of Silver stacked before I started buying Gold.

      Currently the Gold/Silver ratio is around 53:1. I think the perceived value in Silver will see it outperform Gold from these levels even if it's history as a monetary metal isn't as rich as Golds.

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  2. Yes, Silver price is at high now and more high are expected. Q3 implication support silver price to rise higher and it is technically strong as well. Many of the experts expect silver to rise above $44 in coming months. There may be a best opportunity to invest in Silver for medium term for some quick profits.

    ReplyDelete