Understanding Silver Market

Silver, the metal, has come a long way as a medium of exchange. It is an indispensable metal in today’s information age having a long and abounding history.

Mankind’s timeless fascination with silver began more than 6,000 years ago. The usage of silver coins can be traced back to the Eastern Mediterranean region during 550 BC. As early as 700 BC, the Mesopotamian merchants stepped further and used silver as a medium of exchange. Later, many other civilizations came to depend on the inherent value of silver as a trading metal. Rome adopted silver as part of its standard coins and that triggered silver to become a medium of exchange for merchants throughout the world. Until the termination of the Bretton Woods Gold Standard in the early 1970s, the international community used gold and silver to back their currencies. However, going by the white metal’s abundant availability and lower cost in mining when compared to gold, it has always been the metal of everyday business.

Indeed, over the years, silver has become synonymous with beauty, wealth, style, and health. For instance, the adage “Born with a silver spoon” is a reference to a prosperous background. The main attraction of silver is the diversity of its uses. It has a number of unique properties that set it apart from other metals. These include strength, malleability, and ductility; electrical and thermal conductivity; and its increasingly important medical application as a bactericide. These properties allow scientists and engineers around the world to undertake research that has an impact on our lives. There are myriad of contemporary uses of silver, including general industrial applications, photographic applications, and jewelry and silverware.  Silver is also an important industrial catalyst, vital for production of various widely used products today, including certain types of plastics.  New silver oxide batteries have twice the electrical energy storage density when compared to lead-acid batteries.  The healthcare industry uses silver extensively, for everything from water and air purification to X-ray applications.  The fascinating list of uses for silver goes on and on, and could easily fill reams.

The demand for silver is built on three main pillars; industrial usage, jewelry and silverware, and photography. Together, these three categories represent more than 95% of the annual silver consumption. However, the photography industry is a large user of silver and is an important ingredient in both, the manufacturing of film as well as film processing. Silver is in demand because of its unique properties.

While Silver is found in many parts of the world, the largest producers were Mexico, Peru, Australia, the US, and China as per 2002 statistics. Primary mines produce about 27% of the world’s silver, while around 73% comes as a by-product of gold, copper, lead, and zinc mining. Silver from recycled materials accounts for about 20% of world silver supply, coming primarily from used photographic materials. However, silver bullion stocks have made another significant component of silver supply in the recent past. Robust demand for silver in the 1990s outpaced conventional supply – mine production and recycled scrap – leading to a substantial decline of bullion stocks held by governments and investors. From 1990 to 2000, bullion inventories declined by more than 1.2 billion ounces. Silver prices in general tend to follow the ebb and flow of the economy. According to industry sources, during the first quarter of the calendar year, silver prices generally increase, with February and March being the strongest as industrial production tends to be strong. The price of silver usually decline during the late spring and summer months as industrial production slows down.

Silver Market

silver consists of two types of markets – physical markets, which are operated by bullion dealers, banks and commodity dealers; and paper silver markets. The London bullion market is the leading physical market, which is also called as the global hub of OTC (Over-the-Counter) trading in silver. Metal industry participants use the exchange for hedging, to protect themselves against adverse fluctuations in metal price. In this a bidding price generates a daily reference price known as the ‘fix’. The New York Mercantile Exchange (NYMEX) is the largest physical commodities futures exchange in the world – trades in oil, gasoline, heating oil, natural gas, propane, silver, gold, platinum, and palladium. The COMEX (Commodity Exchange) division’s silver futures and options contracts are used by a wide variety of market players in the silver industry to hedge price risk. Silver futures and options are also used in investment portfolios. Silver is invariably quoted in the US dollars per troy ounce. COMEX trades millions of ounces of silver on every trading day in paper silver. Experts say that it can manipulate silver prices at its will, by shorting, going long, or betting in any way it may choose, as long as no one asks for delivery.

Silver vs Gold

Throughout the history, silver has served mankind as the primary monetary metal. However, unlike fellow monetary metal gold, most silver use is non-monetary. The industrial demand for silver is quirky. Unlike gold, silver is an extremely critical metal for all kinds of high-tech manufacturing applications.  The Industrial demand for silver is large and growing by leaps and bounds with the proliferation of new computing and communications devices. Silver’s industrial demand is voracious and growing almost regardless of how high it runs. However, silver appears to be undervalued over the years at least from the crucial supply and demand perspective. Going by this, the industrial commodity is set for a massive leap in price. Commodity experts say that the primary motivation for curbing silver price is probably peripheral to gold. In general, both will go up with the declining value of the dollar and other currencies.

Despite huge supply deficit, why silver has not experienced the rally that gold has, in the past? Perhaps, because lack of investment demand and futures traders are willing to sell significant amounts above $5. According to World Silver Survey 2003, one important difference between the two metals was that gold seemingly attracted a few longer term ‘buy-and-hold’ investors, whereas, silver appeared to be of interest only to short-term players, which made it difficult to hold on to gains.

China’s Role in the Silver Market

Since 1999, China has emerged as the single-most significant factor in the silver market, as a large silver producer, a most challenging factor. The Silver Institute estimates that the Chinese government has disposed off more than 225 million ounces of silver inventories since 1998. There has been a lot of talk about China and its impact on the price of silver. The mainland has dramatically been increasing its share of the world’s silver refining capacity to keep silver prices artificially low, by dumping silver on the market and shorting like crazy on the COMEX, in order to drive other refining competitors out of business. In spite of an obvious attempt to show how much silver China was producing and exporting, there the stark was reality that the Chinese government sold (dumped, via leasing) more than 50 million ounces of silver in 2002, from official government stockpiles.

Recent statistics show a worldwide deficit in silver of around 65 million ounces. This means that just China alone supplied almost 80% of the existing inventories necessary to balance that deficit. Rightly speaking, this specific donation from Chinese is so specific, without which the silver prices would have been much higher. If the Chinese don’t dump more than 50 million ounces of existing inventory on the market, one has to run after the other sources, which are likely to demand higher prices. That’s how markets work. Stated simply – China, just about by itself, has kept silver prices depressed.

Investing in Silver

Like the equity markets, fundamentals ultimately drive the commodities market’s supply and demand.  If the demand for a particular commodity is greater than the supply, its price will be bid-up in the free markets until equilibrium is reached and the market “clears” with demand, perfectly equaling supply.  If the supply of a particular commodity is greater than the demand, its price will be sold-off enough to kick-up demand and reduce supply so the twain meet comfortably at a middle equilibrium point. According to Adam Hamilton, founder, Zeal Intelligence Research, US “The macro-forces of supply and demand ultimately move market prices that are certainly not rocket science, but core supply/demand fundamentals are very important for prudent investors to keep in mind. Long-term investors are successful only when they let fundamentals drive their major buy and sell decisions, not fleeting emotions.”

Today, silver is sought as a valuable and practical industrial commodity, and also as an appealing investment. It enjoys the dual role of an important industrial as well as an investment metal. Going by its value, on the investment front, millions of individuals throughout the world recognize silver’s intrinsic value and have included it in their investment portfolios. According to the Precious Metals Advisory Newsletter, published by the CPM Group, a specialist precious metals consultancy based in New York, investors have been increasingly interested in silver. Among the groups of investors who are focusing on silver, many are institutional investors and large fund management companies. These companies often avoid investing directly in commodities. Instead, they invest in mining company stocks as a proxy for the underlying metal. Given this, silver mining stocks are attracting a lot of attention at present, the CPM Group concludes. However, analysts say silver has been in a major bear market for more than two decades. Adjusted for inflation, at these prices, it’s probably free. Silver will follow gold to whatever heights it goes.

Outlook

Going by the choppy stock market, economic slowdown and decreasing currency values, commodity markets are again coming into the limelight. Since the commencement of 2002, The Economist’s industrial commodity-price index has risen by 25% in dollar terms. Commodity experts say this is the beginning of a long bull-run in commodities. Silver will begin to pick up this year or the next with a rapid ‘spike’ in prices occurring at the end of the decade. In the coming months, there is ultimately only one factor that will affect future prices of silver – global physical supply and global physical demand.  If supply exceeds demand, prices will drop.  If demand exceeds supply, prices will rise. 

According to US-based Pan America’s Chairman and CEO, Ross Beaty, “The outlook beyond 2003 is promising for the silver market, mainly due to the many developing applications of silver in new technologies. In early 2003, a funding bill was introduced to the US Congress that would provide over $5 million for research into using gold and silver catalysts for fuel cell and other technologies. This could have enormous potential for significant new silver demand. Another bill in Congress provides funds for research into silver-based wood preservatives and marine anti-fouling paints, as an alternative to arsenic – containing preservatives, now being banned in many States in the US.

Finally, extensive research continues into silver-sheathed superconductors as mainstream power transmitters. These three new applications of silver could together use more than 200 million ounces of silver annually if developed into commercial use.

Adam Hamilton predicts that once the inevitable rise in the silver prices based on supply and demand fundamentals begins, more and more investors will take notice of this phoenix rising from its ashes as it appreciates.  Gradually, investment demand will rise, putting further pressure on inelastic physical supplies and driving up prices.  This investment demand will create further price rises, which will beget more investment demand, which in turn, will spawn more price increases, which further will increase silver desirability in the investment world, ad infinitum.

N Janardhan Rao,  Senior Economist.