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Commentary

Silver bubble

24 Feb 2011 by Jim Fickett. (Dead link removed 20 Jun 2013.)

Despite many claims that silver is in short supply, the only shortage is one temporarily produced by a bubble in retail investor interest – there is ample silver to meet industrial needs. The current price, at roughly six times the cash cost of mine production, is driven only by fickle investor demand. A sign that the price may be near a high is that, while demand for newly minted coins to satisfy small retail investors remains high, the holdings of exchange traded funds have been shrinking for two months.

There is no shortage of silver

Many websites have long advocated the purchase of silver because of a rumored shortage, or impending shortage. Ron Paul is typical. Here is an extract from his blog entry of 27 Mar 2008, as the silver price rose to about $15/ounce.

please look into the history of palladium- palladium went from 60.00 per ounce to 1200.00 when Ford was buying up all of the metal for cataletic converters so they could keep production going.. ofcourse palladium came back down but settled in the 250.00 dollar area.. now with silver.. Silver is used in many more manufacturing applications.. Silver is now in shortage.. when these huge companies go to secure a silver inventory to keep their factories open, it will be just a matter of time till the price of silver will truly explode! as many of you have said.. it is hard to find right now

It is true that mints have had a hard time keeping up with investor demand for silver coins, and true that ETF buying has driven up the price. But the shortage is one felt by, and driven by, retail investors. There is no shortage for industrial usage, nor does one appear imminent.

The Silver Institute publishes supply and demand data based on information from the well known consultancy GFMS. Data is still being compiled for 2010, but we have the following picture through 2009:

Note that industrial usage is far smaller than mine supply. Other usage, such as jewelry or silverware, is highly discretionary, and unlikely to drive a high price. Note also that at least through 2009, the big increase in demand was from investors, not industry.

Supply cost is low

The Silver Institute said that for 2009,

Primary silver mine cash costs remained relatively stable year-on-year, rising by less than 1 percent to $5.23/oz.

So mining supply is more than adequate for essential uses, and the marginal cost of mining the stuff is only about $5/ounce, about a sixth of the current price.

Current market: investors are driving

The current price can be explained on the basis of investment demand.

The above graph shows that investment demand in 2009 was extraordinarily high. This very high demand continued into 2010. We do not yet have comprehensive data, but consider the following:

  • Combining inflow data for exchange traded products (ETPs) through 11 Nov 2010 with more recent data through 11 December shows that ETP holdings rose in 2010 by at least 2348 tons, or 75.5 million ounces
  • The US Mint reports that it sold 34.6 million ounces of silver coins in 2010

The aggregate demand from just these three sources was about 120 million ounces, i.e. in the same neighborhood as the very high total investment demand in 2009. We do not have complete data for 2010 yet, but given the strong demand for newly minted coins and ETPs, it seems likely that net global investment demand was, in fact, even higher in 2010 than in 2009.

Current market: ETFs shrinking, mint demand still rising

More sophisticated investors are getting out, leaving small retail investors holding the bag. In January, according to Barclay's (via Kitco), silver in exchange traded products fell. As of 16 February, the same was true for this month – but mint sales remain strong:

Holdings of gold and silver by exchange-traded products rose Monday, although they remain down for the month, reports Barclays Capital.

… Silver ETP holdings rose 23 tons Monday, although they are still down 56 for the month so far.

“In contrast, continuing last month’s trend, coin sales of silver remain very strong,” Barclays says. “The U.S. Mint has reported sales have hit 53 tons for the month already, following last month’s record sales of 200 tons.”

That dynamic suggests we may be near a top.