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Silver Fundamentals
Silver Prices Have Risen
CPM Group's research has concluded for several years that silver prices would have to rise into a new range at some point, as prices below $5.50 were too low to sustain sufficient silver mine production and other supplies to meet longer term silver fabrication demand requirements.
The market was living off of inventories held by investors, bullion banks, and others. These silver inventories were was had been retained over five millennia of silver being an important financial asset. While it was clear that in 1990, when the period of stock drawing down began, there were more than two billion ounces of such silver stocks in bullion and coin form, it also was clear that the market was absorbing these stocks rapidly over the subsequent 15 years and that the time would come when these stocks would reach critically low levels, and that at that time prices would adjust to a higher level, in order to help restore a balance between supply and demand. The conclusion was that prices would have to rise to a range above $6.00 on a sustained basis to stimulate new silver mine production and restrain some fabrication demand.
The rise in silver prices since 2003 appears to be the beginning of this re-rating of silver.
There were several upward spikes in silver prices earlier. In 1995, a trading company took a large position in silver. Its exercise of silver options in April of that year caused the shorts to scramble to find metal, pushing silver prices up 62 cents in two days to $5.99. Prices quickly subsided. Prices rose again in early 1998, as the shorts that had sold physical forwards to Berkshire Hathaway's trading agent had to scramble to meet their forward commitments. Prices rose to $7.50, basis the March 1998 Comex contract, on 6 February, during this period. Spot prices rose above $8.00, as the deliveries of the February forwards were processed.
In both instances, market participants wondered whether these moves were the start of the anticipated sustained longer term upward appreciation of silver prices. In both cases, the moves were indicative of gathering tightness in the silver market, but they proved to be early warnings to the silver market, and not the beginning of the major re-rating that had been anticipated. That major move, which now appears to have begun, would have to wait until the silver market's balance of supply, demand, and inventories had grown even tighter.
This report presents a quick overview of the factors that have caused silver prices to rise from an average of $4.60 in 2002 to an average of $6.69 in 2004, a 45% increase in two years. The factors involved relate to silver supply, fabrication demand, investment demand, and inventories.
As conditions in the silver market are reviewed, observations will be made concerning some of the ancillary issues in the silver market.
For example, as mentioned above, silver prices spiked to $8.35 by early April 2004, following a sustained upward move than had emerged in November 2003. When prices reached these high levels in early 2004, a large investor sold 25 million ounces of silver. It effected this sale near the peak of the upward move in silver prices. In order to sell such a large position with minimal negative impact on the price, the investor sold its metal by selling July 2004 futures on the New York Comex. This position was delivered into the silver market on 1 July 2004, the first delivery date for the July Comex silver futures contract.
Several interesting aspects of this sale are worth noting. For one thing, the price of silver did not skip a beat, despite this massive delivery. The price of silver rose 18.9 cents that day, and a further 6.2 cents the next day. The amount of silver registered against Comex positions jumped 48.2% from 44.3 million ounces to 65.6 million ounces. The banks that took delivery of this metal did not quickly disgorge it, either. They seemed to have had investors which were willing buyers ready to hold this silver, and keep most of it registered with the Comex Clearinghouse. Thus, an investor that had bought silver at a lower price earlier managed to sell an enormous position of silver, and did not negatively effect the price of silver.
Some observers noticed these large deliveries, and hypothesized that this metal represented silver that had been sold by the Bank of China, via calls that were exercised when the price of silver spiked above $8.00 in early 2004. That was not the case. It was in fact a more matter-of-fact sale by an investor.
Taking a look at the silver price from a longer term perspective, it is clear that the price of silver remains low compared to its highs of 1979 - 1980, when it touched $50 per ounce. When the price of a commodity rises sharply, there often are reactions to the higher price in the form of increased supplies and reductions in fabrication demand. The longer term silver price chart suggests that while prices have risen sharply, the move is not a sharp spike compared to the increases in silver prices witnessed in the 1980s. This indicates that the price of silver may have further upside potential. Certainly there are some price-related reductions in silver use in price-sensitive jewelry and decorative objects, but most fabrication demand remained largely insensitive to silver price increases over the past 18 months. It will take larger moves to reduce silver use in many industrial applications, such as chemical catalysts, ball bearings, mirrors, electronics, batteries, and solders.
The concept that what we have seen in silver prices to date still does not represent a critically large increase in prices is further supported by a look at the inflation-adjusted silver price. Clearly prices are rising, but adjusted for inflation silver prices remain below the levels they maintained from 1968 through 1989, in the accompanying chart. In fact, real silver prices remain low by the standards of levels going back to the 19th century.
Silver also remains affordable in many applications compared to potential substitute materials. In many electronic and chemical process catalyst applications, the alternatives to silver are gold, platinum, and palladium. Silver remains far more affordable than any of these metals, and is likely to continue to do so.
Why Prices Have Risen
Silver prices have risen for several reasons. The single most important reason may be that available inventories of silver in bullion and bullion coin forms are reaching low levels. Over the past 15 years bullion inventories are estimated to have declined from around 2.2 billion ounces to around 300 million ounces or so today. Furthermore, there has been a shift in the ownership of the remaining silver, from 'weak hands' that were willing to sell their silver below $5.50 to stronger hands, that were willing to hold this silver while waiting for higher prices.
This continues in the present period. We mentioned the 25 million ounces of silver that changed hands in July 2004. That was silver that an investor had purchased earlier, probably at prices below $5.00. That investor was willing to sell at $8.00. Other investors were willing to buy the silver at $8.00, and now are holding this metal. They are likely to be willing to wait for even higher prices to sell than the previous owners were.
This is not always the case. Around 800 million ounces of silver were purchased by investors between 1980 and 1989, at a weighted average acquisition cost around $12 per ounce. These investors, or rather their estates in many cases, sold off this metal over the course of the 1990s, at average prices closer to $5.00. Investors do change their minds sometimes, and they do sometimes liquidate losing positions, capitalizing their losses. Generally speaking, however, investors who purchase physical silver, and gold, tend to hold it on a generational basis. That is, they do not tend to sell it nearly as quickly as they liquidate equity, bond, or mutual fund positions, but rather tend to hold physical metals for periods of years, decades, and even lifetimes.
There has been an extended period of strong fabrication demand for silver, and market deficits eating away at reported and unreported inventories. These supply and demand conditions did not immediately reflect themselves in higher prices, due to the large inventories that had been readily available at near-market prices. As inventories reached critically low levels, and the ownership of the remaining inventories shifted, the price has reflected these market imbalances, with a lag.
Another factor behind the rise in prices has been the rekindling of investor interest in silver. As was the case in 1979, this has been less a matter of new buying by investors - although there has been some of this occurring. It is more a matter of the current investors holding silver inventories pulling back from selling. These inventories have been relatively available to the market, to meet the ongoing deficits, at prices of $4.00 - $5.00, for much of the past 15 years, because the investors holding these stocks of silver had lost their expectations that silver prices would rise. As prices began rising over the past 18 months, some of the remaining stock holders have seen that silver prices can rise, significantly, and have decided to wait to sell later, hopefully at a higher price. This has reduced the flow of silver from bullion inventories into the market, adding upward pressure to the prices.
The same mechanism occurred in 1979 and 1980, when silver prices shot to $50 per ounce. New investors were buying silver, attracted by the upward move in prices, but the larger impetus for higher prices at that time, as now, appeared to come from old investors deciding not to sell any more silver into the market until prices were significantly higher.
Surpluses and Deficits
The next chart illustrates the imbalance between supply and demand in another way. This chart shows the annual surplus or deficit of newly refined metal entering the market from all sources relative to fabrication demand.
A few points ought to be made. This is total supply. It includes mine production, secondary recovery from scrap, any government sales, and net trade with the transitional economies of the former Soviet Union, China, North Korea, Cuba, and Vietnam. The flow of silver into and out of these transitional economies, as they are called, remains segregated in these statistics because of uncertainties related to the use of silver in these countries. There has been an improvement in the estimates of silver mine and secondary refined production in most of these countries (although Chinese production data remains somewhat less definitive than it might be). There is very little information on the use of silver in these countries, however. To add their supply to the supply columns of a market balance without adding the offsetting demand estimates would skew a market analysis. As a spokesman for the Bank of China said a couple of years ago: Anyone telling you how much silver is being used in China is at least lying to you. No one knows that. Given the unreliability of this information, the best way to handle these countries analytically is to measure their net trade with the international market. So, they appear as a net source of supply or demand in these statistics.
Similarly, on the demand side of the market equation, these surpluses and deficits use fabrication demand, and exclude investment demand for both bullion bars and coins. This is the conventional approach of all commodities analyses, and there are several good reasons for this. One is that investment demand is different from fabrication demand. In the case of silver, investment demand is positively correlated to prices: As prices rise, investors buy more silver, and vice versa. This is the opposite of fabrication demand, which moves inversely to prices. Perhaps more important, investment products retain their silver properties, and can be resold into the market rapidly.
These seemingly mundane issues of the definitions of supply and demand matter importantly to any analysis of the silver market. By changing definitions, counting investment demand with fabrication demand, adding untenable estimates of demand in hard-to-measure countries, and modifying other definitions in inappropriate fashion, partisans seeking to portray a market in a particularly bullish or bearish light can produce what seem on the surface to be detailed analyses of the market, while actually presenting a misleading view of the market's actual conditions. In the securities markets, various regulatory agencies seek to assure that published market analyses of given equities honestly portray the conditions of the company. Efforts are underway, at least in the United States, to improve equity market research and tighten controls that seek to prevent the distribution of reports containing distortions. In the physical commodities markets, there are no such watchdogs, and the markets in most countries are fully deregulated. Anyone can publish anything about a commodity, and there are no regulatory agencies with any authority to impose any quality standards on the reports.
There are several important points to make about this chart. One is that the silver market, since 1960, has gone through two prolonged cycles of surpluses followed by deficits of new supply relative to fabrication demand. The current period of deficits has been much longer than the previous one, which lasted from 1971 through 1978.
Another key point to make is that these deficits have contracted sharply over the past decade, from 202.8 million ounces in 1997 to around 41.5 million ounces in 2004.
Bullion Inventories
One of the key issues facing the silver market is how much silver is remaining in bullion and coin inventories worldwide. Some inventories are known: Reported stocks held in Comex warehouses, inventories held by Japanese dealers and fabricators. Most other inventories are not reported publicly, and are held in a great deal of secrecy.
Secrecy is one of the most important attractions of silver and gold for investors over the past 5,000 years. Another has been the indestructibility of these metals. These two factors, along with the long histories of these metals as a form of money, a measure of wealth, and a store of value, means that unlike any other metals, gold and silver inventories are extremely difficult to estimate.
The bullion inventories estimated in the accompanying chart include both reported stocks, which now are down to less than 150 million ounces, and estimates of unreported stocks.
The data series extends back to 1950, when the U.S. Treasury stood as the market maker for silver. The Treasury offered to buy and sell silver in an attractive band. As a result of this, the Treasury had amassed an enormous stash of silver, nearly two billion ounces, by 1950. As the 1950s progressed, the silver market changed. Fabrication demand began to rise sharply, in the emerging personal photographic market, and in electrical equipment and appliances. The rise in demand placed upward pressures on prices. The Treasury moved to withdraw from the silver market, which it did during the 1960s. However, due to the Treasury's involvement in the silver market, there are reasonably good statistics on silver inventories for the period until they extricated themselves. The Treasury had been the buyer of last resort, and offered above market prices for silver for much of the period up to the early 1960s. As a result, much of the silver that existed at that time made its way to Treasury vaults, or into circulating silver coinage.
This gives analysts a good base on which to build subsequent silver inventory models. The actual amount of silver remaining in bullion inventories appears to be in line with the amount shown here. There is a wide band of potential variation from the actual figure, but it is clear that the amount of silver that remains in bullion stocks at present is far less than has existed at any time in the past half century, and in fact extending back into the early parts of the 20th century. Additionally, it is clear that, whatever the actual number is, it is far less than the amount of silver bullion that was lying in inventories in the early 1970s, when silver prices moved from around $1.29 to $5.00, and in the late 1970s, when silver prices moved from around $5.00 to $50.00.
Indeed, the decline in liquidity in silver inventories has been a key variable leading to the increased volatility in silver prices.
Putting It All Together
Thus, the silver market has entered a period where the combination of a persistent shortfall of newly refined silver relative to fabrication demand has led to a draw-down of inventories from historically high levels to historically low levels.
Basic economics dictate that the market will need to come back into balance. For this to happen, prices will have to rise sufficiently to stimulate increased supplies of silver to be developed and/or discourage fabrication demand. Much of silver supply and demand is relatively price inelastic, however. Around 80% of silver mine production comes out of the ground as byproduct of gold, copper, lead, and zinc mining, and responds more to the prices of these metals than to the price of silver. Standard secondary supply is relatively price inelastic as well, with production costs far below even the cyclical lows of $3.50 witnessed 15 years ago. Secondary refining mostly is photographic materials, with some silver recovered from jewelry, electronic scrap, spent ethylene oxide catalysts, and other industrial products. The flow of this silver is related more to the product cycles and demand for these products than it is to silver prices. There is another component of silver scrap, which comes from jewelry and decorative objects in India, Pakistan, and other countries in Asia and the Middle East. This is more price responsive.
The same is true on the demand side of the silver market. Silver use in most applications is relatively price inelastic, and silver is seen in many applications as a lower cost alternative to more expensive materials. Jewelry and silverware, especially in Asia and the Middle East, is the most price sensitive sector of demand. There are some signs that silver use may have softened in some countries in Asia in 2004, as the price of silver rose, but the information is only preliminary at this time.
As a result of these price inelasticities on both the supply of and demand for silver, prices may have to rise and stay at relatively high levels compared to recent prices to bring the market back into balance.
The next chart illustrates CPM Group's supply and demand projections for the next 10 years. These projections represent our main scenario. We run five scenarios, typically, for our 10-year projections. At present, the uncertainty in the photographic industry over the course of silver use in that industry is leading us to run more than five alternate scenarios. Our long-term studies present the five major scenarios, however.
This scenario is based on the premise that silver prices remain firmly above $6.50 per ounce in 2004 dollar terms over the coming decade. Even so, you can see the market remains closely in balance.
Note that silver supply is projected to rise roughly 175 million ounces in this scenario. That is a phenomenally large amount of new silver to come into the market. There are two large silver mines slated to come onstream during this time - Apex Silver's San Cristobal in 2007, and Barrick's Pasqua-Lama around 2009. These two mines will add around 50 million ounces of silver to new supply. Much of the other increases here reflect byproduct at copper and gold mines. Even so, with an enormous 175 million ounce increase in total silver supply, the market barely comes into balance over the coming decade.
You can run dozens of scenarios, with enormous increases in mine production and substantial declines in photographic use of silver over the coming decade, and still find a tight silver market for the next 10 years. This suggests strong silver prices on a prolonged basis.
Supply
Total supply already has increased sharply since the middle 1990s. Supply had been unusually flat for much of the period from the early 1980s until 1996. From then until 2001 supply rose, from 567.5 million ounces in 1996 to 744.6 million ounces in 2001.
During this time mine production rose sharply. Peruvian silver output rose particularly sharply, while output in Australia doubled and numerous byproduct mines, primarily copper and gold, increased production in a wide range of countries, such as Indonesia and Papua New Guinea.
Secondary recovery also rose sharply during this time, expanding approximately one quarter over this five year period. As explained earlier, secondary supply is more a function of silver use, especially in photography, than it is a matter of silver prices. During the late 1990s there was a sharp increase in silver use in photographic films and papers. As more silver was being used in these products, more silver was being recovered as the films and papers were being processed.
Since 2001 total supply has fallen slightly. Much of this decline has reflected reductions in silver mine production, primarily at gold and base metal mines that were shuttered during a period of low prices for these metals. This appears to be reversing this year.
Fabrication Demand
Silver use in fabricated products has been declining for four years, since 2000. The largest decline has been in the jewelry and silverware sector, which is the most price sensitive use of silver. Silver use in photography also has been declining.
Photographic use of silver actually has been falling since 1999. There is much commentary in the market about silver losing market share to digital photography, and this trend indeed is emerging.
Much of the earlier declines in silver use in photographic products was not related to digital imaging replacing conventional photographic processes, however. In fact, silver use was rising in some films and papers over the past few years as a result of the advent of digital imaging, as some digital imaging processes were using silver-bearing film to capture images, later digitized, while in other instances digital images were, and are, printed on traditional silver-coated paper. These trends may be dissipating now.
Over recent years, however, several other factors contributed to weakness in silver use in photography. For one thing, there was a sharp economic downturn in many parts of the world, which combined with war, terrorism, and the SARS epidemic to reduce travel, and thus picture taking. The photographic paper and film markets also had experienced a large build up of unsold inventories up to 2000. These inventories had to be worked down, reducing demand for silver for new products. The working down of these inventories stretched out longer than film and paper manufacturers had expected, due to the recessionary business conditions of 2000 - 2002. These trends all contributed to reduced silver use in photography during this time, which masked the longer term effects of digital imaging.
Since 2002 digital inroads have accelerated. Photography companies were expecting that photographic use of silver might continue to rise 2% - 3% over the long run, as recently as 2002. By late 2004 the view was that silver use might decline -1% to -5% per annum instead.
As mentioned above, the decline in silver use in jewelry and decorative objects has been larger in volume terms than the drop in silver use in photography over the past few years. It should be understood that there are two distinct markets for silver jewelry and decorative objects. The larger one centers in Asia and the Middle East, and represents a form of savings as well as collectibles. The smaller portion of the silver jewelry and silverware market is in the industrialized economies, where these products are seen more as luxury items and discretionary purchases.
Most of the decline in recent years has been in the Asian markets. These markets realized enormous increases in silver use during the 1990s. Silver use has come off from the high levels of the late 1990s, but remains far larger than it was prior to 1993, and seems likely to remain so in the foreseeable future.
There are several new uses that are emerging for silver. Perhaps the most exciting and interesting is the use of silver as a shield for superconductive wire. This technology, which reduces the transmission loss of electricity by using metal ceramic wires cooled to the temperature of liquid nitrogen, has been under development for more than a decade. It has been moving from development to commercialization over the past few years, and appears to be using significant amounts of silver already. How much silver is being used is not clear, as the companies involved in this technology are extremely quiet about their silver usage and requirements. CPM Group estimates that several million ounces of silver are being used in this application at present, in 2004 and 2005, and that the growth rate of silver use in superconductive wires may far outstrip any loss of market in the photographic sector going forward.
Many of the other new uses are masked within the categories of silver use in electronics, batteries, and chemicals. Silver has found several new applications in eletronics, in electronic films and pastes, in the paste wires that defog rear windows in automobiles, in batteries, and in a range of chemical process catalysts. These uses show up in the overall categories of silver use in electronics, batteries, and chemicals.
Silver also is gaining a market in biocides, used in everything from water purification systems for drinking water and swimming pools, to silver-treated clothing and industrial coatings. While this is a rapidly emerging new use, the volumes of silver used in these applications appear to be relatively small, on the order of 10 million ounces or so, at present.
There is discussion about silver being used as a replacement chemical in wood preservatives. This seems unlikely to emerge as a new use for silver, as there are several copper-based chemicals that are more efficacious and lower cost, and which already are approved for these uses by various government regulatory agencies.
India
There are two countries that are both very important to the silver market, and very misunderstood. One is China. The other is India.
There are big changes underway in the Indian silver market at present. India has had a traditional affinity to silver. It is estimated that more than three billion ounces of silver are held by individuals in India, mostly in the form of jewelry and decorative objects.
While Indian individuals already own enormous amounts of silver in jewelry and silverware, the country still is a large importer of more silver every year. Imports were legalized around 1993. Before that, there was a very large smuggling industry to bring silver into the country. After the government legalized imports, demand rose even more rapidly.
Exports still are illegal in India, incidentally. The government has been discussing legalizing exports over the past few years, but has taken no definitive steps in that direction. It has created a panel to review gold and silver market regulations and issues as of early 2005, but it is not clear whether there will be any quick movements in the area of export legalization.
The government meanwhile did begin selling some silver from its own inventories at the start of 2005. Because exports are illegal, and the country remains a net importer of silver, the government silver is being sold into the domestic Indian market. The inventories being sold are not monetary reserves held by the Reserve Bank of India. The government has around 86.6 million ounces of silver, representing two-thirds of total central bank silver inventories worldwide. The government is selling long-held metal, much of it confiscated from smugglers in the 1970s and 1980s. The sales are expected to be managed in a way to trickle the silver into the domestic market, reducing imports into India but not unduly disrupting market conditions.
Other major shifts are occurring in the Indian silver market, meanwhile. The Indian silver market may be broken down into three broad categories: Industrial use, rural savings in the form of jewelry, and urban gift giving. India is losing market share in industrial products such as chemical catalysts and electronic plating salts and chemicals, to China and other countries. This is reducing silver use in India. There also is a shift away from silver and gold objects as gifts, for example at weddings, in favor of imported manufactured luxury items. Rural savings also appears to be shifting, somewhat, away from silver and gold.
These trends could reduce India's silver use sharply going forward. India may not be a large source of growth in future demand. It is unlikely to become a large source of supply, however. In the future, should exports become legalized and modernization continue to reduce the perceived attractiveness of silver and gold as forms of savings, periods of sharp increases in metal prices might stimulate sales from long-held inventories. It is not anticipated that these inventories would be sold off merely because exports were legalized, however. It would take the incentive of sharply higher prices to stimulate sales.
China
The rise of China as a major economic power has been a central theme in almost every sector of the world economy, from autos and electronic components to silver, lead, and copper. It is true that China is emerging as a major force in most markets. China represented less than 10% of world smelting and refining capacity for copper, lead, and zinc 15 years ago. Now it represents between 20% and 30% of each of these sectors. These trends will continue in the future.
China will be critically important to silver. However, the importance China has played in the silver market over the past five to ten years, and the importance it will play in the future, often are quite distinct from the points made about China in market reports.
Over the past several years China has emerged as a major user of silver. This includes photographic films and papers, electronic chemicals and components, and other applications. In many of these applications, Chinese use of silver has been more for the export market than it has been for domestic consumption. This has begun changing, especially since 2002, as Chinese domestic consumption of many silver-bearing manufactured goods has accelerated. However, much of the growth has been a shift in manufacturing of these products from major industrialized nations, South Korea, Taiwan, and even India, to China.
Chinese exports of silver also have been important, and significantly misunderstood. China has exported a great deal of silver over the past few years. Most of this has come from two types of sources. One of these sources is silver refined as a byproduct of lead, zinc, and copper smelting. China now is a major site for refining of base metals, and Chinese smelters, private companies, have been aggressive buyers of base metals concentrates around the world. Chinese base metals smelting and refining uses both domestic and imported mine output, concentrates. The gold and silver that is being recovered from these concentrates generally does not have a market within China, and so it is being exported.
The second source of Chinese silver has been from scrap recovery and other refining operations. Eastman Kodak invested more than $1 billion in modernizing the Chinese photographic industry from the late 1990s into the current period. Part of this modernization included sourcing silver overseas and importing silver nitrates into China. This displaced the silver that had been sourced domestically within China prior to this modernization program, estimated to have been as much as 40 to 50 million ounces per year. This silver needed to find a market. As with the smelter output, a domestic market was not readily present, so much of this silver has been exported.
Very small quantities of silver have been sold from government inventories during this time, and the Bank of China has issued public statements pointing out that it has not been the source of most of the silver coming out of China. Even so, rumors persist that the silver coming from China has come from government inventories, which may 'run dry' at some point. This has not been the case, however, and the shift in the flow of refined silver from China into the world market should be expected to continue. The Bank of China meanwhile has ceased being the national gold and silver market maker, as part of a liberalization of the precious metals markets within China. Since it had served this role up until 2002, it assisted the newly emerging, deregulated private refiners, smelters, and exporters in arranging shipments of metal overseas. The fact that the Bank of China served as a shipping expeditor for some of these private sector sellers may have contributed to the misunderstanding as to the source of the silver.
Moving forward, China will continue to be a major source of silver supply and demand. The demand for silver will reflect both domestic consumption and its role as the manufacturer to the world of a wide array of silver-bearing products. Photo film and paper plants are being closed in other countries, with the film and paper for these markets being sourced from newer, more efficient, and lower cost Chinese plants built over the past several years. The same is true with chemical catalysts and electronics components.
China also will become a more significant miner of silver. At present, most silver mined in China is byproduct of base metals and gold, in a pattern similar to that in other parts of the world. This will continue, although there are some attractive silver deposits that may be exploited primarily for their silver in the coming decades.
Markets
The final three charts in this report relate to the overall market. The first chart shows the volumes of silver cleared through the London interbank market, and traded in the world's futures exchanges. The bulk of the futures and options trading occurs on the New York Comex.
This chart shows the tremendous contraction of silver trading through London since the late 1990s. In 1997 London banks cleared more than 70 billion ounces of silver, roughly 100 times the physical supply and demand for this metal. By 2000 this had contracted to less than 30 billion ounces, dropping to slightly more than 20 billion ounces in 2002. Volumes have expanded since then, but have remained sharply less than was being traded in the late 1990s.
This is important to the silver price since such large volumes can only have represented interbank trading of silver. This decline represents a sharp drop in the liquidity of the silver market. It also represents a reduction in the proprietary trading in silver by banks, much of which originated on the short side of the market. These two trends - less liquidity and a pulling back by shorts - has helped open the possibility of higher silver prices. Interestingly, as silver, and gold, have returned to investors' attention in the past three years, there has not been a commensurate increase in interbank trading.
The next chart shows the gross and net open interest on the Comex silver futures and options contracts held by large non-commercial market participants. This chart illustrates the large increase in gross and net long positions in silver over the past two years, and the contraction in gross short positions.
The last chart shows the gold/silver ratio. There is no fixed ratio that really matters, but some investors and traders continue to pay attention to this ratio. The ratio has ranged between 16:1 and 100:1 over the past four decades. At present, the ratio is around 60:1. When considering where the gold:silver ratio is likely to head, CPM Group undertakes separate analyses of the gold and silver markets, and develops independent price projections. It then divides one by the other. Our analyses of the gold and silver markets suggest this ratio has further to fall. A ratio of 40:1 or 50:1 appears reasonable based on the long-term prospects for both gold and silver prices.
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