What's been driving the silver price?

Author: Julian Phillips

Silver has been outperforming gold in recent months as fundamentals have been positive, not only from a monetary viewpoint but also from an industrial one too.

The Silver Price is hitting new recent highs (most recently having breached $36.00) in a more vigorous performance than even gold.   Many in the developed world precious metal markets are amazed at the performance of silver and see this continuing, whereas others feel it is running away with itself.    The "backwardation" in silver [when ‘spot' - or immediate delivery prices are higher than for future delivery] has stressed just how much immediate demand there is for silver and clearly a physical shortage of the metal has arisen.  

There are two apparently conflicting pictures of the role of silver.   The industrial side of silver demand, currently thriving and the investment side, which is also thriving and should continue to do so.

INDUSTRIAL FUNDAMENTALS EXCELLENT

Overall the fundamental outlook has favored large price rises in the metal.   After the use of silver in photography was heavily lessened by the advent of digital photography, many thought that that was the end of silver, but its price continued to rise when gold rose and fall when gold fell.  Then came many revolutionary uses for silver in the medical field and the electronics field where demand is growing rapidly.    Today, industrial uses account for 44% of worldwide silver consumption.

Still, silver has largely continued to be mined as a by-product of base metal mining with little need for solely silver mining alone, until now.   Today, we find that the number of silver mines is growing fast as the metal can cost only around $4 per ounce to produce.   At a current price of $36 this makes it a dream metal to mine.   But it will take some time for silver mining to catch up to growing demand, a few years at least.   While there are huge supplies of silver still untouched [whereas replacing the gold mined is getting an increasingly more difficult task] we do see the flow of silver supplies growing fast in the future.  Eventually this will slow the rise in the price of silver to the pace of gold price rises.   And yes, we may see a rapidly growing supply of silver from scrap or re-cycling sources in time, which may slow down demand in addition to rising supplies.   But again, this will take some years still after which we will see a change in silver's price patterns.  

Meanwhile, demand growth from not only the developed world, but from the emerging world should continue to outweigh such new sources of supply.   The last year has been an eye-opener in the silver market as we watched China turn from a net exporter of silver to a net importer.   China had gross exports of 1,575 tonnes of silver last year, down 58% from a year earlier.   China's gross imports of silver increased 15% to 5,159 tonnes in 2010.   In 2005, China was a net exporter of nearly 3,000 tonnes of silver.   Last year, in 2010, China was a net importer of more than 3,500 tonnes of silver.    Incredibly, Chinese net imports of silver surged four fold in just one year from 2009 to 2010. We fully expect this growth of demand from that source to continue in 2011 and possible for the next decade.

Demand for silver in China has risen sharply in recent months and years. Growing middle classes and savers in China, India and other Asian countries have been turning to "poor man's gold" and using silver as a store of value. Gold has risen above its historical nominal high in local currency terms internationally and silver is seen by many as a cheaper alternative.   

OFFICIAL SELLING

For decades we saw ‘Official selling' of silver as three governments sold off their stockpiles of silver [that had once been the coinage of the land].   The three countries were India, China and Russia.   Today there is a negligible amount of silver sold by these three previously large suppliers.   Such a withdrawal of large supply lines has ensured demand outweighs supply.   There is little likelihood of these suppliers re-appearing.  

INVESTMENT DEMAND

-          With that in mind investment demand has come in as a new source of demand.   The main vehicle through which silver is bought for investment in the developed world is the Silver Trust (NYSE: SLV) which now holds 10,794.79 tonnes [347,063,746.900] ounces currently.   

-         While COMEX is not a physical market for silver [only 5% of the deals done there involve the movement of actual silver], the gradual drain of COMEX silver inventories seen in recent months continues and COMEX silver inventories are at 4 year lows.   Total dealer inventory is now 1,311.35 tonnes [42.16 million ounces] and total customer inventory is now at 1,887.40 tonnes [60.68 million ounces], giving a combined total of 3,198.97 tonnes [102.847 million ounces]. 

-         To an Asian investor with a limited amount of savings, silver is proving a more than credible alternative to gold.  The price of silver has, this century, followed that of gold.   It falls further and rises higher than the gold price, but goes up when gold does and falls when gold does.   We believe it will continue doing so for the foreseeable future. 

SILVER AS A MONETARY ASSET

Silver has been money since man's history began.   History shows that it has always been linked to gold as coinage.  Until 1946 even in the U.K., silver was used as coinage.   The use of silver as money has now been withdrawn globally.   It was from the stockpiles of old coins that the bulk of "Official" silver sales have only just been completed.   It may well be that the monetary authorities of the world have no intention of using silver as money in the future.   That does not detract from silver being used as an ideal retainer of wealth.   Silver and gold will always be universally accepted as ‘giving a sense of stability of the money system' [quote from Alan Greenspan this week].   That's why it is being accumulated as an investment now.   A look at the darkening future of the current monetary system reinforces the thought that these two metals will protect one's wealth.

We don't believe that central banks will go back into the silver market again, because they will not see silver as they see gold, as the ultimate form of money.   It will remain such in an individual's mind as well.   We feel that its price will continue to confirm that.   We emphasize that in the cases of both gold and silver, a monetary role for them is not required to maintain the current high prices.   [If monetary authorities called the sky green, it won't go green - at the end of the day gold and silver will always act the same way as money]

SILVER MOVING WITH GOLD

The silver price continues to move with the price of gold, not because they have the same demand and supply fundamentals or there is the same quantity of the metal available, but because investors and users perceive that the silver and gold prices reflect the state of the current global monetary system.   Such co-ordinated movements are saying that both metals are not being priced themselves.   They are both pricing the monetary system and its prospects, as they have done for millennia.   The huge growth of the investment side of the two metals is confirmatory evidence of this.

Julian Phillips is a long term analyst of the global gold and silver markets and is the founder and principal contributor for Global Watch - Gold Forecaster -www.goldforecaster.com and Silver Forecaster - www.silverforecaster.com