The inflation of silver

I have not written about silver (and gold) for a while, and there’s no secret why. Even with the #silversqueeze movement early 2021 the price has still not moved anywhere. However, the lack of interest in the sector only increases my conviction long term.

Gold and silver are my most frustrating investments, at least so far. The interest rates go up, precious metals go down. Interest rates get pushed down, no response from the precious metals. (Don’t get me started on the money supply). This is an exhausting situation, and I think many have given up on the sector. I am stubborn, and have been in a similar situation with uranium, so I still hold my position. (If I had started with investing in uranium earlier, maybe 2017, I would maybe be fed up by the start of 2020. Right at the beginning of the turn for the sector). A year of underperformance or flatlining can turn around very quickly.

Gold and silver trade very similarly, but with my risk tolerance, I follow silver more closely. Silver also has the more interesting demand structure with about 50% from retail and 50% from industrial.

Why are we here

As in many other commodities I think investors do not believe in it after several years. We are in a “The boy who cried wolf” situation. We even had the #silversqueeze this Winter and retail trying to drain the COMEX. (COMEX is the primary futures and options market for trading metals such as gold and silver. However, they mainly offer paper contracts, and do not want customers to stand for delivery. Their physical supply is more what you see at a car dealership showroom. They do not have that many cars parked outside). With the massive buying of physical silver, both from coin dealers and through the PSLV (Sprott Physical Silver Trust) we had a spike up in the paper contract price over $28, but it was soon pushed down again. Still, the movement continued to stack silver and buy PSLV for months afterwards. It is therefore frustrating for many to see the silver price is trading lower than it did a year ago.

The big inflation of silver

The reason why the price of silver is trading lower is the inflation we have in silver supply. (In this case I am talking about “paper silver”). With so many paper contracts for silver, the amount of “silver” in the market gives the market an image of oversupply. If you have an oversupply of a product the price usually moves down. Very few of the paper contracts are expected to be held for delivery. Some people are talking about a 500:1 ratio for paper to physical silver. In the midst of February 2021, when the #silversqueeze frenzy was at its highest, you suddenly saw a tremendous supply of paper silver being sold in the market. The silver market seems to be trapped in a situation where the paper contracts decide the price, and not the supply demand of the physical silver.

The supply and demand we see for physical silver

Production of silver is falling, and according to First Majestic Silver, mines produce about 800 Moz a year. Annual consumption of silver is about 1.0 Boz. The 20% that is not covered by mining comes from recycling and above ground supplies. How big these above ground supplies are is difficult to estimate. No one really knows. (We have a similar situation with estimating above ground mobile inventories of uranium). 

57% of silver consumption is from industrial applications. We are talking electronics, medicine, solar, water purification, window manufacturing, etc. (Silver used to be in high demand due to its application in photography, before digital cameras became widely available. Industrial use of silver fell due to the transition to digital photography. This slack has now been picked up by demand from photovoltaics (solar panels) and EVs).

The remaining 43% demand comes from coins and bars who absorb 22%, jewelry with 17%, and silverwarewith 4%. With the #silversqueeze movement this year, the demand for coins and bars have been a lot higher than normal.

Why do you invest when the market is rigged?

At the moment, financial players are able to control the market, but I do believe that one day we will see an end to this silver manipulation. If silver had 100% industrial demand there would be more held for delivery. (The retail demand for coins and bars we are seeing now, is trying to force the same effect). The more people try to force delivery of actual silver, the less paper silver will be able to dictate the price. 

In the Palladium sector they had a situation we hope will repeat with the silver sector. (The key commercial use for Palladium is as a critical component in catalytic converters – a part of a car’s exhaust system that controls emissions). Palladium had a futures market that broke down because strong physical demand broke the short interest players.

Sprottmoney had the following explanation for the price going vertical from $1,600 to $2,600 in just a few months in 2018: “After a rally from January 2016 to January 2018 of over 150%, or $682, Palladium fell just 28%, or $318. Then it took off again, and as we know now, after a vain attempt to cap the price they decided to give up this time and not risk being even more record short this time around. They realized that paper futures no longer had the same effect on the price of the underlying commodity anymore and did not want to risk being caught massively short as the price continued to soar higher.“

The increasing demand for the physical product, together with a high short interest in the futures market, made the massive price increase possible. The longer the price is kept down, the more energy is stored. This is the reason why I am not letting my eyes off silver.  If $21 is the floor for silver, or we might have to go lower remains to be seen. I am keeping my silver position and hope to get rewarded in the long term.