Jeff Christian is the President of CPM Group, New York, a firm focused on the fundamental analysis of global commodities markets. Jeff founded the CPM Group in 1986. Previously he had been the head of commodities research at J. Aron & Company, which was acquired by Goldman Sachs & Co. Chintan Parikh is a silver and precious metals analyst at CPM Group. CPM Group is a leading commodities research, consulting, investment banking and asset management company. It provides independent market leading research on the commodities markets to customers ranging from governments to investment funds worldwide.
Silver prices have traded between $8.79 and $20.79 over the past 12 months. The price averaged $14.97 in 2008, up 11.3% from $13.45 in 2007 and the second highest annual average silver price on record, surpassed only by the $20.65 average of 1980.
In short, silver prices have been very strong, and very volatile. That should not be surprising to anyone. First, silver prices have risen due to enormous interest on the part of investors around the world, who have been buying silver along with gold and platinum group metals as a safe haven and hedge of their assets in the face of enormous economic and financial market problems.
Additionally, silver traditionally has a more volatile price than that of gold. It is a smaller market, in dollar terms, with fewer participants on both the buying and selling side of the market. Whereas gold investors tend to buy gold and rarely are net sellers as a group, in the silver market investors are much more willing to sell their holdings when they expect prices to fall. Investors have been net buyers of physical gold on a worldwide basis in all but three of the past 40 years, and in the three years in which investors were net sellers of gold, they only were net sellers of small amounts of the metal. In stark contrast to this, investors have been net sellers of silver in 24 of the 43 years since 1965. Of course, that means that they were net buyers in 19 years, or 44% of the years. In the most recent period of net investor selling, investors were net sellers of silver for 16 consecutive years. This fundamental difference in how investors deal in silver compared to how they invest in gold speaks volumes about the differences in the two metals' price behaviors. As a result of this investor tendency to be large net buyers or sellers of silver, along with other factors, silver prices tend to be more volatile than those of gold.
The outlook for silver is inextricably linked to the course of U.S. and global economic conditions. If one expects economic conditions to bottom out during 2009 and show some indications of recovery by late 2009 or early 2010, it would be reasonable to expect investors to remain keenly interested in silver during early 2009, and possibly to back away from strong buying levels as 2009 gives way to 2010. In this environment, silver prices may trade between a low of $10 or $12 and a high perhaps as lofty as $17 or $18 over the course of 2009, with somewhat lower prices in 2010 possible as investors re-allocate some of their money and attention away from precious metals and back to equities.
That has been the consensus economic outlook over much of the past six months. In early 2009, however, economic conditions and financial institutions' stability have deteriorated further and faster than the consensus had expected. In this environment, investors have shifted even more of their attention away from equities toward gold and silver. Should this revised economic view prove the more likely outcome, then the period of strong investor demand for silver may be extended for a longer period of time, and silver prices may remain somewhat stronger.
Investment Demand
The key to understanding the evolution of silver prices always has been primarily related to investment demand trends. Mine production, scrap supply, fabrication demand, inventory levels all are important, but by far the key driver for silver prices is investor attitudes toward silver and how those attitudes are being reflected in investor buying and selling of this metal.
As mentioned above, investors will be consistent long-term net buyers or sellers of silver. From 1990 through 2005 they were net sellers, disposing of an estimated more than two billion ounces of silver that they had accumulated in the 1980s, the 1960s, and, apparently, in the centuries before that. Investors were large and persistent net sellers during the 1990s because they had become disenchanted with silver.
By 2005 and 2006, attitudes had shifted. In fact, the shift had been underway for nearly a decade, with investors backing away from their net selling habits while new investors entered the market as buyers starting in the middle of the 1990s. The year of heaviest net selling by investors was 1997, the very year that Warren Buffet's Berkshire Hathaway was accumulating its 129.7 million ounces. While Berkshire Hathaway was buying, other investors were selling, at a minimum an estimated 325 million ounces of silver on a gross basis in that one year alone. Knowing that, no one should be surprised to learn that the silver price averaged $4.91 in 1997.
After 1997 the volumes of investor selling declined. Investors remained net sellers through 2005, but they were selling steadily less metal. Those long-term investors that were disenchanted appeared to be running low on metal to sell. Other, new investors were turning their attention to silver. After the stock market crash, tech bubble burst, recession, financial market scandals, and terrorist attacks of 2000 and 2001, investors began to become increasingly bullish toward silver and interested in buying silver.
By 2006, gross new purchases were exceeding gross sales by investors. Investors became net buyers of silver in that year, for the first time since 1989.
The significance of the shift from net investor selling to net investor buying cannot be over-emphasized. Twice in recent, modern history have investors emerged as persistent net buyers.
The first time was in the 1960s. At that time the U.S. Treasury had effectively controlled the silver market worldwide for roughly eight decades. The Treasury stood ready to buy U.S. domestically produced silver and to sell silver to qualified users and others at prices below the value of the silver used in circulating coinage. It also issued silver-backed certificates: one, five, and ten dollar bills that could be turned in for silver bullion at national banks. As electrification, air conditioning, commercial photography, and other silver-using applications became increasingly popular after World War Two, through the 1960s, there was massive demand for silver held by the Treasury. By the early 1960s this was applying strong upward pressure on silver prices. Investors saw this happening, and began buying silver. This added to the upward pressures on prices. The Treasury had to switch out of silver-bearing coinage and stop issuing silver certificates. The price of silver rose from less than $1.00 per ounce in the late 1950s to around $2.44 in 1968. Silver was freed from its link to currencies as a result of the strong increase in investor demand.
After prices rose to around $5.00 per ounce in the early 1970s, investors began selling their silver.
The second time investors emerged as net buyers again was in 1980. At that time, silver prices rose from around $5.00 to $50.00. Investors continued to add silver to their collective holdings from then until 1990, by which time prices had dropped to around $4.00.
The third emergence of investors as net buyers began in 2006. Investors have been net buyers of silver since 2006, for all the obvious reasons related to seeking financial hedges, safe havens, portfolio diversifiers, and alternative assets. The price has been rising strongly since then.
The outlook is that investors will continue to be net buyers for several years to come. The lessons investors are learning in 2008 and 2009 will not easily be forgotten, and the expectation is that investors will continue to buy silver and gold as forms of savings and investments for years to come. While economic conditions remain hostile, silver and gold will be very attractive.
Even when economic conditions improve, investors still may buy silver and gold. In fact, they may increase their purchases: As personal wealth recovers in an economic expansion, investors may well continue to move a portion of their assets into silver and gold. As their wealth expands, the number of dollars they may want to convert into silver may rise commensurately.
Supply
We do not want to imply that trends in supply and demand are unimportant to silver prices. They are very important. They may not be as dynamic of determinants of the silver price as investment demand, but they are critical to keep in mind.
The two major components of silver supply are mine production and secondary silver recovery from scrap. Mine production accounts for approximately 70% of total silver supply. It is estimated that total supply rose to 806.1 million ounces last year, up from 785.4 million ounces supplied in 2007.
Silver is mined in dozens of countries worldwide. Most of the silver mined in the world is produced at polymetallic mines, along with metals such as gold, lead, zinc, copper, and other metals from bismuth and cadmium to tellurium and selenium. Approximately, 85% of the silver mined around the world comes from mines at which silver is not the primary product, but a by-product along with other metals.
Silver mine production in the market economies is estimated to have been around 548.4 million ounces in 2008. This would have been up 2.6% from 534.4 million ounces in 2007. Higher gold, copper, lead, and zinc prices during the first half of 2008 encouraged increased production at these mines, boosting silver output as well.
Going forward there are several new projects that are slated to come on stream. However, the current economic downturn coupled with severe tightness in credit markets is expected to lower the growth of silver supply in the long run. Many mining companies already have begun to announce mine closures or cutbacks in production.
Fabrication Demand
Fabrication demand for silver was strong between 1980 and 2000, but has been more subdued since then. The metal's varied characteristics and technical properties make it useful in a wide range of applications. Its largest uses are in photography, jewelry, and silverware, although many different electrical, electronic, medical, bactericidal, and other applications utilize silver as well.
Total silver use is estimated to have risen slightly in 2008. Preliminary estimates suggest total demand for silver at 730.2 million ounces in 2008. This would be up slightly from 726.2 million ounces in 2007. A large part of increase in the total demand for silver could be attributed to increased jewelry demand. Although silver price rose in the early part of the year, silver jewelry was much more affordable than other precious metals. Use of silver in photography continued to decline in 2008.
Use of silver in many industrial applications either is one that does not allow substitution away from silver, or it is an application in which silver is the most cost effective alternative. As a result, the overall the demand for silver held up fairly well in 2008, compared to demand for other precious metals. Going forward, it is expected that the rate of growth in the total silver demand will be adversely affected by the deepening global economic recession.
Based on CPM Group's Silver Yearbook 2009. Due for release 28 April 2009. Available at www.cpmgroup.com and other outlets.
The views expressed in this Newsletter are those of the author(s). They are offered to readers for information and general guidance only. Nothing in this Newsletter is intended, and should not be taken, to constitute economic or investment advice.
