Silver steps up as gold wanes

There has been a remarkable new development in precious metals in the new year, with silver sales in January outpacing gold sales in absolute dollar terms in several markets such as U.S. Silver Eagle coin purchases.

But January has not been kind to gold and silver bullion investors. The spot gold price has come well off last December’s all-time nominal highs in the US$1,426 per oz. range and is now trading at US$1,326 per oz. Spot silver prices likewise have come off 30-year nominal highs above US$30.50 per oz. in late December and have sunk below US$27 per oz.

While gold and silver prices had great runs in 2010 and looked ready for consolidation, silver still has some unusual supply and demand characteristics that have many veteran resource investors pointing to silver as the metal with the greatest potential for explosive price gains this year and beyond. 

Speaking at the recent Cambridge House conference in Vancouver, Sprott Asset Management founder and CEO Eric Sprott and analyst David Franklin both emphasized just how hard it was for Sprott to take physical delivery of 15 million oz. silver for their new physical silver trust. For an amount of silver that is traded in a few hours on the COMEX futures exchange in New York, it took Sprott two and half months to get delivery of their physical silver, and they said the bars “looked new,” suggesting they were recently mined.

At the retail level, silver coins and bars from established dealers are now often sold out or have their deliveries delayed, despite rising markups.

This is the crux of the matter: the growing disconnect between the vast and instantaneous paper trading of silver contracts on futures exchanges, and the tiny and exceedingly tight physical silver market.

Relative silver bears such as Tau Capital’s John Lee point to price charts to emphasize the gold-silver price ratio, which is out of balance in gold’s favour, as it seems far less risky to bet that silver prices, with their greater volatility, will fall hard to rebalance the ratio.

Silver bulls, in turn, keep pounding on the silver market’s fundamentals, which have been painstakingly sussed out by analysts such as Ted Butler over the years, and are nothing short of bizarre. Essentially, the bulls argue that the current silver price reflects paper silver trading, but it will in time be priced much higher to recognize supply and demand fundamentals.

According to the United States Geological Survey, about 46 billion oz. silver have been mined in human history, compared with 5 billion oz. for gold, though Butler and the World Gold Council estimate that only 1 billion oz. silver and 2 billion oz. gold remain in above-ground stocks today, owing to day-to-day losses and industrial consumption in non-recycled products. Annual global silver production is steady at about 681 million oz., with much being a byproduct of gold or base metals mining, adding some inflexibility to mine supply.

Sprott criticized GFMS and its partner the Silver Institute, which are the most-often quoted sources for silver supply and demand figures, for being “problematic” in how they calculate investment demand for silver: plugging in an “implied net investment” number to perfectly balance out the total silver supply and demand numbers each year, rather than tabulate actual investment in silver bullion. 

Sprott showed how his own company’s tally of silver holdings at year-end 2009 by only five silver exchange-traded funds and two large investors produced a silver-investment demand number that was a whopping 225 million oz. larger than the figure arrived at by GFMS and the Silver Institute.

The huge short positions in silver taken by large institutions is a story all by itself, and is the subject of a new lawsuit that alleges price manipulation of the silver market by JP Morgan and HSBC Securities, which by mid-2008 controlled more than 85% of the commercial net short position in silver futures contracts.

Last May, Butler estimated that the eight largest silver traders held a net short position of over 66,000 contracts, representing more than 330 million oz. silver, or roughly half of the world’s annual mine output and a third of the world’s total bullion above-ground supply. Sprott noted that comparable short positions of the eight largest players in the gold market represented just 1.2% of above-ground supply.

“In every comparison possible, the short position in COMEX silver contracts is off the charts, and if you think the short positions sound potentially disruptive, you’re not alone,” Sprott and Franklin stated last June, when silver traded at US$19 per oz.

Silver bugs have sat in their lonely bunkers talking to each other for more than 15 years, but have finally scrambled up, squinting, into the sunlight. They’re eager to tell a much wider audience that silver’s time has come, and that last year’s stellar gains are just a warm-up for even greater returns ahead.