China’s nebulous silver market

The potential for expansion in Chinese silver demand becomes clear when analyzing how the country’s boundless growth over the last few years has affected the silver market.

Looking at its share of global fabrication demand, China grew to well over 6% in 2004 from around 3% a decade ago. In 2005, this share is expected to increase further and fabrication demand in China will outpace growth, according to a new report compiled by London-based Gold Fields Minerals Services (GFMS).

The increase in Chinese silver demand, positive though it might look, has been greatly overshadowed by increases in demand for other industrial commodities, such as base metals. China’s shares of global aluminum and copper demand in 2003 — at 19% and 20%, respectively — were almost twice as high as they were five years before, and are forecast to continue expanding, at least for the foreseeable future.

With 63.8 million oz. silver produced from mines in 2004, China is currently the world’s fourth-largest silver producer. This supply comes from a considerable number of smaller mines, rather than a few large ones. This fragmentation of the mining sector, as well as the tight control and distortion of the market by the People’s Bank of China (PBOC) and central committees that took place for much of China’s history, makes collection of mine production data difficult. As a result, there are conflicting views regarding the historical data. Nevertheless, there is a general consensus that production grew rapidly during the 1980s and 1990s.

It should be noted that any published data on China’s silver supply — including refining/scrap production — should be viewed with extreme caution, as there are potential issues of double counting and errors in the identification of the sources of silver (for example, mine production, scrap or a change in stocks).

The bulk of scrap supply in China comes from photographic and electronic uses. GFMS research has concluded that, during the regulated years, the majority of scrap was actually sold through unofficial channels, mainly to the local market or exported to Hong Kong.

The past five years have seen rising interest in the amount of silver that has been recovered from base-metals concentrates in China. We know that during the early to mid-1990s, the amount of silver recovered was very small, as tight regulation of the silver market made shipments of concentrates into China highly uneconomic. Our estimates are that the recovery from imported concentrates stood at less than 3.2 million oz. per year until the late 1990s — tiny compared with the other elements of silver supply in China. The picture has changed since then.

Our estimate for 2004 was that just over 32.2 million oz. silver was contained in imported concentrates, or more than half of Chinese mine production. The previous five years have seen about a three-fold increase in volumes recovered. This increase has mainly been driven by China’s remarkable gross domestic product growth, and the resulting increase in demand for base metals.

Data on demand for silver was relatively easy to collect during the time of official control of the market. One had simply to take the PBOC data, and correct it to allow for unofficial activity. Although, since the liberalization of the silver market, fragmentation has made measuring demand more difficult, our data indicates that the bulk of demand is from the industrial sector, particularly electrical and electronic end uses. Jewelry demand has also been growing rapidly, much of it for export. For example, China is now the second-largest source of U.S. silver jewelry imports. Overall, Chinese silver fabrication demand has grown at an average annual rate of 12% over the last five years.

Curiously, imports have been identified even when China was a major exporter of the metal. Bullion has been imported mainly to satisfy needs for a particular quality of metal. Exports, on the other hand, were driven by the discount of the PBOC’s buying price against the international price. The bulk of China’s exports of silver were channelled to Hong Kong. Overall, China has been a net exporter for the past decade. More recently, and in particular in 1998 and 1999, silver exports rose to unprecedented levels. They remain buoyant now, although it appears they may plateau in 2005 as mine supply and concentrate imports peak. China mostly exports its silver to a variety of countries in Europe, East Asia, the Middle East and, of course, India, which has frequently been the largest consumer of Chinese silver.

Since 1998, China has contributed to global silver supply through a run down of domestic bullion stocks, mainly from official and quasi-official inventories. We believe such stocks still exist, albeit at significantly lower levels than in the mid-1990s. GFMS estimates that supply to the market from Chinese bullion stocks in 2004 reached some 34 million oz. and peaked at nearly 67 million oz. in 1999.

In the past, China was a country with a substantial local surplus of silver. In 2004, it reached nearly 19 million oz., down from 26 million oz. in 2001. Early estimates for the country’s supply and demand of silver in 2005 suggest this internal surplus will fall noticeably, perhaps even as low as 3.2 million oz. With mine production unlikely to show any dramatic increase, and scrap levels in the country being reasonably low, future increases in fabrication demand are expected to put China into a deficit situation over the next few years. Whether the country will become a net importer of metal, of course, depends upon whether government stock sales at some point come to an end.

— The preceding is an edited version of an information bulletin published by the Washington, D.C.-based Silver Institute.