Is Silver at the start of another double digit move upwards?
Over the past 5 years the period between late June to early September has seen some of the fiercest rallies in gold and silver prices, with double digit percentage moves fairly typical. In 2013 the price of silver in particular rose nearly 30% as the market grappled with intense physical investment demand for coins and bullion in the midst of a severe supply shortage. 2015 has been a lacklustre year for gold and silver so far in US Dollar terms, but there are signs that the same conditions which led to the 2013 surge are starting to emerge once again, especially in the silver market.
Falling Prices are Triggering unprecedented retail demand
The ongoing rout in commodity prices, triggered by an expectation amongst investors that the Federal Reserve will begin raising rates this year, along with a severe slowdown in the Chinese economy has hammered the price of the precious metals, which has been in turn, triggered a wave of investment demand from investors wishing to own physical metal. This disconnect between the “paper” spot price and the demand for physical metal continues be a paradox for the gold and silver market – gold and silver appear to be one of the few goods on earth that the price decreases when scarcity increases!
As an illustration of just how tightly supplied the silver market is, the US Mint recently had to suspend the sale of Silver Eagle one ounce coins due to what officials dubbed a “significant” increase in investment demand. The US mint wasn’t alone. Sovereign mints all over the world have been rationing the sales of precious metal products, with the Royal Canadian Mint also recently placing their flagship Gold Maple Leaf coin on allocation for the months ahead as there is not enough supply to meet demand. Some metals dealers in July were reporting that their allocation amounted to just a week’s worth of typical sales for the summer period! Such rationing of coins is fairly common for old timers in the gold and silver markets, and while these short term supply constraints can help explain some of the tightness in the market, there appears to be something much bigger going on.
Silver is experiencing a structural supply problem
The US Mint’s latest sales suspension is the second this year, an obvious sign that demand is exceeding supply on a regular basis. The US mint rationed the sale of Silver Eagles between January and May of this year, a small component of more widespread rationing period which has been ongoing for the most part since 2013.
These periods of rationing are down to the structural problem in the silver market – an increasing numbers of industrial processes rely on silver as an important input. From electronics and medical applications to advanced aerospace industries, silver is becoming an important raw material of the twenty first century. Gone are the days when silver coinage and jewellery constituted the lion’s share of demand. As a result, mints all over the world face fierce buying competition from these industrial players, and are unable to respond to increased demand as most of the silver is already accounted for. In fact, the silver market has been under supplied for nine out of the past ten years – with last year 2014, recording just a tiny surplus.
This scarcity is likely to remain an ongoing theme for silver in the years ahead, and bottlenecks in coin supply will be an ongoing problem.
An obvious question arises here. If silver is in such tight supply, why does the price not reflect this? It’s a good question – and the answer can be largely be found in the paradox we identified earlier – the futures market. It is estimated that for every futures contract of silver there are over 100 paper claims. The price of this “silver” is determined through the price discovery mechanism of electronic exchanges, digital buying and selling which are often highly correlated to the direction of the broader market (nothing to do with fundamentals). Indiscriminate selling is commonplace, and with no need ever own physical silver before you sell, the opportunity for “silver raids” are there for those with the financial muscle to do so. It would appear price action in the precious metals market is one of the clearest cases of the “tail wagging the dog”. How long the market can go on like this is anyone’s guess, but there could well be a day on the near horizon where the paper value of gold and silver trends towards a level which is so far removed from reality that an unprecedented revaluation will need to occur. In the meantime, we watch the unfolding price action between now and labor day with interest to see if the structural supply problems in Silver translate into further price gains.