JULY 6 2007 1:30PM - Now we're talking, some real buying has emerged in the last couple of days as silver and gold have climbed off their lows. Silver in particular is now close to escaping the gravity of the final bottom I was looking for. Not out of the woods yet, but another 10 cent continuation of this bounce would be rather bullish in the short term. In addition, the PM stocks have been on a tear with the HUI punching through a sublime resistance zone near 352 today. All in all, a great ending to a "summer doldrums" week for the PMs. See, I told you things always pick up after I utter that cliche!
The iShares silver ETF (SLV) added 1.5 million ounces yesterday and with the building of investor sentiment, it could easily go over 140 million ounces by next week. Silver lease rates have also improved modestly but the situation still bears watching.
For today, I wanted to revisit a comment I made on February 21 regarding my belief in the "defensive" value of Silver Wheaton at that time in comparison to other silver stocks and Pan American Silver in particular. Shortly after these comments, I established a position in Silver Wheaton in order to increase the "quality" and liquidity of my silver stock portfolio. Sure enough, SLW has proved to be quite defensive as the stock has registered gains of more than 30% during a period when silver prices have barely stayed even. Well, I am now preparing to reverse my bet and switch to Pan American as the "quality" anchor to my silver stock portfolio, if just for a short while. The reason is earnings; that is, Pan American should earn significantly more than Silver Wheaton in the second quarter and this may cause a number of institutional investors to reassess their relative allocations.
Finally, I wanted to mention my approval of the new Virtual Metals/Fortis' The Silver Book, an inaugural publication on the silver market in a similar vein to CPM Group and GFMS. This study of the silver market has a slightly different twist compared to the others, and what I like most about it is the fact that there is no attempt to balance supply and demand. In previous comments, I have made known my disdain for the inclusion in the various metal yearbooks of "implied" investment, disinvestment, or what have you, because such a method creates an aura of accuracy that is simply not there. Instead, The Silver Book just calculates the difference between the known and estimable supply and demand figures and arrives at either a surplus or deficit. I would leave out ETF demand as well because it is simply a change of investment ownership between market participants, but I do understand why it is included in THE SILVER BOOK: because at least it can be directly measured.
Interestingly, The Silver Book approach results in a calculated surplus of known and estimable silver supply over demand for every single year going back all the way to the early 1980's. Many people, especially those who base their bullish case for silver on the supposedly extreme structural deficit in the silver market, will not be happy with this report. They will probably claim it is a smear campaign by the evil silver users or their accomplices, the "commercials". Yet the conclusions in this report are very similar to those that I have independently reached based on my own research, which admittedly is less arduous and data driven but perhaps more qualitative. Based on this now official confirmation of many of my own private research conclusions, I will probably start to comment more frequently on the macro fundamental factors underlying the silver market, in defiance of the consensus. Yes, my position will be seen as different from the more "senior" and experienced "silver analysts" such as David Morgan and Ted Butler, and no doubt it will create some controversy. So be it. Besides, why listen to me if I merely parrot what the other guys say?
There are three additional observations in this report that are important for silver investors to understand. First is the fact that there are more than 20 billion ounces of silver in above ground form today. In making this statement, I don't use the term "fact" lightly but rather in the sense of it being the inescapable reality. Now, these 20 billion ounces are not predominantly in investment form as bars or coins, but rather as jewelry, ornamental and art form, and various industrial products. As a result, recycling and refining are very important considerations in assessing the impact of these non-investment stocks of silver in terms of future supply (more on this in a moment). This situation is similar to gold, where a large (but relatively smaller) portion of the estimated 5 billion ounces of above ground gold is in the form of jewelry and ornamentation. Having said this, it is very important to realize that there is probably more gold in bar and coin form than there is silver, and this creates a powerful advantage for silver as an investment vehicle based on rarity during any investment horizon measured in less than decades. Many years into the future, gold will surely end up as the rarer form of PM investment as the cycle of converting ornamental to investment form reaches its peak -- simply because there is probably 5-10 times more silver in ornamental form than there is gold. What I'm saying is that the opportunity in silver is in TIMING the investment, not blind hoarding until kingdom come. Indeed, I believe this is what makes my approach at SILVERAXIS unique: a balance between dedication and objectivity in the silver market.
The second important observation made in The Silver Book is the emphasis on recycling data. GFMS and CPM Group are also very detailed and methodical in their analysis of recycling in the silver market, but I tend to agree with The Silver Book that these firms may have historically underestimated the figures for a number of inadvertent reasons. Sure, recycling is somewhat of a black hole but better information will no doubt be gained in the future as a function of greater effort. For now, I am going to assume that the true recycling rate is somewhere between the GFMS, CPM Group and Virtual Metal figures. Even with such a derived average, the known and estimable portion of the silver market would remain in a surplus, though somewhat smaller than The Silver Book has calculated.
For now, there is at least one area that can be addressed with little risk of being wrong. It has to do with a mistake made by many commentators on the silver market: the claim that 90% of annual mine supply is irretrievably lost through non-recoverable industrial use. Right off the bat this is nonsense given that jewelry and silverware alone have historically accounted for more than 25% of mine supply net of recycling (no matter which silver study you use). Meanwhile, industrial recycling has run at a rate of anywhere between 10-30% of mine supply. These two figures combined essentially mean that as much as 50% (and certainly not less than 1/3rd) of annual mine supply is retained in above ground, recoverable form. Another way to say this is that between 33-50% of annual mine supply is added to the total above ground stocks of silver each and every year. This rate is much lower than the rate for gold, but it is decidedly not quite the same shocking story being sung by the vast majority of commentators. I'll have much more to say about this later as it has important implications for the future of silver.
Third, silver investors should objectively assess the hype surrounding the many new uses of silver in products such as RFID product tags, medicines, antimicrobial consumer goods, wood preservatives, batteries and the like. These uses, while exciting and important, are unlikely to be major sources of demand in the next few years. I even question the 778 tonnes (25 million ounces) of silver forecast in The Silver Book for use in wood preservatives during 2007 -- I will ask them about this and relay their response here. In the meantime, I stand by the conclusions I reached a while back in my commentary about The New Uses of Silver.
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