Prieur du Plessis is the author of the Investment Postcards blog - subscribe here.
I am on record calling the silver market a Hunt Brothers type of market a few days before the market crashed. Well, it has happened. After soaring to a peak of $49.79 per ounce on 26 April, the silver price crashed to a low of $33.01 on 18 May.
With silver trading at a notch below $35, the question is: whereto now? In my analysis of the platinum market I compared the platinum price after the Tohoku quake in March this year to the platinum price after the Kobe quake in 1995. I did the same with the silver price, and wow, see what emerged!
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Sources: I-Net Bridge: Plexus Asset Management.
The silver price reverted to the levels prior to the Tohoku disaster and has since tracked the price movements of the Kobe disaster. It is most interesting to note that the silver price took off a few days after Japan’s twin disaster. Why? I ask myself.
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Sources: I-Net Bridge: Plexus Asset Management.
The only argument I can come up with is that sudden demand caught the market seriously short. This sudden demand could have emanated from the crisis in the MENA region as the affluent people in those countries took refuge in silver as a store of value that they could move across borders. In addition to that, investors probably took fright at the jump in energy prices as a result of the MENA situation and rushed into the silver market. I think the earthquake in Japan perhaps led to fears that silver scrap recovery could also be severely hampered as the annual scrap recovery is equivalent to 29% of annual mining production.
It seems to me that, as in the case of industrial metals, the outlook for silver is heavily dependent on China. China’s fabrication demand for silver amounted to 21% of world fabrication demand ex coins last year. The country’s fabrication demand over the past five years has grown in line with the GDP at a rate of 11% per year. At a growth rate of 9% per year it means that China’s fabrication demand will swell by 88 million ounces from the current 163 million to 251 million ounces by 2015. Mining production over the past five years has grown by 4% per year. If I assume that the growth rate will be maintained, it means the country’s mining production will rise by 22 million ounces from 98 million ounces in 2010 to 120 million ounces by 2015. A net shortfall of 66 million ounces! Yes, that excludes scrap recovery and investment demand.
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Sources: CPM; Silver Institute; Plexus Asset Management.
China used to be a net exporter of silver in the past mainly due to sales from government stockpiles. The situation was reversed in 2007, though, and the country’s imports are currently around 11% of total world supply.
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Sources: CPM; Silver Institute; Plexus Asset Management.
From my research a very interesting fact came to the fore. The CPM Group’s seasonality index for silver has a very close relationship with the seasonality of China’s CFLP manufacturing PMI! That explains the importance of China in the world silver market.
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Sources: CPM; CFLP; Li & Fung: Plexus Asset Management.
With this year’s trend of China’s CFLP manufacturing PMI being significantly lower than the apparent normal seasonal pattern, it shows how artificial the jump in the silver price was in March and April.
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Sources: CFLP; LI & Fung; Plexus Asset Management.
Now we are back to normal, but we are not in normal times yet. The manufacturing sectors in China and the rest of the world were severely affected by Japan’s disaster and it is thus unlikely that the normal seasonal patterns will repeat themselves, at least not over the next three to four months. The rebuilding of Japan is likely to rub off positively on the rest of the globe and especially on China’s manufacturing industry. It seems to me that the normal seasonal lull in China’s manufacturing activity has been brought forward by Japan’s disaster. Will Japan’s recovery reinforce the normal strength from September through end-December?
But what are the major market players up to?
It normally hits the headlines about what investors in physical silver ETFs are doing. My research however indicates that the silver price leads the physical holdings of ETFs by approximately four days. It also seems to me that the number of players in the physical silver ETF market as represented by the ETFS Physical Silver Shares is limited as the physical silver held by the custodian are normally unchanged for nearly a week. What the graph below is telling me is that the recent rise in the price of silver indicates that an inflow into physical silver ETFs can be expected in the next few days.
Where I previously thought that the jump in the silver price towards the end of May would likely be as a result of an inflow in physical silver ETFs the market proved me wrong. The jump in fact led to selling of the metal while the subsequent drop in the silver price saw investors jumping back into the market. Since then the silver price range-traded indicating relatively little interest in the metal.
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Sources: etfSecurities; I-Net Bridge; Plexus Asset Management.
To me the most important factor to watch in the silver market to get a lead where the silver price is heading is the open interest in derivatives in silver on Comex. The commitment of traders is given on Tuesdays. In the graph below I plotted the open interest (futures and options combined) with the closing price of silver the week prior to the announcement of the open interest. Amazing stuff! The week before the silver price plummeted in the closing week of April, the open interest fell by 24 000 contracts equal to 120 million ounces of silver! Somebody made big bucks at the expense of others.
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Sources: CFTC; I-Net Bridge; Plexus Asset Management.
What the relationship suggests is that when the open interest is trending upwards you should be buying silver and conversely, when it trends down you should cut your longs and if you are brave enough you can even short the market with some confidence. The current situation is a clear bottoming of the open interest and that, together with increased interest in physical silver interest is indicating to me that the current bounce in the price of silver is likely to be extended.
I am therefore as positive on silver as on platinum. Buy!
Source: Investment Postcards
