Review and Outlook
Silver’s extraordinary run over the last two and a half years has seen its price more than triple. Remarkably, this has occurred in spite of a notable expansion in mine supply and far more modest growth in fabrication demand. The principal explanation for why the price has nevertheless performed so strongly is the establishment of investment on the demand side of the equation. The sustained net disinvestment that characterized the market in the 1990s gave way first to a more neutral situation in 2001-03, with this, in turn, followed by more substantial net investment in 2004-05.
Total supply in 2005 increased by almost 4% to 911.9 Moz (28,364 t). Growth in global silver mine production exceeded expectations, with an increase of 3% or 21.1 Moz (657 t) in 2005, to reach a new high of 641.6 Moz (19,954 t). Total scrap supply rose a perhaps surprisingly modest 3% in 2005 despite the increase of 10% in the silver price. Last year, government sales rose 2% to 68.0 Moz (2,114 t), still more than a quarter down on the level recorded in 2003.
World Silver Supply and Demand (Moz)
|Net Government Sales||66.5||68.0|
|Old Silver Scrap||181.2||187.3|
|Implied Net Disinvestment||-||-|
|Jewelry & Silverware||247.8||249.6|
|Coins & Medals||42.3||40.6|
|Net Government Purchases||-||-|
|Implied Net Investment||38.7||47.5|
|Silver Price (London US$/oz)||6.658||7.312|
As for future supply, higher silver and base metals prices have improved the outlook for mine production, with fairly significant growth expected from 2007 onwards. In addition, there is scope for an increase in producer hedging, although we would not exaggerate its potential. On the other hand, scrap supply (in stark contrast to, for example, gold) is proving to be relatively unresponsive to higher silver prices. Government sales will remain a feature of silver supply but, because official stocks are reasonably low, again unlike gold, they do not represent a substantial threat to the price.
The 3% rise in total fabrication last year hides some varying performances of the key sub-components. The pace of the decline in photography quickened last year to a 9% fall, although these losses were more than offset by gains within industrial fabrication, which comfortably surpassed its 2000 peak. When it comes to fabrication demand in the short to medium term, there is little price elasticity for most areas of silver use. Even in the jewelry and silverware sphere, the raw material value, in contrast to for example gold and platinum, represents only a low share of the retail price for the majority of articles. On the photographic front, high silver prices are having a marginal impact but nothing like as great as that of digital technology. Most industrial uses of silver are also largely insensitive to price over the short run. However, we would sound a note of caution over the longer-term prospects for an area that now consumes 47% of all fabricated silver were double-digit prices to be sustained.
Silver Price - Developments in 2005
The silver price rose a solid 10% last year to an annual average of $7.312. As in 2004, this increase was the largest of the main precious metals, with gold up 9%, platinum gaining 6% and palladium falling 13%. Silver’s intra-year gain was far more dramatic at 38%, reflecting the strength of the fourth quarter rally that took the price to an 18-year high of $9.225. The chief driver of prices during 2005, especially in the fourth quarter, was again the surge in investor interest. However, industrial demand’s strong growth, the fact that jewelry and silverware did not collapse and supply’s response to higher prices proving quite restrained also featured.
Conditions in 2005, in isolation, however still merit the title of a bull market, given that the rally broadly extended into prices in other currencies. Increases for the yen and euro price, for example, were slightly higher than in dollar terms, though rupee price gains were much more modest. The increase in local prices for the top three producers, namely Peru, Mexico and Australia, were also slightly smaller at between 6% and 8%.
An analysis of prices in real terms also comes back with a bullish verdict since, on this basis, the annual average was last higher in 1989. Real prices also provide some insight as to how sustainable today’s double digit prices might be; during the 1980s on this real basis, the annual average silver price was only below $10 in two years and was above $15 in five.
After a quiet start to 2005, lease rates entered a new phase in early May when a rate spike began a volatile but ultimately upward move. The percentage gains were greatest at the short end; the 3-month rate rose from almost zero to a more respectable 0.6% or so over the year. Gains at the longer end were still impressive; the 12-month rate’s annual average almost doubled to 1.8%. As with prices, further strong gains have been seen so far in 2006; the average for the January-April period for the 3-month and the 12-month rates, for example, jumped to 2.3% and 3.9% respectively. Jewelry and silverware also added some support to prices, again particularly on dips, in the first three quarters of 2005 as this area’s offtake looks to have been notably firmer, despite already higher prices. This sector weakened in the fourth quarter but signs of a slump anywhere were largely absent until December. This overall stable performance is testament to the importance of rapid GDP growth in the likes of India and China.
That scrap failed to derail the rally was largely due to structural factors, namely the high share of fabrication going to industrial ends (where recycling rates are low) and the ongoing retreat in the photographic sector (and therefore its scrap) due to digital inroads. Net government sales also showed a limited price response. There was some opportunistic selling on price upticks but overall volumes were constrained, particularly by the Chinese, adding support to previous assertions that the latter’s stocks were heavily reduced on previous levels.
Mine production also did little to impact prices as its increase at 3% was modest and well telegraphed. Producer hedging grew fast in 2005 and much of this concerned secondary miners locking in what they perceive as attractive prices for their silver and some project hedging. However, the absolute scale of the increase was small and there was little evidence of a change in primary producers’ typically negative attitude towards hedging.
Strong growth in Mexico and Australia assisted global mine production to a record high of 641.6 Moz (19,954 t), a 3% or 21.1 Moz (657 t) increase year-on-year. The improvement was partly explained by record performances at two of the world’s largest silver producing mines, namely Penoles’ Fresnillo in Mexico and BHP Billiton’s Cannington in Australia. Peru, ranked as the number one producer, also registered healthy gains, with higher output at Antamina, El Brocal and Yanacocha all contributing to the country’s 4% jump in recorded production volumes.
Offsetting the gains described above, lower output was noted, in order of increasing magnitude, in the United States, Bolivia, Poland and Canada. Canada generated the bulk of last year’s losses, accounting for 52% of the gross decline in global mine production. Mine closures and reduced output at Eskay Creek, where reserves are expected to be exhausted by 2008, explained much of the fall. Elsewhere, Poland’s KGHM reported substantially lower by-product silver at the company’s copper operations, while in the United States and Bolivia losses were modest at a respective 1.0 Moz (30 t) and 1.1 Moz (35 t).
Last year, net government sales rose at the margin to reach 68.0 Moz (2,114 t). Supply fell from both Chinese and Russian stocks, substantially so in the case of the former. However, these declines were more than offset by the appearance of official sector sales from India, which were good for nearly 26 Moz (800 t). A small contribution to the overall figure was also made by modest sales from a handful of other countries.
Total global scrap supply rose modestly in 2005, up by 3% to 187.3 Moz (5,826 t). Considering the 10% rise in the dollar price, it might have been expected that the increase would have been greater. One reason this was not the case is that a substantial component of silver scrap recovery is now quite price inelastic, being driven by environmental and other legislative constraints. Consequently, recovery (for example from electronics) tends not to respond dramatically to price increases. Secondly, the recovery of silver from photographic applications dropped sharply in most of the main markets (including the United States and Japan). This partially offset growth in recovery from the electronics and electrical sectors.
Higher prices did, however, impact more markedly on recovery from the jewelry sector. Both India (largely from private individuals) and Italy (mainly through heavy trade destocking) recorded substantially higher levels of jewelry scrap in 2005.
The outstanding delta-adjusted silver hedge book in 2005 increased by a substantial 24% compared to the corresponding position at end-2004. The hike in producer hedging was restricted to the options portion of the book, while forward sales experienced a modest contraction. Fresh hedging by Bema Gold and Apex Silver Mines, respectively related to financing requirements of the construction of Kupol in Russia and San Cristobal in Bolivia, made an important contribution to the measured rise. A further lift was provided by the higher price used to value the options book ($8.83 versus $6.82 at end- 2004), which contributed to a rise in the implied delta against the contracts.
Industrial demand in 2005 grew by a robust 11% to 409.3 Moz (12,732 t). The primary drivers of this impressive performance were buoyant global economic growth and strong consumer demand for products that in one form or another utilize silver. Demand for mass produced, low cost electronic items was, in particular, important in generating higher offtake. Growth was seen both in existing areas, such as cell phones, or newer ones, for example plasma display panel (PDP) flat screen televisions as these grow more affordable and are absorbed into mainstream use. What is probably most significant is that total industrial offtake in 2005 was 9% higher than the previous peak, recorded at the height of the ‘tech bubble’ in 2000. All of the major regions recorded higher demand last year, with the exception of Europe, where offtake was marginally down.
The most spectacular growth in both quantity and percentage terms for industrial demand was seen in India, up 19.8 Moz (617 t) or 59%, driven by higher demand in the electronics and electrical sectors as well as by a significant rise in plating of fashion jewelry. US offtake also rose strongly, pushing above 100 Moz for the first time (basis GFMS’ series which starts in 1990). As was typical of most countries where offtake rose, electronics and electrical applications were the key drivers. Silver in these uses rose by 10% last year. Offtake of brazing alloys and solders rose more modestly, by ‘only’ 8%, reflecting somewhat weaker consumer demand (for products like air conditioners) compared to the electronics sector. Despite higher prices, jewelry and silverware demand rose in 2005. However, this was only by 1% and the total, 249.6 Moz (7,763 t), was the second lowest since 1995. The two main contributors to the gain were India and China, though a large rise was also seen in Russia. All saw robust domestic consumption, largely thanks to buoyant GDP growth, though the first two also enjoyed vibrant jewelry exports. The latter was largely due to these countries’ lower costs, in particular for high labor, gemset pieces whose share of most consuming markets is growing. Increasing competition from India and China largely explains why the two other main fabricators, Thailand and Italy, saw respective falls in fabrication (including silverware) of 1% and 10%. Lower jewelry consumption within Italy and certain other western countries was another contributory factor. A continuation to the secular slide in silverware consumption in many markets accounts for much of the drop in this area, which is thought to have been steeper than for jewelry alone.
Photographic demand for silver declined by a further 9% last year to 164.8 Moz (5,126 t). The bulk of the loss was due to sharply lower silver use in the production of color negative film, sales of which are falling due to consumers switching to digital image capture. Silver requirements for the manufacture of photographic paper and X-ray film also fell at the margin last year. Since its peak level in 1999, the use of silver in photography has slumped by 63.1 Moz (1,961 t) or 28%.
2005 saw implied net investment rise to 47.5 Moz (1,478 t). Over the last two years there has been substantial growth in activity from mainly institutional investors in silver futures and, especially last year, in over-the-counter market instruments. For much of 2005, investment demand in silver tracked moves in the gold price, as well as expectations thereof. From the latter part of the year and still more so in the first third of 2006, however, an important factor was speculative buying ahead of the launch of the much-awaited silver exchange traded fund. This started trading on April 28th and, in the first two months since inception, has amassed holdings of 78.5 Moz (2,441.6 t).
Coins and medals fabrication declined by 4% last year, as higher minting across much of North America and in Germany, in particular, was offset by weaker output in Portugal, Spain and China.
Source - The Silver Institute