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Thursday, April 26, 2012

The Silver Megathrust

Stephan Bogner
April 26, 2012 - 2:08pm
 „History does not repeat itself, but it sure does rhyme. (Mark Twain)

Between 1970 and 1979, the silver price was increasing steadily from $1.50 to $6, before taking off in September 1979 from $10 to $50 within 5 months. During that bull cycle, demand for silver did not increase but actually declined (sharply in 1979). It was as late as 1983 when demand increased confidently from 12,000 to 27,000 tons per year until 2000 – yet the silver price was in a 20 year bear market during that time. In 2003, when silver started its new bull market, the demand actually dropped to 23,000 tons until 2005 – during which 2 years silver almost doubled from $4.50 to $8. Since 2005, demand is rising stronger than ever, having reached 33,000 tons in 2010, whereas the silver price is rising strongly as well.

The initial comparisons indicate one important phenomenon in the silver market, namely that (industrial) silver demand is “price inelastic”: that is, changes in price have a relatively small effect on the quantity demanded. The demand for other commodities is known to be “price elastic”: that is, changes in price have a relatively large effect on the quantity demanded (if tomato prices blow up, go bananas). This basically translates into: no matter if the silver price crashes or explodes, demand – unimpressed – will keep its own dynamic pace, because demand does not respond to price changes. Firstly, silver is the most broadly used metal, because of its unique characteristics, such as highest thermal and electrical conductivity of all metals. In most of its few thousand application fields, silver is considered a non-substitutable product. In contrast for example, when the platinum price increases too strongly, automotive demand traditionally substitutes for cheaper palladium thus potentially driving down the platinum price. 

Secondly, silver typically makes up only a relatively small component in the total of the product and the total of its costs. Both these demand characteristics/inelasticities (not substitutable and small cost component) are crucial to understand the silver price, because they remind that no matter if price explodes or crashes, (industrial) demand virtually does not care, but keeps on consuming as per its own factors/fundamentals. Notwithstanding, an increased demand principally has a positive effect on the price, of course (GFMS expects fabrication demand in 2012 to rise by approx. 3-5% to around 29,000 tons silver, whereas fabrication demand accounts for more than 80% of total demand; fabrication demand includes industrial applications, photography, jewelry, coins and silverware).

Now let’s have a look at the price elasticity of supply – a way to show the responsiveness (“elasticity”) of the quantity supplied to a change in its price. What happens to the silver supply if the price crashes or explodes? Nothing much either. Surely, if price explodes people tend to melt their forks and knives besides selling their silver investments, hence private and commercial recycling and selling will increase in the short-term (yet silver is already being recycled “where possible”, and most of the silver ever consumed by industry can be considered as lost respectively not recyclable). More importantly, core supply (mining) does not change significantly if the silver price changes. This shows us a second important phenomenon of the silver market, namely that silver is supplied predominately as a bi-product during the mining of other metals, such as gold, copper, zinc and lead (in 2011, mining accounted for 73% of total supply, whereas primary silver mines only contributed 29%). This implies that the silver mining output does not depend on the silver price, but rather on the price of the primary metals, such as gold, copper, zinc and lead. For example, if the copper price doubles, copper mining typically expands generating more silver output. If the copper price is cut in half, silver output shrinks no matter if silver price doubles or quadruples. The mining and consumption of primary metals like copper and zinc is dominated by the automotive and electrical industry thus largely depending on economic growth in developed and/or non-developed countries. If economic growth collapses in the future, less silver is mined which principally translates into higher prices. If economic growth flourishes in the future, more silver is expected to be mined – however, so much more silver must be mined to even meet demand that it is (more or less) safe to consider it as not realistic (in today’s terms): In 2010, total silver supply was 23,000 tons and total demand was 32,000 tons. 

The difference is called (supply-demand) deficit, whereas the “chronically missing silver” comes from destocking. Why is someone filling up the gap as the price shall “correct the deficit” by way of rising thus decreasing demand? Because it would not work, of course (as we have seen above). Thus, when destocking has come to an end and industries do not get supplied with sufficient silver (no matter where the price may trade or be fixed at), the respective (silver-containing) product can not be produced in “unlimited” quantities anymore thus (increasingly) limiting the production output and its economies of scale. Hence, it is the price of this “limited edition” (silver-containing) product that will increase in order to get supply and demand balanced out, whereas the silver price principally does not to change as it would not effectively increase supply or decrease demand (as we have seen above). Notwithstanding, a decreased supply principally has a positive effect on the price, of course.

The difference between gold and silver, and every thing in general, is its present supply and demand respectively its valuation/perception and ultimately its price. Firstly, silver (0.08 ppm = 8 gram in 1,000 tons) occurs on average 20 times more often in earths continental crust than gold (0.004 ppm). On earth (incl. hydrosphere, atmosphere and crust to a depth of 16 km), silver (0.13 ppm) occurs 26 (=13x2) times more often than gold (0.005 ppm). Hence, (below-ground) gold is more rare than silver. Secondly, gold deposits form near surface and at depth, whereas silver predominately forms near surface and not at depth. Thus, fewer silver deposits will be discovered in future due to technological breakthroughs since 1950s having discovered most near-surface deposits already. Hence, (below-ground) silver trends to be more rare than gold. Thirdly, most of all gold ever mined (approx. 90% of 150,000 tons total) still “exists” (marketable) as dominantly being hoarded as a hedge against money (either fiat-money or gold-backed money). Most of all silver ever mined (1.6 million tons total) has already been lost as typically being irrecoverably consumed by the industry. Hence, (above-ground) silver is more rare than gold? Not quite there yet – as estimates calculate around 600,000 tons still “existing” marketable in form of coins, medals, bars, jewelry and other silverwares. Assuming yearly silver demand at 45,000 tons, no mine output, and no (other) destocking, it would take 10 years until there is around the same amount of (above-ground) silver left as gold (150,000 tons) and another 3 years until the rest is lost as well (this includes the assumption that the owners of the 600,000 tons silver would sell consistently with higher prices). In the end, silver may be more rare than gold as below- and above-ground silver is (currently) being vanished into thin air...
Finish reading with more charts @Silverseek

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