Credit: Shutterstock photoBy Willem Middelkoop :
As investors in silver, we have experienced great frustration in trying to track supply and demand of physical silver. Frustration because the leading research groups have systematically underestimated investor demand since the outbreak of the credit crisis. Eric Sprott showed back in 2010 that the real silver holdings by ETFs at the end of 2009 exceeded the number reported by GFMS,another research group, by at least 43%. After the start of the credit crisis, retail investors fled in huge amounts to the traditional safe havens of gold and silver. I personally, just like Eric Sprott, have firsthand experience in what the market for physical precious metals looks like, as I founded AmsterdamGold.com at the end of 2008. I sold this bullion web shop in 2011 to a listed company after it reached sales of over $100 million. We both witnessed firsthand retail investors investing just as much money in silver as in gold, in dollar terms.
Demand
CPM Group, one of the research groups focusing on silver, publishes an annual 200+ page report on silver fundamentals, but surprisingly without showing a simple total supply and demand chart. What they do show is the total supply in relation to fabrication demand, a topic they like to spend an inordinate amount of space on. Looking at this chart, one gets the comfortable feeling silver is freely available, and that there is no issue at all in terms of supply constraints.
However, silver demand is made up of more than industrial demand. In a recent note on silver investment demand, CPM Group opens by proclaiming that "investment demand is the most important driver of prices in thesilver market. It subsequently fails to incorporate this investment demand in its own supply and demand graph. Incredible indeed.
The real flaw in their analysis is their focus on silver as a commodity. Silver is seen as something that is used in industry for a variety of purposes, fabricated into products, and sold on. Industrial demand is, therefore, analyzed in great detail. Even jewelry gets a section under fabrication demand, as it is first put through a fabrication process before being sold to retail. Investment demand is not put through a similar process, and CPM Group therefore does not add this to their demand figures. Apparently, this is not sound commodities economic analysis. This is despite the fact that according to CPM, 862 million ounces of silver was channeled towards investors between 2006-2013, roughly 13% of the total supply.
Once we add CPM's data on investment demand (ETFs, coinage, and bullion demand) to the equation, the picture becomes much less rosy. It then appears that a deficit has persisted since at least 2006, the period where CPM paints a cozy supply surplus. After cross-comparing CPM data with that of GFMS, we concluded that there was a huge gap. Over the last 10 years, this demand difference averaged 11%, or over 100 million ounces. This is no statistical error, but a huge deviation. So is GFMS overstating, or is CPM understating?
India
Another worrying aspect of the demand figures is the failure to specify Indian silver demand, which exploded in 2013 on the back of the 10% gold import restrictions. Recent data has shown that this import was just shy of 200 million ounces, over 20% of world mining supply, and more than double the 2012 demand. But in CPM's elaborate report, we could only find one reference to this added demand: "A more recent example relates to the Indian government's restrictions and heavy duties on the import of gold over the past few years. Indian investors have, as a result, bought more silver to replace their investments for gold." CPM data, however, shows no significant demand rise in either jewelry under fabrication demand, in non-industrial demand, or in investment demand, to accommodate this additional Indian demand.
CPM notes that thesilver marketcan stay in deficit for a very long time before the price reacts: "For 14 years between 1991 and 2005 the market was able to remain in a deficit before prices showed any major response". Well, the explanation is obvious. Government inventories have been drawn during that period to keep the silver price down. These inventories are now almost gone, according to Silver Wheaton, the leading silver streaming company.
Here again, there are major differences between the CPM volumes of government sales and those of GFMS, with those of the latter exceeding those of the former by a factor of seven over the last 15 years. In other words, the draw-down of inventories is taking place at a pace 7x times quicker than CPM wants us to believe.
ETFs
GFMS reports, on average, 5% more ETF inventory build than does CPM. As said, Eric Sprott showed that the real silver holdings by ETFs at the end of 2009 exceeded the number reported by GFMS by at least 43%. But the most important objection we have to the CPM analysis is the way they process the ETF demand and the way they link this to inventory. CPM adds this year's ETF demand to inventory for the next year, implying it is a silver stock available for purchase, and giving the impression that there is a large build-up of inventory we can fall back on. Nothing to worry about regarding supply of the metal.
Nothing could be further from the truth. These ETF holdings are not added to available inventory (or does CPM know that silver ETFs lease out their silver?). The ETF inventory is growing persistently, and has done so regardless of whether the silver price was $17 or $45.
As Jeffrey Christian of the CPM Group himself states, "many investors buy silver and gold not as an investment in any short-term or speculative sense of the word, but as a core part of their long-term assets". CPM mentions silver investors mainly consist of what he calls "stackers", people who buy silver not for a short- or intermediate-term investment, but as a means of preserving wealth. They will hold indefinitely until the systemic issues have been resolved.
Mr. Christian admits that what constitutes inventories is a complex matter. He defines inventories as silver held in bullion bars, coins, and medallion forms, that can be sold at a moment's notice. Clearly, silver ETF holdings are not inventory under his own definition, as history has shown that they do not become available even at $45 silver. In effect, there is no justification for regarding these as inventory, in the same way as we cannot claim unreported silver holdings are available inventory. The silver is there, but not an immediate issue for the silver bullion market.
The reason for the CPM omissions could well be found in the following email from Jeffrey Christian to one of our researchers : "CPM's data are best estimates, but we know there are big holes in our data". Despite this, the world digests the group's data as if it were the sole and only truth.
With all the enigma surrounding the precious metals markets and silver in particular, our analysis shows that thesilver marketmay be in imminent danger of supply disruption. Just recently, a Chinese supplier company announced it has reached an agreement with Santa Cruz Silver, a miner in Mexico, for the purchase of $28.4 million of silver from its mines. This is not a hedging deal. Barring a small discount for making funds available upfront, the Chinese have not made any pricing arrangements, and silver is to be purchased at spot. The sole purpose of the deal from a Chinese perspective is to lock in guaranteed supplies of silver, something one only does if they believe shortages are imminent.
Of course, we gave CPM/ Jeffrey Christian a chance to check an earlier version of our facts and react to our findings. Clearly there was no interest in a dialogue. Jeffrey Christian's reply by email:
Dear Sir:
There are many, many errors of fact and analysis in your piece.
Given that you have staked out a posture of nastily attacking CPM and me personally, and taking private comments out of context in a way intended to embarrass us, we feel that your ignobility justifies us suggesting that we not respond further in private to you, lest you further distort our private comments to you and the nature of the physicalsilver market and allow you to publish an embarrassingly (to you) inaccurate piece on Seeking Alpha. It is a free world, after all, and you are free to appear foolish.
Should you wish to actually understand thesilver marketand have the errors of your data and analysis illuminated, CPM Group gladly would take you on as a paying client and help you with the imperfect work you have produced. Let us know if you wish to undertake such research and consulting services. Otherwise, have fun with your Seeking Alpha piece.
By the way, here are two things of note. First, I do not call them 'stackers.' They call themselves that, proudly. Second, basic commodities research, across all commodities, measures total supply less fabrication demand to arrive at a surplus or deficit. Only people promoting gold and silver, i.e. GFMS, Sprott, and other marketeers, vary from the standard analytical procedures of commodities economic analyses and add investment demand such as coins and bars into their fabrication demand figures. But those are the least of the errors in your paper.
Cordially,
Jeffrey M. Christian
We still hope CPM will prove fault in our analysis and show they are willing to take investors seriously. We challenge the company to make the same effort in coming to an accurate investment demand that it currently does for fabrication demand. This would inform the market in a more balanced way.
Willem Middelkoop (additional reporting/research by Terence van der Hout)
Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it. The author has no business relationship with any company whose stock is mentioned in this article.
Additional disclosure: Our Commodity Discovery Fund is long silver ETFs.
See also So The Fed Does Have Gold: The Netherlands Just Repatriated 122.5 Tons Of It on seekingalpha.com
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.
