Silver Wrap Up

July 26, 2003

This article provides a final "in-depth" assessment of Silver and Silver related equities as investment opportunities over the coming years.

The following table was published in May 2003, as part of a World Silver Survey, by the Silver Institute. Source:

With this as context, the following comment appeared in the media on July 24th:

"This week's fresh attempt on the upside baffled many as the poor fundamentals that clipped the last run up were magnified by an announcement of job cuts on Wednesday from Eastman Kodak, the leading maker of photographic film and one of the world's biggest silver consumers. Ingrid Sternby of Barclays Capital said in a daily report that the market looked ready to drop, with the number of long positions held by speculators on the New York futures market showing a massive increase since early July.

"The market now looks ripe for what could be a violent phase of fund liquidation that would take prices sharply lower," Sternby said, adding that Eastman Kodak's job cuts suggested that there was no case for prices to be sustained at current levels."

Another quote - also on July 24th - was as follows:

"Kamal Naqvi of Macquarie Bank said: "My bias is towards this rally being a short-lived event again, on the basis that silver much more than gold is driven on supply/demand and it's hard to see a good reason for prices to rise so strongly with photographic demand weakening."

Given that the thought processes of both these analysts are being influenced by Kodak's woes (and Ms Sternby's view is also being influenced by the net long positions) it would be instructive to focus on both of these issues - which, incidentally, represent the "conventional" arguments against silver:

There is a ratio in financial management expressed as "Revenue per employee". The existence and relevance of this ratio should be borne in mind when reading the following press announcement (source:

What Kodak ACTUALLY announced was:

"Rochester, New York-based Kodak, the leading maker of photographic film, which has been scrambling for alternative markets as film demand shrinks, said it would cut 4,500 to 6,000 jobs, or between 6 percent and 9 percent of its global work force. The cuts will be made primarily in corporate administrative departments, manufacturing and research and development, the company said."

If we proceed from the base assumption that Kodak's action was an attempt to maintain its revenue per employee, then it may be reasonable to assume an anticipated fall in revenue of up to 9%.

Later in the same report, the following quote appeared:

"Sales rose slightly to $3.35 billion from $3.34 billion. Excluding the benefit of foreign exchange, sales declined 6 percent, the company said. Worldwide sales for the Photography segment, its biggest, fell 2 percent to $2.34 billion."

So the argument relating to Revenue per Employee holds true, and Kodak's decision to cut staffing by 6%-9% is not particularly sinister for the world of silver as a whole - although a drop in photographic sales of 2% should be adjusted by a further 6% to compensate for exchange rate movements (assuming the 2% number above has not already been adjusted)

If we proceed from the base assumption that the ENTIRE photographic industry's sales will decline by (say) 10% this year, (including X-Ray film which may in fact not be as negatively impacted by digital technology) an implication is that demand for silver for this application will fall from 205 million oz to 184 million oz - by 21 million oz.

In turn, that will STILL leave a market supply shortfall of 50 million ounces that needs to be covered by Government stockpile disgorgement assuming that:

  • Investment demand does not change
  • Other industrial demand - primarily from electronics, and superconductors does not change
  • Mine production does not fall further (it is unlikely to rise)
  • There is no net impact of an unwinding of existing derivatives contracts

Apart from China and India, no Government has any silver inventories to talk of. Further, "available" COMEX inventories - the only other significant available stockpile excluding mine inventories - are down to around 46 million oz.

So it boils down to whether China and/or India will continue to sell large quantities of silver inventory into the market, which begs the question: Why would they do this?

Well, it could be argued that both of these countries would like to see stable silver prices insofar as rising prices might negatively impact other employment generating industries. However, for example, if photographic film sales were further negatively impacted by yet higher prices - then, presumably, the self regulating mechanism of the markets would kick in, and the move to digital would accelerate. (One industry would benefit at the expense of another). As a sweeping statement, the silver components in the electronics industry are probably not price elastic, and the superconductor demand is at present probably irrelevant in terms of overall volumes. It follows that a rising silver price is unlikely to cripple the electronics industries.

It does seem reasonable to expect a rising price of silver to negatively impact on Jewellery and Silverware demand, but it could also be argued that there might equally be a compensatory increase in demand for coinage and investment. Both arguments are speculative, and probably cancel each other out.

Of course, because of the lack of transparency regarding the stockpiles of both China and India, it is difficult to form a definitive view regarding their capability of maintaining/increasing the rate of inventory disgorgement. Overall, however, there seems to be no commercially compelling reason for either of these governments to modify their historical behaviour regarding silver, and it is probably safe to assume that they will not. (If anything, sales from these sources are likely to reduce).

From a Silver Bull's perspective, the "worst case" scenario would be if COMEX plugged the market shortfall by running its stocks down to zero, AND both India and China disgorged inventories, but such a development would probably be more bullish that bearish taking a longer view.

Interim conclusion

Falling photographic sales do seem likely to place a mild downward pressure on the silver price, but are unlikely to impact seriously on the need for Governments to continue to disgorge inventories to plug the demand shortfall. Overall, the net situation seems to be price neutral.

Turning now to the question of all these institutions which are "long" (Ms Sternby's other concern). What does this mean?

We need to be clear that Institutions are not (yet) accumulating inventories of physical silver for investment purposes. In fact, the position as reflected in the Table at the beginning of this article shows that there has been net DISinvestment from all sources.

On the other hand - in the derivatives market - the fact is that for every long position there is a balancing short position, and if the "Institutions" are long, then someone else (possibly bullion banks and/or Commercials) must be short.

Let's look at the trading position on TOCOM over the past week, by way of illustration

As at July 24th

As at July 17th

A comparison of the week-on-week statistics shows that the Open Interest position has increased by 2247 bars of 60kg, or 4.75mm oz.; and that "new purchases" grew as a percentage of total purchases from 51% to 74%, whilst the percentage of "new sales" grew from 37% to 43% . - Clearly there has been buying pressure, and this is possibly what Ms Sternby has been referring to..

However, when we delve a bit more deeply into the nature of the open positions, we note that 78% of all new long positions were in the April and June 2004 contracts.

So, the question arises: If an Institution buys (say) a 10 or 12 month call option or a 10 or 12 month futures contract, why would it look to cash in its chips after the silver price has risen by only 10% - when the contract still has many months of upside potential? Of course, there is also a question regarding the identity of the purchaser. There is no evidence to support the conclusion that the purchasers were, in fact, Institutional.

Swing Factor

From the above analysis, the most logical conclusion to be drawn is that - provided Central Governments do not move to disgorge more inventories, the silver price is unlikely to come under significant downward pressure from either falling photographic demand or unwinding of net long positions.

Further, based on THIS argument - provided the Central Governments do not significantly REDUCE their disgorgement, the "worst case" scenario seems to be a maintenance of the silver price at roughly its current $5 per ounce - with a steadily reducing demand for film offset by a steadily reducing propensity of Central Governments to disgorge.

All of this ignores the longer term propensity of the demand for other industrial applications to grow, and it also ignores a potential shift in market perceptions towards silver as an investment.

In the NEAR term, the swing factor is clearly trading related, and the propensity of the net shorts to be predisposed to unwind their positions.

Looking at the trading situation on the charts, it is clear that Silver is overbought at present:

Both the oscillator and the MACD are in overbought territory, and there is a huge gap on the chart.

But the break-up in Silver last week was very significant in that - on the longer term charts - the evidence is growing that Silver is entering a Primary Bull market. Clearly - given the thinness and volatility in the Silver price at present - it would be unwise to attempt to "trade" in and out because a "scalper" might find himself stranded with no ability to get back in.

And so, the issue boils down in the end to "Will there be a propensity on the part of the bullion banks to unwind their short positions?"

Perception is Reality

In the world of marketing, there is an old adage that "perception is reality". If the market perceives Silver to have entered a Primary Bull phase, then the Primary Bull phase will be a reality - whether this is justified or not. Logic therefore dictates that from this point onwards, the propensity of net longs will be to remain net long, and the propensity of shorts will be to unwind their shorts.

In plain English, if the charts are evidencing an emerging Primary Bull Trend, the net short positions are going to be severely (and increasingly) burned over time. The most logical outcome of this is that net shorts will be moving (maybe even scrambling) to cover their positions, and this will provide and added impetus to the rate at which the price rises over the period of unwinding.

And all of this will be occurring against a backdrop of contracting government stockpiles.

Overall Conclusions

  • Fundamentals have for some time been favouring a long term investment in Silver and Silver related equities
  • Technicals now favour a long term investment in Silver and Silver related equities
  • Clearly, the timing is now perfect to enter the Silver market in that the risk/reward equation now favours "reward".
  • The current overbought situation should not be regarded as an opportunity to sell existing holdings. Rather - should the silver price pull back from here (which it might not) - it should be regarded as an opportunity to accumulate larger holdings.
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