The Silver Market Is Even More Cornered

In one of my last articles I presented a thesis that the silver market was cornered. In this article I would like to discuss the fundamentals driving this market. In my opinion, in the medium-term three factors should have a positive impact on silver prices.

In 2016 the Chinese accumulated a record amount of silver

Last year as many as 1,261 tons of silver (40.6 million ounces) were accumulated at the Shanghai Futures Exchange. As a result, the total amount of silver in the Shanghai vaults went up from 596 tons at the end of 2015 to 1,857 tons at the end of 2016 (an increase of 112%):

Chart 1

Click to enlarge

Source: Simple Digressions

To compare, at the COMEX the silver stocks went up from 4,997 tons at the end of 2015 to 5,706 tons at the end of 2016. In other words, “only” 709 tons of silver were added to the COMEX vaults (an increase of 14%).

Next, although the 2016 silver race was won by the Chinese there is still more silver at the COMEX than in the SFE vaults:

Chart 2

Click to enlarge

Source: Simple Digressions

Summarizing, at the end of 2016 both the COMEX and the SFE were holding 7,564 tons of silver (243.2 million ounces).

However, the world’s largest holder of silver was the iShares Silver Trust (NYSEARCA:SLV). During 2016 this giant increased its holdings by 728 tons (23.4 million ounces). As a result, at the end of 2016 SLV was holding 10,617 tons of silver (341.3 million ounces). The chart below summarizes all figures:

Chart 3

Source: Simple Digressions

As the chart shows, the three largest holders of physical silver were holding 584 million ounces of silver, in total. It means that these three entities accumulated as much as 69% of 2016 estimated silver production. To remind my readers, at the end of 2015 the silver, held by these three entities, was equivalent to 56% of 2015 production. Simply put, now the silver market is cornered to a much larger extent than it was in 2015.

Silver demand and supply

According to the Silver Institute, there is a secular gap between the global demand for silver and its supply:

Chart 4

Source: Simple Digressions and the Silver Institute data (excluding the 2016 estimate)

As the chart shows, every single year since 2006 the demand for silver has been higher than its supply. Well, to be honest, I doubt these figures. The cumulative gap between the demand and supply over that period was 1.4 billion ounces of silver so the question is: “Where did all this silver come from?” The answer is really embarrassing – nobody knows. I have conducted rather deep research into this question but found nothing. (Any ideas?)

Anyway, the Silver Institute is the most reliable source of data I could find so let me continue this discussion taking these figures as well-founded. On the other hand, I believe that the main long-term message sent by the data above is simple – it looks like the demand for silver is generally higher than the supply of silver.

Now, let me look at the last forecast delivered by the Silver Institute:

Click to enlarge

Source: Silver Institute, page 5

The column marked in green depicts a 2016 forecast of the main supply and demand figures (in a few months the final figures should be available). However, as discussed in the section above, the stakes of silver, held by three largest holders of silver (SLV, COMEX and SFE), are already known: in 2016 SLV accumulated 23.4 million ounces of silver and COMEX plus SFE accumulated 63.3 million ounces of silver. After adding the holdings of these entities to the physical surplus / deficit I arrive at the total gap between the demand for silver and its supply:

source: Simple Digressions

As the table shows, if the Silver Institute 2016 forecast is correct the total gap should stand at 139 million ounces of silver. This gap is one of the highest ones recorded in modern history (refer to Chart 4).

The main driver of silver demand

There are two main factors standing behind the demand for silver:

  • Industrial demand
  • Investment demand: jewelry / silverware plus coins and bars plus ETP inventory built plus exchange inventory built

The industrial demand depends on the state of the world economy. In the medium-term this factor is, more or less, stable.

The investment demand is much more complicated and much more volatile, especially in the short-term. It depends on a number of factors but, in my opinion, it is the investor sentiment that has the biggest impact on investment demand.

Next, if the industrial demand is more or less stable and the investment demand is much more volatile it should be the investment demand that drives silver prices in the short-term. As a result, the higher investment demand should have a positive impact on silver prices. And vice versa.

The graph below shows the recent trend in investment demand:

Chart 5

Source: Simple Digressions

The arrow marked in red indicates that, despite a bear market in gold and silver (2012 – 2015), the investment demand for silver was in its upward trend. The result of this higher demand was visible last year when silver prices went up from around $14 to above $21 per ounce (July 2016).

According to my estimates, the upward trend in the investment demand should have continued in 2016 so a positive scenario for silver prices is still intact.

Industrial demand

I have mentioned above that the industrial demand is, more or less, stable in the medium-term. However, there is at least one factor that should drive the industrial demand higher in the coming years. In my opinion, it is the strong development of the solar power industry. According to Global Data, the world installed solar photovoltaic capacity should grow from 227.7 GW in 2016 to 756.1 GW in 2025:

Chart 6

Click to enlarge

Source: Simple Digressions

Now, according to the Silver Institute:

“Silver is consumed in the manufacturing of solar panels for the photovoltaic (PV) generation of power from the sun’s energy. A high silver content layer is pasted on the front side of a silicon solar cell, as well as a lower silver content layer on the rear side.”

I estimate that in 2015 as many as 1,532 ounces (47.6 kilograms) of silver were needed to construct a 1 MW power plant. Over the years the silver content in solar panels has been in its steady decrease (due to the technological progress). I estimate that the silver content in each solar panel will decrease at a rate of 3% per year (I arrived at this figure comparing the silver content in solar panels in 2014 and 2015).

As a result, although in the coming years more and more solar panels will be installed the growth in silver usage will not go up proportionally. The chart below illustrates the forecasted demand for silver reported by the solar industry until 2025:

Chart 7

Click to enlarge

Source: Simple Digressions

As the chart shows, this year I expect a drop in the demand for silver, reported by the solar industry. However, starting from 2018, the demand should be in a steady increase. In 2024 it should exceed its peak established in 2015 (78 million ounces). In other words, in the coming years the solar power industry should be one of the main drivers for silver demand.

Summary

In 2016 the largest three holders of physical silver (SLV, COMEX and SFE) increased their silver stakes by 86.8 million ounces (an increase of 17.4%, compared to the end of 2015). Using a different measure – at the end of 2015 the silver, held by these three entities, was equivalent to 69% of total annual mine production (at the end of 2015 this ratio stood at 56.1%). It means that now the silver market is still cornered by these three large holders.

What is more, in the coming years, the demand for silver should be supported by a positive investor sentiment in the short-term and the developing solar industry in the medium-term.

As a result, in my opinion, the cornered silver market plus positive developments in silver fundamentals should materialize in much higher silver prices in the coming years.

Disclosure: I am/we are long GDXJ.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.