This is the tale of two markets rolled up messily into one.
For starters, the international silver price is not really the price of silver. Surprised? I know I was.
To illustrate this point in some detail, I had written a piece on the physical gold market entitled “Physical gold demand surges as financial assets bleed out.“
Why physical? That’s because the price of precious metals we see in international markets is the going rate of paper metal prices, not of the real thing.
Paper metals are essentially contracts for delivery, a futures market, traded indefinitely. Ownership changes hands all the time – of the contract, again, not of the underlying thing.
In the article mentioned, I noted the following,
…according to a 2013 report by the London Bullion Market Association (LBMA) and the London Platinum and Palladium Market (LPPM), in 95% of transactions, contracts are rolled over and no physical delivery takes place. Physical metals are thus generally not exchanged at the metals exchange.
Similarly, Andrew Lane, a precious metals writer said,
Around 95% give or take of Gold owned—not traded—owned across the globe is unallocated gold. That is a staggering statistic.
A similar mechanism is in place for silver.
Elaborating on unallocated silver, BullionMax writes,
…(is) quite simply, not the same as owning physical silver. Rather, it’s a claim on some quantity of silver, an IOU issued by a bank to the investor. Unallocated bullion is the property of the bank, not the investor.
Drawing on my earlier article again,
Paper metals, being representations of the real thing, can be orders of magnitude greater than the actual physical supply. As a result, these markets can be very volatile, and their liquidity is often used to cover margins during losses in the broader financial markets.
Thus, the supply and demand fundamentals of the physical substance do not determine the price of paper gold. The paper market follows its own heavily-financialized logic and is divorced from physical fundamentals.
The scale of the problem becomes apparent when one looks at a 2014 study by Fabrice Drouin Ristori, founder and chairman of GoldBroker, who estimated,
…for every ounce of physical silver, there are 250 ounces of paper silver circulating in several financial products. In other words, only one contract or certificate issued out of 250 would be convertible in physical silver.
Eligible vs registered silver
Astonishing as that sounds, how can we be sure that there is a deep imbalance at play in the silver market?
Well, the COMEX told us, stating in February 2021,
…in an effort to represent a conservative deliverable supply that may be readily available for delivery, made a determination to discount from its estimate of deliverable supply 50% of its reported eligible silver at this time.
This means that the bars that were considered to be available for redemption, were just halved.
To break this down just a little bit, eligible silver is any silver that is in conformance with regulations for good delivery.
That means that if someone wanted to pull physical silver out of the market, the eligible silver would be of good enough quality and meet the necessary specifications of standardization to be officially released through the COMEX and close the contract.
However, eligible silver does not have any such warrant issued with it. That means, that the long-holders of physical silver have no obligation to return the silver to the exchange when a contract holder wishes to collect.
Indeed, the long holders likely believe that physical value would keep on appreciating, and at a time of shortages, it seems unlikely that these resources would be sold off without a hefty price rise.
To make matters even murkier,
…surveys conducted indicated no clear consensus as to how much silver is dedicated to long-term investments.
So, the exchange has acknowledged, that it does not know how much physical silver will be available for release if market participants decide to go in for physical redemptions.
This is both because there are too many contracts in the first place, and that much of the metal which is counted as eligible for delivery will never be registered.
Registered products are those which are readily available to investors who want bullion delivery.
In essence, these are the same as eligible silver but accompanied by warrants for physical withdrawal.
Intense drawdown
Since we now have a flavour of the deep dichotomy in paper exchanges, the next bit becomes rather intriguing – physical drawdowns are at their highest levels ever.
In the month of September, the LBMA silver inventories fell an incredible 4.9%, declined for 10 consecutive months, and registered inventories are now only at about 45 million ounces.
Across the Atlantic, the New York City-based COMEX saw a drawdown of 1,404 tons during September.
The stock of registered silver is even lesser, at only 1,186 tonnes or roughly 38 million ounces.
Although the all-time low is nearer 20 million, the graph below shows how physical silver holdings at the COMEX have fallen off a cliff in recent months.
As per Andy Schectman, President and CEO of Miles Franklin Precious Metals, incredibly,
…contracts that are open that could say we want delivery. There are 1,802% more of these contracts than there are bars backing them.
What on earth?
Although eligible silver stocks could shift to being registered, why would long-term holders elect to do that? The majority of COMEX precious metals are held in select vaults throughout the US, owned by entities that cater to their own clientele.
This is where it may get a touch confusing.
Let’s assume an entity owning a vault that is accredited by the COMEX also issues an ETF for silver. In total, the hypothetical silver-backed ETF has 80 units.
Now, the COMEX reports show that the entity’s vault reports a total of 100 units.
So, out of 100 units that are reportedly available for delivery, (putting aside the fact, that there are already too many paper contracts), 80% are pre-owned by the ETF holders of the entity and secured for their own clients, not traders on the exchange floor.
According to Manly, this is exactly what happened in the case of JP Morgan’s iShares Silver Trust (SLV), where only 28.3% of the holdings were not held in the ETF.
He added,
And this is just one example. So straight away we see the magnitude of the danger in assuming that ‘Eligible silver’ is somehow connected to COMEX.
Thus, only the fast-depleting registered silver is of any consequence to the investor looking to withdraw corresponding holdings.
Unprecedented demand and price divergence
Dr Tyler Wall, President and CEO of SD Bullion stated,
… (the market) is as tight as I’ve ever seen it.
In my view, much of the drive for physical demand is coming from decades of easy credit availability that has twisted our financial systems and processes of identifying value.
With low-interest rates and quantitative easing becoming entrenched in the global financial architecture, asset values were inflated well beyond fundamentals, and risk was a near non-issue.
Monetary tightening this year has put an end to the party. We have seen shares, bonds, public REITs and pretty much every other financialized product take a beating.
Well-known economist Nouriel Roubini, in an interview with Bloomberg, stated that 60-40,70-30, and other traditional combinations of portfolio construction have continued to bleed from both the equities and debt sides.
Even cash is offering negative real rates of return given the stubbornly high inflation.
Unlike most financial instruments, paper bullion is tethered to a hard asset, at least to some degree.
Many long-term investors, including financial institutions, are wary of more turbulence in the markets and the threat of stagflation.
Instead of continuing to hold paper precious metals and watching their portfolios erode, several contract holders have chosen to make withdrawals en masse and hold the real underlying asset – physical silver.
Yet, the international price of silver has continued to fall despite the sharp increase in scarcity due to ongoing withdrawals and the growing intention of long holders to not release the metal back into the system.
In fact, the paper price is 18% down YTD.
Like other assets, it has been plagued by the strong dollar and rising rates.
On the other hand, the physical price of silver eagles is showing clear signs of breaking out upwards.
Mario Innecco, a former bond trader in the City of London and now a Youtuber, believes,
The shift from paper to hard assets is just beginning.
This further underscores the fact that metal and futures are actually two separate markets, often papered over as one.
Andrew Maguire, trader and Director at Kinesis was left speechless that in some cases the physical premium of silver eagles issued by the US Mint was 75% above spot, and is fast approaching 100%.
More alarmingly, the silver contracts went into backwardation in September, meaning that the spot prices were trading above futures prices. This inversion signals that buyers expect that supply is uncertain in the future and that paying a premium for early or immediate delivery is the prudent decision.
Andy Schectman described the current situation in the following way,
So as the price has been falling, the biggest money in the world (commercial banks and institutions), has been bleeding dry from the top down all of the available metals – LBMA, COMEX, Dubai, Shanghai, the back door of ETFs…
He added,
…the price is the greatest tool of misdirection by the people accumulating it.
It appears that Schectman is noting that since the price represents the abundant paper contracts and not silver itself, it stays lower than it should, dissuading purchasing interest.
In fact, the situation could be even worse for the average contract holder. After discussions with his professional networks, Dr Wall said,
…they didn’t think there’s any unspoken silver left, just people haven’t figured it out yet…
International buying
Other than institutional buying, demand for physical silver has been strong in Germany, China and throughout Asia.
India recently lowered the base import prices of silver and other commodities. This move has lowered tax payable by importers.
As the largest buyer of silver in the international markets, and given that the holy festival of Deepavali was earlier this month, first estimates of inflows of silver reportedly surged to 1,700 tonnes in the month, overshadowing the outflows from COMEX contracts, and contributing to physical tightness in the global market.
Buybacks
In a reversal of roles, bullion dealers around the world have begun to offer attractive deals to silver owners, in a bid to buy back the metal. This is a sharp indicator that metals organisations see physical prices heading higher.
Dr Wall stated that his firm had been offering $11.0 above spot for US Mint Silver Eagles over the past week.
Innecco was also approached by precious metal dealers in the UK offering him 10% – 20% above spot, which he anticipates would continue to rise.
The sudden emergence of these buyback bonanzas highlights the global shortages in the physical silver market, with reports of customers being unable to procure any product as far afield as Australia, the United Kingdom and the United States.
Growing debt and the pivot
On a related note, public and private debt have ballooned the world over, and the size of obligations today is truly mind-boggling.
With the Fed tightening rates, the Bureau of Economic Analysis estimated that the Federal government owed $736.6 billion in interest payments during Q3 2022 alone.
This situation is becoming increasingly untenable, and the chances of a pivot by Governor Powell continue to increase, as other western central banks, notably in England and Canada begin to ease off the gas.
In such a situation, physical precious metals will rally due to the falling away of interest-bearing competition from higher-yield products.
Outlook
Jeff Clark, a Senior Precious Metals Analyst at GoldSilver.com, said,
…by 2030…I think you want to hold on to your silver, let’s just put it that way…next is the upcycle. The only thing we don’t know is the timing. Silver’s DNA is very clear…. It’s boring, boring, and then all of a sudden what happens? There’s this sudden, almost violent spike where it just comes out of nowhere, catches many people off guard and goes on this huge run…so, I think 2023 could be very interesting for silver… When physical investment demand is high, silver does tend to react and go into one of these spikes.
In an environment of high inflation, oncoming financial headwinds and continuing geopolitical strife, he added,
…I still think silver is going to be the trade of the decade.