Myths in the silver market

CPM Group
Precious Metals and Commodities Research and Consulting

The precious metals markets are secretive places. That is one of their attractions to many investors and
others who value privacy. It poses problems for all market participants, however, because it makes these
markets, so small and illiquid compared to other financial markets, susceptible to rumors and manipulation.
While there is nothing new to this, in recent weeks and months the silver market has been repeatedly hit by
rumors spread by traders and others seeking to scare users and investors. Market professionals cite the
persistence of these rumors as a major factor in the decline in silver prices below $4.90 since
October 2000.
It is important to distinguish among myths, rumors, beliefs, and misinterpretations. In free markets, as in free
countries, everyone is entitled to his or her opinion and beliefs. The precious metals markets are no exception
to this, with some individuals holding strong beliefs that do not necessarily measure up to empirical market
evidence. The point of this brief discussion is not to seek to sway anyone from deeply held beliefs, but rather
to set the record straight on certain fundamentals that have been distorted by persistent rumors and
misrepresentations.
Myth 1: The Chinese government is selling large amounts of silver from its stocks
The issue of silver sales from Chinese government stocks has been one of the most pervasive topics of
discussion in the silver market, and perhaps the most misunderstood. The topic came to a head in early 2000
when rumors were circulated of large amounts of silver entering the market. Not so coincidentally, these
rumors began at the same time that the liberalization of the Chinese silver market was taking a great leap
forward on January 1, 2000. The Chinese silver market has been closely controlled by the People's Bank of
China since the Communist Revolution in 1949. The PBOC has been moving toward deregulating the gold
and silver markets within the country, and extricating itself from the role of national market maker. This has
led to massive shifts in the flow of silver around China, compounded by structural changes in the
Chinese photographic industry that has led to large amounts of silver that formerly went to Chinese film
makers now being available for export. These changes have radically transformed the entire metals market
within China, and have led to increased exports of silver, and gold, over the past few years.
The inaccuracy is the assumption that these exports represent here have been some sales from these stocks,
but they are a small portion of the total amount of metal being exported. Some estimates by PBOC silver
sales run as high as 60 million ounces. Chinese government sales actually have been around 10 million
ounces or so per year in recent years, and are expected to be roughly 12.0 - 14.5 million ounces in 2001.
Most silver exports have been by domestic refiners processing base metal concentrates and domestic scrap.
In the long run the new laws may lead to a decrease in exports as domestic refiners now can receive higher
prices within China, reducing the incentive to smuggle metal out, and domestic consumers and investors now
can pay lower prices for silver within China.
Myth 2: Digital photography already is sharply decreasing silver use in photography
It has been repeatedly suggested for nearly two decades that digital photography would one day replace
traditional silver-halide based photography entirely. More recently, there have been suggestions that the
declines are already in place and eroding photographic demand for silver. Again, this is not accurate.
Silver use in photographic materials—papers and films—is estimated to have risen about 6.0% worldwide in
2000.
Demand is estimated to have increased 8.3% in the United States, and 6.3% in Japan. Major photographic
companies are increasing their manufacturing capacity in the face of stronger demand growth. From 1980
through 1998 the compounded annual growth rate in silver use in photography was around 4.0%. Last year's
increase was 50% above that long term trend growth rate. This represents a definite acceleration in the
demand for a silver-bearing photographic product that flies in the face of the rumors that digital is killing this
market. One of the main reasons for the recent strength—ironically enough—has been the advent of digital
photography, although most of the increased silver use reflects expanding traditional photography. Consumer
appetites for conventional photography have been growing stronger world-wide. The Advanced Photo System
introduced in the late 1990s has boosted both picture taking and the number of reprints being made, while
rising disposable income from Asia to Latin America has increased demand in these countries. Also, most
consumers are not ready for digital photography at this point, with the cost still prohibitively high for most
people in the world and many consumers not yet computerized.
Many observers had presumed that pure digital photography, which does not use silver in actually capturing
the image, would naturally lead to a decline in silver usage. However, just as the 'paperless office' has
prompted a surge in paper use, digital photography is increasing the popularity of photography and of
traditional photographic demand. Much of the digital imaging business is actually a combination of traditional
imaging techniques and newer digital technologies. The images are captured on conventional film, and much
of the final output still uses either conventional photographic papers or other silver-coated papers. In between,
the images are digitized, edited, and manipulated. In sum, digital photography is not necessarily a negative
for silver.
In fact, if one is objective about the impact of digital photography on silver, one needs to calculate both the
possible long-term losses in silver demand on the consumption
side of the market and the reduction in supply that would occur due to reductions in silver recovery from spent
photographic products, which accounts for around 85% of the 190 million ounces recycled each year.
Myth 3: Kodak has bought forward a year's worth of silver, removing the world's largest silver user as
a source of demand for the next year.
Another report that circulated throughout the market had to do with Eastman Kodak, one of the world's largest
silver users. In December 2000 a news item reported that Kodak had hedged its silver needs through 2001.
This was perceived by some observers as bearish for the silver market, as these observers intimated that this
source of demand for silver consequently would be absent the silver market. Actually, this fact was nothing
new and can be found in the company's regular quarterly filings with the Securities and Exchange
Commission. Most of the company's silver requirements are purchased through annual supply contracts, as
has been the case for decades. Similar statements can be found in Kodak's previous filings with the SEC.
Myth 4: Berkshire Hathaway has sold its silver
Berkshire Hathaway has found itself at the center of intense public scrutiny since it announced in February
1998 that it had purchased 129.7 million ounces of silver between July 1997 and January 1998. Since then, it
has often been suggested that various periods of silver price weakness have been directly related to sales by
Berkshire Hathaway.
First, one can look at why Berkshire Hathaway bought silver in the first place. In the February 1998 press
release accompanying the announcement of the purchases, management stated that "the equilibrium
between supply and demand was only likely to be established by a somewhat higher price." Moreover,
Berkshire Hathaway has long hailed itself as a long-term investor, and does not seem likely to sell its recently
acquired assets on relatively minor price fluctuations. The average purchase price of Berkshire Hathaway's
silver was less than $5.00.
This, however, did not stop some observers from suggesting that Berkshire Hathaway had sold some or all of
its silver position. Offered as evidence of these sales was the fact that a major refiner in Europe, which had
been known to be storing silver for Berkshire Hathaway, told its clients and others that the bulk of the silver
being stored at its facilities had recently been moved. Another piece of "evidence" was that Salomon Smith
Barney recently delivered a net 1.8 million ounces of silver into the December 2000 Comex delivery period.
(Berkshire Hathaway often is viewed as the major silver customer of Salomon.) These two factors do not
necessarily mean that the silver has been sold. It may have been moved in an attempt for greater opacity.
Myth 5: Barrick hedging
In the third quarter of last year, market discourse focused on the prospects of current and future forward silver
sales by producers. Barrick Gold was the target of much of the initial speculation, as some market reports
focused on the fact that Barrick reported in a regular quarterly report that it had spot deferred silver sales
contracts in place. As with Kodak, the existence of these positions was not new; the fact that the market
decided to focus on it at that time was.
As of the end of 1999, Barrick had entered into spot deferred contracts to deliver 14.3 million ounces of silver
over the following five years. As of the end of 2000, Barrick had 20.0 million ounces of spot deferred silver
contracts at an average price of $5.32 per ounce, for 2001 and beyond. These hedges were for future output
at the Pascua mine, development of which has been deferred, so further hedging is not expected until such
time as gold and silver prices rise to levels that lead the project back toward development.
Myth 6: Other producers are selling forward
The focus on hedging data from various producers and manufacturers led some market observers to opine
that other producers must also be selling large amounts of silver, and that this was contributing to the
weakness in silver prices. This phenomenon is not new, as the gold market has constantly been plagued by
suggestions that for-ward sales by producers have created conditions of 'over-supply.
Forward sales do not work this way. When a producer sells silver or gold forward, it commits to delivering a
certain quantity of metal at some point in the future. At the time of the transaction, no extra metal actually
enters the physical market.
Myth 7: Mexican output is rising sharply
Refined silver production in Mexico rose 8.4% in 2000. Many observers have trumpeted this as a cause of
lower prices. Again, closer examination reveals the true under-lying causes. Mexican output was reduced in
1999 when the Torreon lead, zinc, and silver refining complex owned by Met-Mex Penoles was closed for a
time due to a pollution problem. This reduced output in 1999. In 2000 the refinery was back on-stream. Not
only did it operate fully processing 2000 mine production, but it produced additional amounts of refined silver
from the back-logged 1999 mine output.
Myths in the Silver Market
Last year Mexican silver mine production is estimated to have totaled 90 million ounces. This was up from 83
million ounces in 1999, but only slightly higher than the 86 million ounces produced in 1998. The rate of
increase was skewed in 2000 due to events at Torreon, which will not be repeated in 2001 and beyond.
Silver Market Rumors are Not New Rumors have confounded the precious metals markets for centuries,
dating back to the Lost city of Atlantis and the quest for El Dorado. There have been persistent
rumors floated by bulls and bears alike. In the late 1970s, after they had acquired the bulk of their silver
position, the Hunt brothers began telling everyone they knew what a great investment silver was. Others
entered the market as buyers, with several acquaintances of the Hunts even using the same floor traders as
the Texans. It got to the point in late 1979 that the one agent for the Hunts only had to walk onto the
Comex trading floor for the buying to send silver prices higher.
Myth 8: Mine production is rising sharply worldwide
Total silver mine production rose at a 6.4% annual rate from 1997 to 1998 as several new mines came onstream.
The rate of increase slowed to 3.9% in 1999 and 4.6%in 2000. A few more new projects are slated to
start in the next few years, but others have been deferred or delayed. Barrick’s deferral of the Pascua project
already has been mentioned. Other projects in Argentina, Australia, Russia, and elsewhere have been
delayed or scaled back. A few existing operating mines, particularly in North America, are at risk of being
closed. Mine production will not rise as fast as had been expected, and in fact is projected to fall
over the next couple of years. Not All Rumors Are Bearish The preponderance of the rumors floated in the
silver market in recent months have been bearish, often circulated with the apparent intention of scaring
investors and others into selling, or at least not buying, silver. There have been a few rumors floating around
the silver market that have been primarily bullish, however.
Myth 9: Large secret silver stockpiles
Perhaps the most interesting rumor is one that could be called either bullish or bearish, depending on one's
interpretation of it. This is the rumor that there are large secret stockpiles of silver held by wealthy investors.
This could be interpreted as being bullish for silver prices, if one concluded that there are several savvy
investors who are bullish on silver and, like Berkshire Hathaway, have purchased physical silver to profit from
an inevitable price rise. It could be bearishly read, however, in that it would suggest there still is that much
more silver around that ultimately can be sold to fabricators to meet industrial demand. Evidence suggest that
such positions, purchased in the middle 1980s and middle 1990s, have been liquidated,
however.