Silver Bullion Backwardation Suggests Supply Stress

By @ibtimes on

Gold and silver are higher against all currencies (except the Canadian dollar) in the wake of the worse than expected trade deficit number ($40.6 billion). Sterling and euro are particularly weak against gold and the US dollar today. 

Silver backwardation continues and while spot silver is at $30.09/oz, the March 2011 contract is at $30.07/oz and April at $30.01/oz. Incredibly, the July 2012 contract is trading at $29.93/oz and the December 2013 contract at $29.91/oz.

Backwardation is when the market quotes a higher price for spot delivery or a more nearby delivery date, and a lower price for a distant delivery date in the futures market. It indicates that buyers are concerned about securing supply in the future and are willing to pay a premium for spot delivery. It suggests that silver bullion in volume is difficult to buy and that the physical market is stressed and becoming less liquid.

Silver
Silver in USD - Long Term

Backwardation starts when the difference between the forward price in the futures market and the spot price for physical delivery is less than the cost of carry, or when there can be no delivery arbitrage. This is generally because the asset is not currently available for purchase or is increasingly illiquid.

It can end in default, failure to make delivery, and in sharply higher prices.

Backwardation rarely happens in the gold and silver bullion markets. Since gold futures first started to be traded in 1972 (on the Winnipeg Commodity Exchange), there have only been momentary backwardations of a few short hours.

The extent of the backwardation in silver is unprecedented. It suggests that retail investment and industrial demand internationally is very robust and the small silver bullion market cannot cater to the level of demand for refined coin and bar product.

This is not surprising considering the massive increase in demand, especially from Asia and China in recent months. In China alone, demand increased a huge four fold in just the last year to 3,500 tonnes.

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Table Courtesy of Mitsui

Investment demand for silver both as a store of value and as a hedge against inflation continues to surprise the bears. Many buyers in Asia have experienced stagflation and hyperinflation.

The demand is also very strong on the industrial side where the increasing range of industrial applications is leading to very significant demand that the silver market does not appear to be able to accommodate at these prices.

Solar energy demand has risen massively from a near zero base and Barclays estimates that this equates to more than 800 tonnes of silver being employed in cells in 2009, which translates to about 8% of silver industrial demand and 4% of global silver supply.

Barclays estimates that silver usage in solar panels could more than double and reach 2,000 tonnes by 2012. This would consume 7% of global silver output.

This is just the solar energy sector. There remains a huge range of industrial applications for silver. While demand from the photography sector has declined, demand from the medical, solar energy, water purification and many other sectors continues to rise significantly.

Importantly, this silver is consumer and because tiny filaments are used, most of this silver will not come back into the silver market. A small amount may, but only at dramatically higher prices.

Those with concentrated short positions in the silver market (as identified in the CFTC investigations), such as JP Morgan, will be very nervous about the extent of this demand. Any effort by them to extricate themselves from these substantial short positions may lead to the squeeze that has been anticipated for months.

This means that silver's nominal high of $50/oz will likely be seen soon rather than later. As we have been saying since 2003, the long term inflation adjusted high of $130/oz remains a viable long term price target. 

Gold

Gold is trading at $1,363.85/oz, €1,007.87/oz and £852.83/oz.

Silver

Silver is trading at $30.08/oz, €22.23/oz and £18.81/oz.

Platinum Group Metals

Platinum is trading at $1,821.50/oz, palladium at $820.00/oz and rhodium at $2,450/oz.

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