Changes In The Silver Market

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July 10, 2013 11:04 AM EST

By Miguel Perez-Santalla, BullionVault

BACK in the good old days, a physical silver trader's dream would be to land a photographic company as a customer.

Polaroid, Kodak, Fuji and many more were on this list of prospects. This industry was a tremendous behemoth in the silver market.

In fact Kodak was technically in the silver refining business. They had created operations to capture scrap silver as well to lower their costs of production for their film. One spin-off from the recent reorganization of the company is Rochester Silver Works out of New York State. There were also many production sites that grew up in their vicinity. I'm certain it was the same at the manufacturing plants of their competitors as well.

In 1999 the photographic market was to hit its peak of silver production. In the United States alone according to the US Geological Survey, this market consumed over 93,000,000 ounces. Globally the photographic industry needed 267 million ounces that year, around one silver ounce in every four traded worldwide. So photography carried real buying power as an industry. But the turn of the century was the beginning of the end.

Since 1999 photographic demand for silver has contracted almost 70% to date. I think the reason is obvious to anyone over the age of 23. A child of 10 years old in 1999 would surely recall the popularity of film today. They would also recall that, in the years of their coming-of-age, photography became dominated by the electronic market. More specifically the use of digital cameras was to be the demise of silver consumption in this industry.

Recently, statistics point to a dropping demand for digital cameras. But this does not mean any growth in the old film industry. Instead it indicates growth in smart phone replacing digital camera use.

Still, photographic film remains a big consumer in the silver marketplace. The medical sector uses film primarily for x-rays, and it has held up very well. But don't hold your breath hoping for a resurgence in this sector either. As the new technology becomes cheaper, more and more hospitals and other users of x-ray film will convert to the digital world, too.

So what does this tell us today? Silver consumption by the photographic market, which at its height represented over 25% of fabrication demand, is still in decline. We have seen roughly a 12 to 15% annual decline over the last 10 years. It is projected that this year's photographic market demand will top out at 81.8 million ounces for global consumption according to CPM Group.

In the year 2003 photographic consumption worldwide represented roughly a little over 32% of total end-product fabrication demand in silver. Now it is down to only 9%. Fabrication demand is currently at about 81% of consumption of annual production.

Meanwhile in the period from 2003 to 2013 annual silver production grew 23%. Will a further decline in photographic demand or the complete disappearance of this once great consumer be a tremendous factor on the silver price? I say it's doubtful. But the fundamentals do mean something, and to understand what has saved the price of silver from the loss of demand from the photographic market we have to look to the new industries that have filled the void.

Next we'll look at the changes in the silver marketplace over the last 10 years, and what they mean to silver users and the silver price. Somebody is buying silver, and investors in this market need to know why ? and who they are ? to better position ourselves for the next price move.

Photovoltaic Demand

The Photovoltaic industry didn't start to show on charts of silver demand until the year 2000, when it consumed approximately one million ounces.

Those 31 tonnes were barely a blip on the silver consumption chart. In fact, in comparison to the smallest of the large consumers at the time ? which was electronics ? it was not even a tenth of their consumption.

Few expected the solar cell industry to become an important player in the silver market for years to come. Indeed, it was not until the year 2008 that the industry reached any volumes of importance, consuming nearly 19 million ounces (590 tonnes). That was barely 2.5% of total fabrication demand according to data from New York's CPM Group.

But what happened in silver's global economy was, in a word, government. Major subsidies were given for the development and promulgation of solar energy by sovereign states. Germany was at first the largest consumer, and was then followed by many other European nations in this objective. But it was not until Washington began to offer subsidies to US energy producers that the silver consumption for these products became of major importance.

The photovoltaic industry in certain countries became very important sectors of the economy. So with the global economic crisis starting five years ago, many were to suffer. Spain specifically suffered tremendous economic losses in this industry when the state pulled its subsidies. This has been a major concern for developers and business involved in solar energy.

However, this was at about the same time that the US began to offer subsidies to this industry. So people who sold or produced solar cells were finally poised to make money, now that the world's largest economy was behind it. At this point silver demand for the photovoltaic paste needed to produce solar cells was growing at a rapid pace.

Suddenly the last quarter of 2009, and going into 2010, saw photovoltaic demand for silver explode. Demand rose at a rate of 50% from the year before and would do so again in 2011. At this time the price of silver also began to soar.

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Was this new demand the driver of the price of silver? The answer simply put is no. Unfortunately for this industry the timing could not have been worse.

The silver price began to move in leaps at the height of the photovoltaic industry's demand, raising the production costs of their end product. And because the PV industry needed a specific form of 999.9 silver (as opposed the standard 999 parts per thousand fineness in the wholesale market) the amount needed was not readily available. This caused a disruption in the marketplace. In a matter of a few months the silver futures market on the Comex exchange would go into backwardation, with near-term prices rising above prices for delivery further into the future.

Normally, when there is plenty of supply, the future price is higher than the current cash price for immediate delivery. But because of the need for the specific quality, much of the physical bars held on the Comex were being removed in search for the much-needed 999.9 fine silver. One of the largest silver producers in the world ? Met-Mex Penoles of Mexico ? was known to produce the proper quality bars and had delivered great quantities onto the exchange. So this led to the major withdrawals we saw.

During this time period there were many market commentators speculating that there was a physical shortage of silver. But the truth was there was plenty of 999.0 fine silver in large wholesale bars (typically 1,000 ounces, some 31 kilograms). Shortages of retail bars and coins for the investing public were caused by a bottleneck of fabrication. They were not caused directly by demand for silver by the PV industry.

Because of the coincidence of the price rise and the simultaneous demand from the PV industry, many other commentators attributed rising prices to solar panel demand. But taking a close look, the PV industry's demand only filled a small portion of the drop in demand from the silver market's traditional monster, which was photographic demand.

Silver mining producers were quite happy that the PV industry had entered the marketplace. Even though, for the foreseeable future, it does not look like they will be able to reach the capacity of consumption at which the once powerful photographic film producers had reached. But even though the PV industry is quite young, it has already been looking to thrift or replace the precious metal's use in production as much as possible because of the price rise in silver.

At the height of the solar industry's consumption in 2011, its demand had barely reached 19% of the height of the consumption of the photographic film industry in the year 2000. Add the problem of reduced government subsidies, and it will take quite some time for this industry to become the monster consumer the silver producers were looking for.

Silver has many industrial uses and its properties lend itself to constant new discoveries. With lower prices, consumption of silver for industrial purposes will remain stable or begin to rise. But higher prices at times are a detractor for the use of this metal.

Bottom line? The fundamentals of silver industrial demand, though important, are not what has been the principal driver of the price in the last 10 years. It has instead been the investment community that has truly filled the gap left by the departure of demand from the film industry, as we'll see in the third and last instalment of this series. There we will cover who the major silver consumers are today, and what the future looks like it may bring.

So Who Is Buying?

FOR ALL ITS monetary and investment history, silver is by far an industrial metal today.

The industrial sector consumed close to 466 million ounces of silver in 2012 according to the Silver Institute. Add what's left of photographic demand, and you get to 524 moz, some 62% of total fabrication.

We already discussed what happened to photographic demand in Part 1 and we looked at photovoltaic silver consumption in Part 2 of this series. There we saw how PV demand remains a long way from filling the gap left by the collapse of photography.

So who does buy silver in bulk? Well, silver is also used in electronics and catalysts. And a fast-growing industry that consumes silver is the production of ethylene oxide.

Ethylene oxide (EO) is used in the production of antifreeze, polyester, heat transfer liquids, gas dehydration, and solvents. It is also used in cosmetics, pharmaceuticals, lubricants, paint solvents, soaps, detergents, gas purification, emulsifiers and dispersants. Because of the wonderful properties of this reactive chemical, its growth has benefited the silver market as well. Because the precious metal is used as a catalyst in EO production.

Some 90% of silver's total catalyst demand comes from EO production. The EO market has enjoyed a 30-year continued growth cycle, according to consultancy Metals Focus Ltd. In 2002 it consumed 100 million ounces of silver, and it is projected by 2017 to reach 225 million ounces per annum. This rivals the historical high of the photographic industry. However, the EO market will not continue to grow at this pace. Because consumers are able to recover the silver from the catalyst. This means that at some point its demand will stabilize and perhaps decrease.

By geographical area, the United States is the largest consumer of silver. It is also the largest consumer of silver jewellery. Over the last couple of years demand to buy silver as jewellery has remained strong, as gold remained at high prices, leading consumers to substitute. But now, with the recent decline in the gold price, there's good reason to think silver will have a bigger struggle to keep its share of the market.

What of that other major consumer of silver ? investment? This is not a primary user. We are talking about the investor, who can substitute at will. As of this writing, the SLV (which is the call sign for the largest exchange-traded silver trust fund or ETF) is holding 320 million ounces of silver. This number represents 31% of annual world silver supply using 2012's statistics.

That's a significant overhang if it comes back to the market. But overall silver investment has grown significantly in both the ETF market and coins and medals. Since 2002 sales of coins and medals grew close to 250% worldwide.

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