core sector communique

Silver: The dynamics of demand and supply

What is Supply and Demand?

Supply and Demand is known as the market equalizer. It can take any product or service and create a fair market price for any item. In theory this is how the free market should really operate, without interference from manipulators. Supply and demand is more of an economic price determent than anything. It takes a market item (product) and finds the equilibrium price using demand for a product and quantity supplied by producers and creates a bisecting line that allows market makers to find the optimal production rate and price.

There are 4 variants we can derive at from the use of the Supply and Demand Model:

1. Demand Increases and Supply remains constant = Higher Prices

2. Demand Decreases and Supply remains constant = Lower Prices

3. Supply Increases and Demand remains constant = Lower Prices

4. Supply Decreases and Demand remains the constant = Higher Prices

As you can see there are really only 2 variables that determine the price of items; Supply and Demand. If Supply increases and Demand remains constant then prices will come down. This is the basic model of price equilibrium using the supply and demand model. Eventually the market will settle on a price for a particular item using this model as long as there is no manipulation of either Supply or Demand.

Supply and Demand - Silver Market

Silver has been a means of trade long before the Roman Empire and will continue to be a form of money till the day we find an item that can match its value and use. When it comes to Supply and Demand in the silver markets we must look at the broader picture of things. We will have to go far beyond our thinking of just the people around us purchasing and selling their jewelry at your local jeweler. We have to look at the entire world far beyond the boarder of the U.S. There are people purchasing jewelry in Asia, India and every other country. Not only does silver have an aesthetic value but silver also has a commercial use. Silver is used in the circuitry of everything from cell phones to satellites that hoover the earth.

Once we look outside of the consumption of silver then we must look at the metal in another light. Silver is a store of wealth for many people. The great thing about silver is that it is a natural earth metal so humans cannot simply create it in a lab. With that in mind we look know that miners make up the supply side and consumers will make up the buyers side. If production increases and consumers want less silver, then prices will fall until consumer feel silver is at a good value. Conversely if production falls and consumers demand remain the same price of silver will increase.

Supplying Silver

When we talk about the supply side of silver we have to look at a few components. There are a few "Suppliers" that make up the supply side of the market: Miners, Government Sales, Scrap Silver and a few other sources. In 2010 the total supply was 1,056.8 Troy ounces. Most of the supply is created by miners which make up 70% of the total silver market. Supply has increased minimally year over year since 2002 which means there really isn't much increase in selling overall. Here is a chart of the Supply for the 10 years in Troy Ounces:

2001 - 877

2002 - 868.3

2003 - 881

2004 - 879.7

2005 - 929.5

2006 - 923.5

2007 - 907

2008 - 904.5

2009 - 922.2

2010 - 1056.8

Source: SilverInstitute.com

Demand in Silver

Demand takes a form of its own and here we will take a look at some of the areas of consumption in silver that help drive the price of silver to different levels. One thing to keep in mind when it comes to silver is that Demand = Supply. Whatever silver is mined throughout the year is eventually used to calculate demand. You may be asking how that is possible and the answer is simple; the silver must go somewhere.

Silver can be sold to refineries, photograph companies or held as reserve which is considered a company's investing asset. The selling of silver to multiple industries is the demand side of the Supply and Demand model. The price is dictated by the amount a particular industry is willing to pay to take control over the supply miners produce.

There are 5 major industries that purchase silver in high quantities: Jewelry, Industrial, Photography, Silverware and Coins & Metals. The amount of demand within each of these industries drives the need for silver, higher which allows specific buyers to demand more silver for products.

For example imagine silver is primarily being used in producing film from cameras in 1940 but as cell phones become more popular in 1990 they require more silver to produce more cell phones. Now that cell phone demand is increasing; cell phone manufacturers must demand more silver from the miners and are willing to pay more to get there hand on the silver. Now the price of silver must rise to match the demand. If prices were not raised cell phone manufactures could buy up all the silver overnight and leave nothing for other industries.

Here is quick chart to show you how the demographics of silver have changed from 2001 - 2010. As you can see that demand in some areas have increase dramatically over the decade while other have declined greatly.

232% increase in Coins and Metal (Silver Bars)

40% increase in Industrial use (Electronics)

-66% Decline in Photography

Future outlook - Silver

While silver has steadily increased in its commercial use in electronics and the demand for electronics will continue to increase, there is a surprising increase in coinage. With the demand increasing heavily in silver coins and metals there is bound to be price spike like we have never seen before. Why is that? Well instead of just a few private investors purchasing silver as a store of wealth and a company purchasing it for their products there has been a vast influx in private purchase by average citizens. Silver is now an internationally purchasable commodity that can be bought through world-wide coin dealers, on the internet and even at your local coin shop.

More importantly as investors and institutions lose faith in the currency of their nation we will see a huge demand spike in silver bars and coins. These investors are willing to pay higher prices in order to protect their wealth. This demand for more silver will cause prices to drive higher as to prevent a repeat of what the Hunt Brothers did back in the 80's. Not only do you have individual investors purchasing physical silver but you have stock exchanges purchasing silver as a part Futures contracts. These futures contracts allow an investor to "own" silver without having to store the silver themselves. They can demand their silver at any time by exercising their contracts. The futures market is a lot larger than you can imagine and prices will move based on the demand.

Remember all this price action has occurred without the public really purchasing silver as a last resort in the event there is turmoil in their currency. Once the people of the world wake up and see that their purchasing power has greatly decreased there will run silver prices up the same way they did housing in 2003-2008 and before that the tech bubble of 1990-2000. Hold on tight because the demand in the silver market will exceed anything that happened in the real-estate and in the tech markets. The real-estate bubble was a United States problem when it occurred and so was the Technology bubble. The currency problem extends far beyond the U.S soil and now the entire world will be demanding silver; which in turn will drive prices to level never seen.

-Umesh Shanmugam