A significant portion of retail investors, especially in India and China, can be priced out of the gold market and turn to silver
In a new report dedicated to a review of current silver demand trends, Thomson Reuters GFMS provides observations and suggests forecasts for the silver market. We find it particularly useful to look at the demand side to see how investor action can influence future share prices.
The report divides major silver market participants into three groups: institutional; retail investors; and high-net-worth investors (having at least US$1 million in liquid assets). Each group has its own motives for investing in silver, and the impact of each class has been changing.
Hedge funds and asset managers represent the institutional investors. They have been one of the key drivers behind the rise in silver prices in recent years, in particular until early 2011. They generated large inflows – which changed to massive outflows in 2008 – when funds were liquidated to raise cash. We observed a similar type of activity this September.
In late 2009, when the global economy showed weak signs of recovery, institutional investors returned to silver as an industrial metal that has an appeal in times when things get back on track. The sentiment did not last for long, and in 2010 and early 2011, investments in silver were again inspired by the metal's safe-haven status.
Overall, unlike in the gold market, where institutional investors are represented by conservative pension funds and buy gold for long-term holding, hedge funds and asset managers that participate in silver market aim at short-term gains. That is what we saw in April and May this year. When silver peaked, institutional investors took profits and left the market.
Individual retail investors focus on physical metal as well as ETF shares. Silver-backed ETFs have grown at an amazing rate since 2006. By the end of 2010, they had accumulated around 600 million ounces (Moz) of silver. In late April 2011, ETF holdings reached a record peak of 621 Moz, though by end-October total holdings declined by 44 Moz to 577 Moz.
India and China dominate physical bar and coin retail sales. In the Western world, U.S. and Germany are the most active countries. Quoting the report:
While western retail markets have enjoyed successive gains, Indian demand has been far more volatile, with record net demand during 2008 giving way to heavy disinvestment in 2009; key to these movements have been consumer price expectations. In contrast, the Chinese investment market has realized year-on-year growth since it was liberalized in 2009, with both physical demand and futures turnover on the Shanghai Gold Exchange having achieved robust growth.
High-net-worth (HNW) investors increased silver purchases, too. They usually trade through OTC and are interested in ETFs. Their motive is mostly "wealth preservation (through asset diversification), while some HNW participants have been attracted by silver's upside price potential."
These are the forces driving the demand for silver from the investment side. They are increasingly interested in the metal. Let's see how important that interest is.
The demand structure for silver is changing. As you can see in the chart below, investment demand as a portion of total demand has been growing considerably in the past two years and reached 26.4% of the total demand (279 Moz) last year. For comparison, the average share of investment demand in 2001-2008 was about 7%.
Though industrial application still dominates the demand structure accounting for almost half of the total (46% in 2010), investment demand grew quickly and became the second most important component, while traditional jewelry and silverware and photography usage have been declining (see the chart below). The investment market has become more influential on the metal's price as a result.
Conclusion: Positive, but…
Looking forward, there are a number of factors that are likely to support silver demand and eventually, its price.
The most important one is a bearish economic outlook. As global economic trouble boosts the price of gold, a significant portion of retail investors, especially in India and China, can be priced out of the gold market and turn to silver. It is expected that Indian physical investment demand will reach 45 Moz (+55% from the previous year) in 2012.
A bearish economic outlook, however, is also the major reason why it's possible we won't see a safe-haven rush into silver by investors. The metal continues to be perceived as an industrial one: in 2010, its correlation with copper was higher than with gold (0.64 vs. 0.58). This is not a huge difference, but it's important. A case can be made that due to the variety of demands for silver, its price will depend on more than investment (safe-haven) demand.