Silver's Mine Supply to Hit New Record This Year, Surplus to be Absorded by investment Demand

Outperformance of silver over gold has sent the gold/silver ratio to around 36/37, the lowest level in almost 3 decades. Geopolitical tensions, natural disasters and subsequent radiation leak in Japan, and ongoing sovereign debt problems in the European periphery have increased demand for safe-haven assets. Meanwhile, rising inflationary pressures resulting from surges in commodity prices and maintenance of expansionary monetary stances by the Fed, the BOE, the BOJ, etc, have raised the need for inflation hedges. Gold is a traditional alternative to fiat currencies and risky assets in such an environment. However, silver has been increasingly appealing in recent years as many investors view it as ‘poor people's gold.

From a fundamental perspective, outperformance of silver appears abnormal given the oversupply situation. Mine supply has been on the rise since 2003. According to GFMS, mine production, accounting for 70% of total silver supply, climbed +2.5% to 735.9M oz with Mexico surpassing Peru as the world's largest silver producing country in 2010. Mine supply is expected to hit another record this year with several new projects in Mexico, Peru and Argentina starting operations. Sales of silver scrap rose +14.1% to 215M oz and producer hedging (61.1M oz) returned for the first time in 5 years as a result of higher prices. Primarily from Russia, net government sales almost tripled to 44.8M oz last year.

On the demand side, while investment demand was and will continue to be the major growth driver, industrial demand will also surge in tandem with the global economic upturn. As we mentioned in our report, ‘New Regime for Silver', the use of silver in the photo voltaic (PV) industry will be a shining star. We believe demand forecasts in the area will have to be revised higher as policymakers across the global rethink their energy strategies after the nuclear crisis in Japan. While sharing the same view that the use of silver in PV will be growing, the GFMS said in ‘The Future of Silver Industrial Demand‘ that silver's antibacterial qualities may be applied on making of cooking utensils, kitchen detergent and refrigerators.

While evolution of new drivers is expected to boost silver demand, excess supply will have to be absorbed by investment demand which is the key determine of silver prices in the near- to medium-term. We retain our bullishness in silver as the global economic and political outlook remains highly uncertain. Yet, investors have to be cautious about volatility in silver prices. Moreover, a massive correction is likely if economic growth proves to be tampered by high oil prices.