Myths in the Silver Market CPM Group Precious Metals and Commodities Research and Consulting The precious metals markets are secretive places. That is one of their attractions to many investors and others who value privacy. It poses problems for all market participants, however, because it makes these markets, so small and illiquid compared to other financial markets, susceptible to rumors and manipulation. While there is nothing new to this, in recent weeks and months the silver market has been repeatedly hit by rumors spread by traders and others seeking to scare users and investors. Market professionals cite the persistence of these rumors as a major factor in the decline in silver prices below $4.90 since October 2000. It is important to distinguish among myths, rumors, beliefs, and misinterpretations. In free markets, as in free countries, everyone is entitled to his or her opinion and beliefs. The precious metals markets are no exception to this, with some individuals holding strong beliefs that do not necessarily measure up to empirical market evidence. The point of this brief discussion is not to seek to sway anyone from deeply held beliefs, but rather to set the record straight on certain fundamentals that have been distorted by persistent rumors and misrepresentations. Myth 1: The Chinese government is selling large amounts of silver from its stocks The issue of silver sales from Chinese government stocks has been one of the most pervasive topics of discussion in the silver market, and perhaps the most misunderstood. The topic came to a head in early 2000 when rumors were circulated of large amounts of silver entering the market. Not so coincidentally, these rumors began at the same time that the liberalization of the Chinese silver market was taking a great leap forward on January 1, 2000. The Chinese silver market has been closely controlled by the People's Bank of China since the Communist Revolution in 1949. The PBOC has been moving toward deregulating the gold and silver markets within the country, and extricating itself from the role of national market maker. This has led to massive shifts in the flow of silver around China, compounded by structural changes in the Chinese photographic industry that has led to large amounts of silver that formerly went to Chinese film makers now being available for export. These changes have radically transformed the entire metals market within China, and have led to increased exports of silver, and gold, over the past few years. The inaccuracy is the assumption that these exports represent here have been some sales from these stocks, but they are a small portion of the total amount of metal being exported. Some estimates by PBOC silver sales run as high as 60 million ounces. Chinese government sales actually have been around 10 million ounces or so per year in recent years, and are expected to be roughly 12.0 - 14.5 million ounces in 2001. Most silver exports have been by domestic refiners processing base metal concentrates and domestic scrap. In the long run the new laws may lead to a decrease in exports as domestic refiners now can receive higher prices within China, reducing the incentive to smuggle metal out, and domestic consumers and investors now can pay lower prices for silver within China. Myth 2: Digital photography already is sharply decreasing silver use in photography It has been repeatedly suggested for nearly two decades that digital photography would one day replace traditional silver-halide based photography entirely. More recently, there have been suggestions that the declines are already in place and eroding photographic demand for silver. Again, this is not accurate. Silver use in photographic materials—papers and films—is estimated to have risen about 6.0% worldwide in 2000. Demand is estimated to have increased 8.3% in the United States, and 6.3% in Japan. Major photographic companies are increasing their manufacturing capacity in the face of stronger demand growth. From 1980 through 1998 the compounded annual growth rate in silver use in photography was around 4.0%. Last year's increase was 50% above that long term trend growth rate. This represents a definite acceleration in the demand for a silver-bearing photographic product that flies in the face of the rumors that digital is killing this market. One of the main reasons for the recent strength—ironically enough—has been the advent of digital photography, although most of the increased silver use reflects expanding traditional photography. Consumer appetites for conventional photography have been growing stronger world-wide. The Advanced Photo System introduced in the late 1990s has boosted both picture taking and the number of reprints being made, while rising disposable income from Asia to Latin America has increased demand in these countries. Also, most consumers are not ready for digital photography at this point, with the cost still prohibitively high for most people in the world and many consumers not yet computerized. Many observers had presumed that pure digital photography, which does not use silver in actually capturing the image, would naturally lead to a decline in silver usage. However, just as the 'paperless office' has prompted a surge in paper use, digital photography is increasing the popularity of photography and of traditional photographic demand. Much of the digital imaging business is actually a combination of traditional imaging techniques and newer digital technologies. The images are captured on conventional film, and much of the final output still uses either conventional photographic papers or other silver-coated papers. In between, the images are digitized, edited, and manipulated. In sum, digital photography is not necessarily a negative for silver. In fact, if one is objective about the impact of digital photography on silver, one needs to calculate both the possible long-term losses in silver demand on the consumption side of the market and the reduction in supply that would occur due to reductions in silver recovery from spent photographic products, which accounts for around 85% of the 190 million ounces recycled each year. Myth 3: Kodak has bought forward a year's worth of silver, removing the world's largest silver user as a source of demand for the next year. Another report that circulated throughout the market had to do with Eastman Kodak, one of the world's largest silver users. In December 2000 a news item reported that Kodak had hedged its silver needs through 2001. This was perceived by some observers as bearish for the silver market, as these observers intimated that this source of demand for silver consequently would be absent the silver market. Actually, this fact was nothing new and can be found in the company's regular quarterly filings with the Securities and Exchange Commission. Most of the company's silver requirements are purchased through annual supply contracts, as has been the case for decades. Similar statements can be found in Kodak's previous filings with the SEC. Myth 4: Berkshire Hathaway has sold its silver Berkshire Hathaway has found itself at the center of intense public scrutiny since it announced in February 1998 that it had purchased 129.7 million ounces of silver between July 1997 and January 1998. Since then, it has often been suggested that various periods of silver price weakness have been directly related to sales by Berkshire Hathaway. First, one can look at why Berkshire Hathaway bought silver in the first place. In the February 1998 press release accompanying the announcement of the purchases, management stated that "the equilibrium between supply and demand was only likely to be established by a somewhat higher price." Moreover, Berkshire Hathaway has long hailed itself as a long-term investor, and does not seem likely to sell its recently acquired assets on relatively minor price fluctuations. The average purchase price of Berkshire Hathaway's silver was less than $5.00. This, however, did not stop some observers from suggesting that Berkshire Hathaway had sold some or all of its silver position. Offered as evidence of these sales was the fact that a major refiner in Europe, which had been known to be storing silver for Berkshire Hathaway, told its clients and others that the bulk of the silver being stored at its facilities had recently been moved. Another piece of "evidence" was that Salomon Smith Barney recently delivered a net 1.8 million ounces of silver into the December 2000 Comex delivery period. (Berkshire Hathaway often is viewed as the major silver customer of Salomon.) These two factors do not necessarily mean that the silver has been sold. It may have been moved in an attempt for greater opacity. Myth 5: Barrick hedging In the third quarter of last year, market discourse focused on the prospects of current and future forward silver sales by producers. Barrick Gold was the target of much of the initial speculation, as some market reports focused on the fact that Barrick reported in a regular quarterly report that it had spot deferred silver sales contracts in place. As with Kodak, the existence of these positions was not new; the fact that the market decided to focus on it at that time was. As of the end of 1999, Barrick had entered into spot deferred contracts to deliver 14.3 million ounces of silver over the following five years. As of the end of 2000, Barrick had 20.0 million ounces of spot deferred silver contracts at an average price of $5.32 per ounce, for 2001 and beyond. These hedges were for future output at the Pascua mine, development of which has been deferred, so further hedging is not expected until such time as gold and silver prices rise to levels that lead the project back toward development.
