Focus on Silver Fundamentals

Precious Metals Commentary

The battle for gold to hold above the psychological USD$1,500 level continued this week with gold whipsawing around that level after failing to hold it convincingly. Bulls are currently losing the battle with gold sitting at $1,493 per ounce, with silver trading at $17.50, so both metals are in a sideward consolidation for now.

We saw a small recovery in the AUD/USD back above 0.67 cents to see gold for local investors trade lower this week to $2,211 and silver remaining close to AUD$26 per ounce.

In a move similar to Boring Company’s Elon Musk's ‘not-a-flamethrower’ release, the Federal Reserve chair Jerome Powell announced a fresh new round of treasury bill purchases, which he deemed as ‘definitely not QE’, when clearly, the expansion of the balance sheet is very obviously a form of QE and no different to previous asset purchases.

As this new ‘Not-QE’ is stimulatory, it eased stock market jitters and the S&P 500 climbed back up the 2,938 and gold sold off slightly despite a lower USD index for the week.

Powell also hinted the Fed is closer to agreeing on another rate cut as early as their next meeting, so this whole initial strategy of Quantitative Easing that Bernanke introduced is started to look like it’ll never end. The whole concept initially stated that when the economy is stronger in a few years the balance sheet will be unwound and rates will move higher, but it is quite evident now that this cannot happen without an economic catastrophe in the US. Good to see the RBA is following in the same footsteps of the failed policies of the Fed, as that should surely bode well for the Australian economy...

Silver Focus

With silver bouncing off $17.00 last week it was good timing for the Silver Institute release a study of global silver investment by respected precious metal research firm Metals Focus. At 30 pages it is a detailed but not overly long look at the state of the silver investment market and worth a read. Below we have a look at a few interesting items out of the report.

One feature of the silver market has been the strength of silver Exchange Traded Products (ETPs) in the face of declining prices post 2011. As you can see from the chart below, the total amount of silver held by ETPs worldwide held above 600 million ounces – in sharp contrast to gold ETPs, whose holdings fell over 40% by the end of 2015.

The reason for this difference is that the gold ETPs are dominated by professional investors (who are more short-term in focus and thus prone to selling) compared to silver ETPs which are held by retail buy-and-hold investors.

As an example, Metals Focus note that 51% of GLD, the world’s biggest gold ETP, are institutional investors while the same figures for the iShare Silver Trust is only 15%.

The lack of professionals in the silver market has been a factor behind its underperformance relative to gold, with Metals Focus saying that hedge funds have been overly influenced by highly visible figures like weekly US silver Eagle sales (which have been poor) or Comex warehouse stocks (which have been high) that are not reflective of silver’s full supply/demand situation.

As you can see from the pie chart below, industrial demand is the major demand driver, with US and India investment and jewellery also being significant.

The upside to such low professional interest in silver is that when this changes, it will _“have a disproportionate affect on the market” g_iven the modest size of the silver market relative to gold.

Regarding physical investment, Metals focus expect it to edge high in the next few years from its current level of 19% of global silver demand. Interestingly, the physical market is “dominated by India, the US and Germany, with a combined market share in 2018 of 80%.” China, while the world’s largest gold market, has very little silver demand as a result of a 13% value added tax levied on the full value of silver bars.

On the supply side mines which primarily produce silver represent only 28% of all silver mine production. The result is that overall silver output is largely stable. This can be a benefit if silver prices rise rapidly as it will not necessarily translate into large increases in silver produced but it does have a downside as silver can keep on being supplied even when prices fall.

In conclusion, Metals Focus says that investor demand for silver “has improved noticeably this year” with growing macroeconomic and political uncertainties and accordingly they “expect investment demand to strengthen further.”

Hoping for Housing to Hold Up

UBS released its Global Real Estate Bubble Index and Sydney is only showing up as mildly overvalued compared to other “brand name” global cities. Low interest rates have resulted in index increases in all cities within the Eurozone but growth rates have continued to slow in a majority of cities as affordability remains a key risk.

Another example of excessive home prices from the report is UBS’ calculation of the number of years a skilled service worker needs to work to be able to buy a 60m2 flat near the city centre. For Sydney that is 7 years, compared to 11 years for New York or 14 years for London.

Seven years may not initially seem that bad but note that “skilled” means “above average wage” and 60m2 is an area 7.75 metres wide and long – more a studio apartment than a flat – but at least 7.75m is wide enough to swing a cat.

If you were wondering why the RBA is lowering interest rates and hoping to push up home prices, the chart below from their latest publication gives the answer.

The percentage of outstanding mortgage balances in negative equity has increased from just over 2% to 3.75% in the past year. The really concerning figure is that for the mining states of Western Australia and the Northern Territory, with almost one fifth of loans in negative equity. The RBA notes that if prices in those two states fall a further 10%, then over 33% of mortgages would be in negative equity.

Curious that the RBA only used a 10% fall when in a recent Switzer TV debate between Steve Keen and Chris Joye both of them agreed that house prices could fall between 20 to 40% in the next recession.

It should then be no surprise that the smart money, being professional investors as reported by Coply Fund Research, have been reducing their exposure to Australian banks with only 9% of funds invested in our banks. This is the lowest on record and is being driven by regulatory concerns, falling home prices and low interest rates.

The professionals are no doubt aware of the Bank for International Settlements paper on how banks fare in a low interest rate environment where they conclude that “persistent low interest rates tend to reduce bank profits, mainly by depressing interest margins” and increases the risk of banks evergreening loans, that is, delaying recognising losses by rolling over loans to high-risk borrowers.

Looks like retail investors chasing dividends have been left holding the bag hoping for housing to hold up.

The Gold to Hold When You Don’t Want to Hold Gold

With global gold-backed ETPs reaching 2,808 tonnes in September, the highest levels of all time, Barclays this week launched another exchange traded gold product (to add to the 73 active gold funds already in the market – how many more do we need).

Its main selling point is that it has no management fee. This is just a continuation of a trend that has been evident for some time, with iShare undercutting GLD’s 0.40% fee with its 0.25% fee and then GLD undercutting itself by launching MiniShares (GLDM) with a 0.18% fee.

Of course, you are probably wondering how it can charge 0% when it has to store and insure physical bars in a vault. Well the catch is that it doesn’t hold any physical gold and it isn’t any conspiracy as they are totally upfront about it.

Structured as an Exchange Traded Note, they say product is an unsecured debt obligation of Barclays and as the prospectus says (in capitals, which we have de-capitalised so you don’t think we are shouting) “the ETNs offer exposure to future contracts and not direct exposure to gold or its spot prices.”

Most likely what they are doing (our guess, as the prospectus doesn’t explain how they are managing the product, so they aren’t totally upfront about everything) is taking your $100, putting say $10 down as margin and buying a Comex futures contact, and then investing the remaining $90 in bonds. Sure, they would get a (piddly) return on the $90, but as there is “a cost to maintain a rolling position in the futures contracts underlying each index” that will eat into the returns.

Why anyone would want to take an unsecured exposure to Barclays in such a complex non-physical gold product we don’t know, not when it is so easy to buy physical from ABC Bullion and store it at a low fixed cost with Custodian Vaults.

By the way, this is the same Barclays that was fined £26m “for failing to adequately manage conflicts of interest between itself and its customers as well as systems and controls failings” over 9 years with respect to its manipulation of the London Gold Fix and subsequently left the physical bullion market and sold its vault to ICBC Standard Bank.

We assume the marketing department thought they were smart by getting the NYSE to list the product with the ticker symbol GBUG. Are they really so ignorant of the gold market that they don’t understand that goldbugs would never invest in a product that wasn’t 100% physically backed, or was it a cynical dig at goldbugs to use that ticker for what has to be the most paper of all paper gold products?

Until next time,
 
John Feeney and Bron Suchecki
ABC Bullion
 
If you have any questions or feedback about this week’s report, we would love to hear from you. You can contact John Feeney (@JohnFeeney10) and Bron Suchecki (@bronsuchecki) directly on Twitter, otherwise please feel free to send us an email at [email protected], or call us during trading hours on 1300 361 261.

Disclaimer
This publication is for educational purposes only and should not be considered either general or personal advice. It does not consider any particular person’s investment objectives, financial situation or needs. Accordingly, no recommendation (expressed or implied) or other information contained in this report should be acted upon without the appropriateness of that information having regard to those factors. You should assess whether or not the information contained herein is appropriate to your individual financial circumstances and goals before making an investment decision, or seek the help the of a licensed financial adviser. Performance is historical, performance may vary, and past performance is not necessarily indicative of future performance. Any prices, quotes, or statistics included have been obtained from sources deemed to be reliable, but we do not guarantee their accuracy or completeness.