ScotiaMocatta
TM
Precious Metals 2013 Forecast
Silver
November 2012
Executive Summary
 Silver has had a less volatile year so far, compared with 2011. Prices have
established support above $26/oz, but there appears to be resistance around the
$37/oz area.
 Investors’ confidence has returned this year, having been shaken during the
post-April 2011 sell-off. ETF investors’ holdings are near all time highs and
funds’ interest has returned.
 Silver’s fundamentals remain bearish as net of investment, the market remains
in a supply surplus. Investor sentiment therefore remains crucial.
 We feel investors will continue to want to monetarise Silver as a means to
preserve wealth and protect against currency debasement and financial risk.
 We remain bullish for Gold and as such are bullish for Silver too.
Introduction
The Silver market has remained
volatile in 2012, but the price range
has been significantly narrower than
in 2011 when there was a $23.75/oz
range between the year’s high and
low. So far in 2012, prices have
traded within an $11.38/oz range.
Since September 2011, the market
has found support just above the
$26/oz level, but there seems
resistance around the $35/oz to
$37/oz range. Given the market
remains in a supply surplus and the economic climate is not that bullish for Silver
demand, we are not surprised prices have struggled on the upside and looking forward
into 2013, we do not think the fundamentals are set to improve. If it were not for
Silver’s monetary attributes, we would be bearish for prices, but Silver has a history
of being a metal used as money, just as Gold does. In the current economic and
political climate where central banks are by default controlling much of the money
flow in the ‘free market’, by their use of quantitative easing, it seems as though there
has never been a greater need for non-fiat money. In the first part of 2012, the world’s
most popular safe-havens seemed to be the dollar, US treasuries, the yen and German
bunds. Considering all these to varying degrees are fiat assets, we are surprised
creditors have so much faith in them. However, because they have become popular
safe-havens they have also become expensive. With ongoing QE likely to undermine
confidence in government-controlled paper assets, we still feel there is more room for
bullion to be monetarised further.
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Precious Metals Forecast PGM
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FABRICATION DEMAND
Fabrication demand covers Silver’s use in industry (56%), photography (8%), jewellery
manufacturing (18%), silverware (5%) and in the making of coins and medals (13%). In 2011,
fabrication demand dipped 1.5 percent to 27,265 tonnes, according to the World Silver Survey;
this followed a 13% rise in 2010. Fabrication demand in 2011, fell back around the level seen
in 2008, which suggests a degree of stabilisation after the drop in demand in 2009 and the
restocking that was seen in 2010. Out of these sectors, demand for coins and medals grew 19
percent last year and that offset declines in the other areas. In 2012, most regions of the global
economy are seeing growth slow, or stabilise at a low level. As such, demand for Silver is
likely to remain subdued, although weaker prices in 2012, compared with 2011, may have
prompted some restocking. However, even US Silver Eagle coin sales are running below last
years levels by around 22 percent in the first nine months of the year. Consumers generally
seem to be nervous, manufacturing PMI data remains in contraction mode in most
industrialised economies and even the US economy has been oscillating between expansion
and contraction. Looking forward into 2013, it is difficult to get optimistic as the outlook for
Europe remains dire and the US recovery is likely to suffer as spending cuts are made in an
effort to rein in the budget deficit. We also feel China may well be content to see lower growth
for a while to ensure inflation remains under control. As such, fabrication demand growth is
expected to slow again in 2013.
Jewellery
Jewellery demand dropped 4.5% in 2011, as the surge in Silver prices in the early part of the
year deterred both consumer buying and trade restocking. The collapse in prices in May and
the volatility that caused put buyers on hold and led jewellery fabricators to destock. The long
term up trend in Silver prices has impacted different aspects of the market differently. The
lower end of the jewellery market has proved price elastic, while the higher end of the market
has benefitted as it has gained some market share as Gold and Platinum jewellery has become
that much more expensive. This has helped Indian Silver jewellery manufacturers increase
exports, which rose 44 percent during the 2011-2012 financial year, as consumers in the West
seem more prepared to buy relatively expensive Silver jewellery than invest in expensive Gold
jewellery. In 2012, the Indian government’s move to double the import tax on Gold led to
prolonged strikes by jewellers and in turn that hit domestic sales of Silver jewellery as shops
were closed. Earlier in the year, forecasts were for Indian Silver imports to fall to between
3,500 and 4,000 tonnes, down from 4,800 tonnes in 2011. Although prices pulled back after the
February rally had run its course, the run up in prices back above $34/oz in September, will
once again likely lead to a drop off in jewellery demand. Globally we expect to see these trends
continue into 2013, where relatively high Silver prices dampen demand for Silver jewellery in
the mass market, but the high end of the market should continue to benefit as the higher the
Silver price gets the more the metal will be viewed as a precious metal and that should enable
it to win market share from Gold and Platinum.
Industrial Demand
Industrial demand for Silver fell 2.7 percent in 2011, as industry destocked and growth slowed
after the stimulus induced gains in 2010 led to a 22 percent pick-up in demand. This year is
likely to see further stabilisation as manufacturing growth has been weak, as seen by regional
manufacturing PMI data. Although some areas of the electronics industry are booming, such as
smart phones and tablets, others areas such as TVs are suffering. Global TV shipments fell 8
percent to 51.6 million units in the second quarter, with demand from developed markets
falling 23 percent. However, although industrial demand is suffering now, the long term
outlook for Silver’s use in industry is exciting. There are numerous new applications for Silver
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November 2012
that have potential to make a big difference to demand – in time. Many of these new
applications are using nano-technology where they use tiny amounts of Silver per application,
but they have potential to be used extensively. In addition, because the amount of Silver per
application is so small, demand is likely to remain price inelastic. These new uses include solar
power, medical applications and smart tags (RFIGs). Industrial applications accounted for 43%
of total Silver consumption in 2011, two years before the financial crisis and the recession, ie
in 2007, it accounted for 50% of consumption. In the years ahead, we expect Silver’s industrial
use to grow as a percentage of total demand. During the years of strong economic growth
between 2004 and 2007, industrial demand was growing at an average of 7% per annum, we
expect to see similar, if not higher, growth rates in the years ahead. However, for the rest of
2012, and for 2013, we expect industrial demand to remain subdued in line with weak global
growth. For 2013, we would look for growth of around 2 percent, with new applications
driving growth and offsetting slower growth from the more traditional industrial uses such as
electronics and photography.
Solar Power – Photo Voltaic (PV)
The adoption of solar power has taken off in recent years. Demand from this industry has
jumped from 30 tonnes in 2002 to an estimated 1,860 tonnes in 2011, which equated to around
6.8 percent of total fabrication demand that year. Production of PV cells has, however, been
affected by oversupply and intense regional competition has caused consolidation in the
industry and that in turn has impacted demand for Silver this year as the market has destocked,
with some estimates suggesting apparent demand may fall between 10% and 20%. In addition,
as solar power tends to be subsidised by governments, cash-struck governments in Europe have
also had to cut subsidies, which has also negatively hit demand. Overall though, we see this as
a medium term set back in what is otherwise a growth industry. In July, 2012, Japan set a
premium price for solar energy that was three times the rate of conventional power, which is
likely to lead to a surge in solar farms in the country. Silver is used in the PV industry in the
form of Silver paste, which in turn is made from Silver powder. The US and Japan are the
largest Silver powder manufacturers. Silver is, however, one of the more expensive
components of the solar cell and therefore it faces competition from other materials. Looking
ahead the metals most likely to replace Silver are aluminium, copper and nickel but until new
technology becomes commercially adopted, Silver paste is likely to remain a key component.
Photographic Demand
Use of Silver in the photographic
industry peaked in 1999 at around 7,000
tonnes. Between 2000 and 2009 the
decline in Silver’s use was accelerating
as seen by the black line on the chart
opposite, but since the recession the rate
of decline has slowed as the slower
economic growth environment has
slowed the conversion to digital
photography in the medical and film
(motion picture) industries. Photography
accounts for some 7.5 percent of fabrication demand, down from 24% at its peak before digital
photography started to make inroads. In 2011, photographic demand for Silver fell 8.3% to
2,056 tonnes. Silver’s main use in photography is for x-rays. Most medical establishments
where possible are using digital x-rays, but they are prohibitively expensive so as medical care
expands in the developing world, medical establishments are often opting initially to install
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November 2012
second-hand conventional x-ray machines and this is keeping photographic demand for Silver
alive. As such, the rate of fall in Silver’s use in this industry might start to level out as we
expect further economic hardship will delay the switch over from conventional x-ray machines
to digital x-ray equipment. Overall, we would expect photographic demand for Silver to drop
at a rate of 10 percent per annum, which is slower than the average drop of 18% during 2008
and 2009, but more in line with the average annual drop of 9% between 2000 and 2009.
New Applications
Silver’s new applications are diverse and are being used in health, electronics and
transport/packaging. Many of these new applications, including smart tags (RFIDs) and Silver
antibacterial applications, use nano-technology with each unit using a tiny amount of Silver.
Until these applications have widespread use their impact on Silver demand is likely to take
time to be felt. However, some applications, such as Silver’s use in consumer electronics, for
example in plasma TV / display screens and in solder, used in a host of electronic gadgets, do
use meaningful amounts of Silver and that was noticeable in the strong rebound that was seen
in 2010. However, in 2011 and 2012 the global economy has moved back into a slower growth
mode and demand for some of these products has slowed again.
Another new application that looks promising and has potential to become a major user of the
metal is Silver–zinc batteries. These rechargeable batteries are being considered for the next
generation of high performance batteries for laptops and mobile electronic devises. Ninety five
percent of the primary elements within the battery can be recycled and re-used to make
batteries again (i.e. after recycling there is no loss of quality in the material and a closed-loop
recycling system could be introduced). Judging by the size of the market for rechargeable
batteries in laptops and mobile devices this could potentially become a large growth area for
Silver demand. In the future, there may even be a role for Silver-zinc batteries in electric cars,
which would drive up Silver demand considerably.
INVESTMENT DEMAND
ETF investors have generally remained
committed to the Silver market. In April
2011, when Silver prices corrected sharply
there were some 2,050 tonnes of
redemptions, equivalent to 11% of total
holding, but buying soon returned and
holdings now stand at 18,615 tonnes as of
mid-October. As the chart shows, although
the ETF position is not at an all time high it
is close to the high and the uptrend in
holdings generally suggests that long term
investors have not lost their faith in Silver. Interestingly, throughout the 2008-2009 sell-off in
asset classes, Silver ETF investors were steadfast. If we experience another broad based
liquidation sell-off across asset classes, we would not be surprised if they remained
unwavering again. Further turmoil in the financial markets may well see investors turn to
bullion as a safe-haven, especially if the turmoil revolves around the US debt and deficit,
which would likely weaken the dollar too. Needless to say, given the supply surplus, investing
in Silver is a confidence game. We can understand why Silver prices can still go up as there are
trillions of dollars worth of paper-based financial instruments that have little intrinsic value. So
if investors’ confidence in these paper assets falls, then the demand for assets with intrinsic
value will no doubt rise. However, at some stage confidence in the financial system will return
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November 2012
and then investors will want to move out of safe-havens and return to more traditional forms of
investments. When that happens, there is likely to be a flood of Silver returning to the market
and prices will correct accordingly. But we do not see that happening anytime soon.
Funds Turn Bullish Again
After a long drawn out correction in fund interest that saw the net long fund position (NLFP) in
Silver trend lower from 50,000 contacts in September 2010, to 6,855 contacts in late December
2011, the funds have been nervous of Silver. The rally at the start of 2012, saw interest spike
higher to 30,000 contracts, but that was short-lived with the NLFP dropping back to 6,222
contracts by July. It then started to surge again in August and by late October had climbed to
40,128 contracts. The fact this latest pickup in interest has taken the NLFP above
the two previous peaks suggests the funds
are feeling more confident again. As we
feel that Silver still has a role as a
monetary asset and expect ongoing QE to
lead to further broad based currency
weakness, we would not be surprised if
Silver prices continue to trend higher as
they follow Gold’s lead. That said, given
the recent surge some consolidation in the
NLFP seems likely in the short term.
SUPPLY
Silver supply in 2011 came from mine output (73%), scrap (25%), forward producer hedging
(1%) and net government sales (1%). The biggest changes to supply came from producer
hedging and government sales, both of which dropped by around 40 percent.
Mine output rose 1.4 percent in 2011, to a new record of 23,688 tonnes according to the World
Silver Survey. Primary Silver mines provided 28 percent of mined metal, 37 percent came
from by-products of lead and zinc, 21 percent from copper mines and 14 percent from gold
mines. Mines in Mexico, China, Russia, Poland and Guatemala collectively added 1,028
tonnes of extra production, while output declined in Peru, Australia, the US, Morocco and
Turkey, which together accounted for a 711
tonne drop in output. This meant Mexico
held on to its position as the world’s largest
producer of Silver, having overtaken Peru
in 2010, while China remained the third
largest producer. Most of China’s Silver
mine output is a by-product from its leadzinc and copper mining, all of which has
been growing rapidly in recent years,
especially lead and zinc, although Chinese
lead and zinc ores tend to contain less
Silver than the global average. In 2012, the
main increases are expected to come from by-product output in India, Indonesia, Canada and
Mexico, while lower output is expected in Australia where lower ore grades are being
encountered.
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November 2012
In 2012, base metal prices have generally been under pressure, but it is interesting to note that
outside of China there have been few mine closures due to low prices. As such, by-product
Silver production has not been hit. In September 2012, base metal prices were lifted by
announcements of quantitative easing and infrastructure spending in China. This led to an
average gain of 24 percent for copper, lead and zinc prices off the summer lows, which will
further reduce the likelihood of production cutbacks. On balance, as long as there is no marked
deterioration in the economic setup in Europe, the US or China, we feel production cutbacks at
base metals’ operations are unlikely to be seen in 2013 as the market seems to have finessed
the cash-and-carry trades to keep metal off market and support prices.
Supply From Scrap
Silver supply from scrap had been falling up until 2009 and that was mainly the result of less
Silver being used in the photo industry. However, the tide has turned and scrap supply is at
record levels. In line with the various commercial schemes to encourage people to scrap old
Gold jewellery, there has been a marked pick-up in the amount of Silver jewellery, silverware
and coins being scrapped – this is especially so in the US, India and in Europe. Scrap supply
from China also climbed, but that was more a result of higher prices encouraging recycling of
Silver waste from the photographic industry. This ties in with reports that as better healthcare
was rolled out into the less developed parts of China over the past decade, they installed
conventional x-ray machines, rather than the considerably more expensive digital x-rays
equipment. In addition, film based cameras and single-use disposable cameras are still widely
in use in China. As we expect bullion prices to rise further, we expect supply from scrap to
continue to grow. Whereas record high Gold prices may have already attracted much of the old
Gold out of the ‘woodwork’, we imagine that supply of old Silver jewellery and silverware will
remain quite price elastic. In addition, tighter environmental legislation about recycling
electronic goods has led to a boost in scrap production and that is likely to remain the case as
more countries adopt similar legislation.
Government Stocks Continue to Fall
In 2011, net government sales from stocks are estimated to have dropped to 358 tonnes, down
significantly from the 1,375 tonnes in 2010. As has been the case since 2007, most of the
official sales have come from Russia, but the fact sales dropped in 2011, when average prices
were at a record high, suggests that Russia’s stockpiles may remain relatively low going
forward. Over recent years, we have been somewhat surprised that Russia is selling Silver as it
has been an active buyer of Gold for its foreign exchange reserves and we would have thought
Silver would complement its Gold holdings. Since 2006, China seems to have stopped
exporting Silver in quantity and although its electronics and solar panel industry have grown
significantly since then, which might account for the fall in government sales, we also feel that
they may well be holding on to their Silver to diversify their foreign exchange reserves.
Overall, we would not be surprised if government sales start to trend lower again in the years
ahead, as Silver becomes more monetarised.
Producer Hedging
Producer hedging started to be seen again in 2010 when 1,568 tonnes were hedged according
to the World Silver Survey, before that there was some hedging done in 2004 and 2005.
Further hedging was seen in 2011, when 333 tonnes were hedged and given the run up in
prices in Q3 2012 and the difficultly prices have so far had in holding above $35/oz it seems
likely that more hedging has been carried out, especially by those producing Silver as a byproduct. Looking forward into 2013, we expect more hedging, as although we are bullish for
6 Precious Metals Forecast PGM
November 2012
prices, these are historically high prices for Silver and given how volatile Silver prices can be,
we feel by product producers will continue to want to hedge.
Balance
The Silver market has been in a supply surplus since 2004 so above-ground stocks have
accumulated significantly. The emergence of the ETFs in 2006, have absorbed much of the
surplus as the ETFs hold around 18,615 tonnes of metal. COMEX stocks have also risen they
stood at 142.7 Moz in early November, up from 117.9 Moz at the start of the year and 106.7
Moz in November 2011. When COMEX stocks rise it tends to indicate physical demand and
physical premiums are weak. Overall, the market remains in a surplus and that is likely to
remain the case until the handful of new industrial applications become large consumers of
Silver. This means that ongoing investor interest is crucial for the longevity of Silver’s bull
market. Although the long term outlook for Silver demand is good, there is a high chance that
between now and the time when the market balance returns to a deficit, investors will want to
rotate their investment money out of Silver and into assets that offer a better return. In the
short-to-medium term, we feel the potential for currency debasement and the need for a safehaven against developments in the financial markets, will keep investors’ interest alive, but we
feel there is no room for complacency and once the West starts to get its debt, budget deficits
and any latent inflation under control, we should expect large scale disinvestment.
Technical
After peaking at $49.81/oz in April 2011, Silver prices corrected in a volatile fashion, but
support was found on three separate occasions above the $26/oz level. The first two tests of
support were seen when prices spiked lower, but the third test was more laboured with prices
spending most of the time between June and July testing support above $26/oz. Having
hammered out a base, Silver then took off in mid-August and rallied to $35.39/oz. Prices are
now pulling back and are looking for a support level that holds. Given the extent of the August
7 Precious Metals Forecast PGM
November 2012
to early October rally it is unsurprising that prices are consolidating at lower levels, but where
prices find support will say a lot about how bullish underlying sentiment still is. A move down
below $30/oz would start to look ominous, but prices could still fall back to the long term up
trend line at $27.90/oz without damaging the chart picture too much. The recent rally overcame
the October 2011 peak at $35.68/oz, but failed to reach the February peak at $37.51/oz. With
the stochastics turning lower and falling, prices look set to fall further in the short term. On
balance we would expect prices to form a higher base now and then to spend time eroding
overhead supply between $35/oz and $37.50/oz. There seems little point forecasting how high
prices might go as we have seen how overbought prices can become - as the Q1’11 rally
showed. That said, we would not be surprised to see Gold reach $2,200/oz and if we take a
Gold/Silver ratio of 1:44 (which we could see again in a bullish environment), then that would
suggest a Silver price of around $50/oz. On the downside we would expect support at the long
term up trend line at $27.90/oz and then again around the $26/oz level.
Conclusion and Forecast
The situation in Silver is complex, the market continues to be in a large supply surplus and that
is likely to be the case for the foreseeable future. Given the high level of stocks around in
Silver it does take a leap of faith to be bullish, but we do feel that Silver is well positioned to
follow in Gold’s footsteps as a hedge against uncertainty and an alternative to paper money,
which if we are heading for a period currency debasement might become all important.
Although there are new applications for Silver that are likely to become large consumers of the
metal, we do not feel these new uses will cause the market to move into a supply deficit for a
number of years still. This means that the investment boom currently driving prices higher is
likely to run out of steam before the more bullish fundamentals take over. As such, we need to
have contingency plans ready for when the investment bull-run ends. When it does, then
disinvestment of Silver is likely to flood the market with metal and prices are likely to tumble.
However, while concerns over the West’s financial system persist, the market is likely to
remain broadly bullish for Silver as a complement to Gold. Both markets are relatively small,
so there is room for both of them and Silver provides a cheaper entry point for those who can
not afford to buy Gold.
Investors’ interest will remain crucial. ETF investors have continued to accumulate Silver, they
have bought just over one thousand tonnes so far in 2012 and given prices have generally been
weak during this period that suggests there is still bargain hunting interest around. However, as
the pool of Silver inventory grows in line with the supply surplus, either existing investors will
have to buy more, or new investors will have to be attracted into the market. We think this will
only happen if investors really do need an alternative form of money as their faith in papermoney wanes. Given ongoing QE this may still unfold. Generally we feel it is easier to be
more confident in Gold than in Silver, but as we have seen in past, given Silver’s ability to
outperform Gold we expect investors will continue to be interested in Silver.
Overall, we are bullish for Silver prices but only in that we expect them to follow Gold’s lead.
We feel prices will struggle initially to get through $36-$40/oz as we feel there is considerable
pent-up producer selling in the region, but if Gold makes a break higher then Silver is likely to
follow suit and in that scenario prices could reach $45/oz. On balance we feel Silver prices will
remain range bound in the year ahead, spending the majority of the time in the $28/oz to
$36/oz range, but short-lived upward and downward spikes out of this range may be seen along
the way.
8 Precious Metals Forecast PGM
November 2012
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9 Precious Metals Forecast Silver
November 2012
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