US silver term structure inverts as supply tightens

Fri Feb 11, 2011 12:58pm EST

* COMEX silver stocks falls to four-year low

* First silver futures backwardation since '97-98

* Strong industrial, coins demand, producer hedging cited

By Frank Tang

NEW YORK, Feb 11 (Reuters) - The tightest physical silver supplies in four years have tipped the U.S. silver futures market into backwardation this week, making near-term prices more expensive than more distant months.

Market watchers said that it has been more than 10 years since silver futures were last in backwardation, an unusual term structure, associated with shortage of physical supply. Warehouse stocks of the white metal have dropped to a four-year low on surging demand, while miners have hedged their future production.

Booming industrial demand for silver and record U.S. coin sales, combined with a surge in demand from mining companies to borrow the metal for their hedge programs have led to a squeeze in the physical silver market.

"The problem is that there is great industrial demand for a specific grade of silver, and there is not enough coming fresh from the mines," said Miguel Perez-Santalla, vice president of Heraeus Precious Metals Management.

"The stocks are being pulled for all the high grade and better materials, and that essentially put a squeeze on the physical market," he said.

Perez-Santalla said that silver futures have not been in backwardation since billionaire Warren Buffett bought 130 million ounces of silver between 1997 and 1998.

Backwardation is a condition where cash or nearby delivery prices are higher than the price for delivery dates further in the future. Usually, forward prices are higher than cash prices to reflect the costs of storage and insurance for stocks deliverable at a later date.

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"The extent of the backwardation in silver is unprecedented. It suggests that retail investment and industrial demand internationally is very robust and the small silver bullion market cannot cater to the level of demand for refined coin and bar product," bullion dealer GoldCore said in a note on Friday.

Warehouse data from COMEX showed that silver stocks fell to a four-year low at 102.5 million ounces (3,188 tonnes) on Feb. 5, about 30 percent below a peak at over 141 million ounces (4,395 tonnes) in June 2007.


"There are regional markets that are quite tight. Certainly, some retailers are saying they are juggling to replenish stock," said Suki Cooper, precious metal analyst at Barclays Capital

Strong silver coin sales have more than offset outflow from the world's largest silver-backed exchange traded fund iShares Silver Trust (SLV), which notched its biggest one-month drop in its silver holdings in January. [ID:nLDE7100MW]

"This month, we have seen the retail interest has stayed strong but the exchange traded product slowdown is not as negative," Cooper said.

"If both of them slow down, I think silver could be in trouble," she said.

Sales of the one-ounce American Eagle silver coins by the U.S. Mint surged to a record at nearly 6.5 million, the highest since the coin's introduction in 1986.

U.S. March futures SIH1 advanced 15 percent to $30 an ounce in the past two weeks, near a 31-year high at $31.22. Year to date, the contract was 3 percent lower after the price of silver nearly doubled in 2010.


Some precious metals dealers said that backwardation in silver was related to the forward sales program by silver producers.

"When a silver mine company has to put on a hedge, it has to sell forward and borrow a lot of silver from the market, and that put a tremendous amount on the market," said Bruce Dunn, vice president at precious metals dealer Auramet.

Silver six-month lease rates also spiked to their highest level in 18 months on producer buybacks. [ID:nLDE7181VA]

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Hedging, which allows producers to guarantee prices for future output, tends to push up lease rates and nearby contract prices.

Cooper, however, said that the global silver market should remain in surplus despite the current squeeze. She forecast the world market to end 2011 with an excess of 4,900 tonnes in silver, versus a surplus of 5,300 tonnes in 2010. (Editing by Alden Bentley)

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Comments (6)
Harrybstard wrote:
If you don’t already know it, silver bullion is the investment of a lifetime. Do NOT buy promises to deliver silver such as derivatives, SLV, futures contracts etc (probable exception would be Sprott’s PSLV which holds physical allocated bars) but buy actual silver bullion and store it your self. Read work by Theodore Butler and GATA if you want to know why, believe me it will blow your socks off. Silver Wheaton is probably the best miner, (actually it’s not a miner but has an amazing business model and despite stellar gains is still good value) Good investing,

Feb 12, 2011 3:59pm EST  --  Report as abuse
Lionhead wrote:
No rational actor would sell their mining supply forward on an element that is actually in less abundance in the earth’s crust than the so-called “rare earth elements.” I suspect the hedging by the miners is being used to relieve the supply constraints in the silver market more so than to lock in price in the near future. Futures forward curves are notoriously inaccurate; the best example of that is the oil markets.

Premiums in the spot market are building as demand is steadily increasing worldwide as the current monetary system is being exposed and global populations are purchasing hard assets to preserve their wealth. There are many cross-currents at work in this market. Be aware of their build up into a schema.

Feb 13, 2011 1:10pm EST  --  Report as abuse
Tightest silver supplies in human history, not just 4 years. Industrial demands remain, and now countries (besides China which has a head start) will soon want to build silver supplies for currency. Because silver is money, real money. Sound money that the Founding Fathers talked about.

Buy and take possession of all the physical silver you can afford.

Feb 13, 2011 4:11pm EST  --  Report as abuse
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