Riding the Silver Bull - Karvy Commodities€¦ · Recently a rally in silver followed by sideways...

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Riding the Silver Bull

Silver is targeting $20 per ounce or Rs.30000 per Kg By the end of accounting year 2006-07

Mine Supply

Govt. Sales

Scrap Supply

Exchange Inventories

Total Supply

Industrial Demand

Jewelry Demand

Photography Demand

Investment Demand

Total

Demand

Silver has begun its upswing and may be expected to reach a high

of $20 during next year. Currently it is trading in the range of $12 -

$14. Fresh buying is expected to emerge at current levels which to

stop falls in the next year.

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Silver Prologue

“Too many people miss the Silver lining,

Because they are expecting Gold” - Maurice Setter

ilver is time and again called “poor man’s gold.” It has always

been considered to be less attractive than gold and other precious

metals like Platinium and Palladium and obviously the price of silver

has always been much lesser than the price of these precious metals, which

creates an illusion that that silver, is somehow worth less. Silver is the

poorest metal among the precious metals pack. This is also evident from

the comparison of silver prices with other precious metals, where silver is

quoted at $12-$14 per troy ounce where as gold is quoted at $550 -

$600. There are many ironies about silver and the most recent one is that

this poor cousin of Gold has made its devotees or investors richer than

any other precious metal and also it has given returns far more than any

other investment option at-least in the first quarter of 2006.

Recently a rally in silver followed by sideways movements for sometime

raises a question that is the silver rally over or there is still a lot to expect

from this highly undervalued asset. Obviously the investors and analyst

world around are optimistic about silver. This is only due to understated

silver fundamentals for a long time which are slowly playing their role and

helping silver to express its fundamentals and prohibiting silver from

following Gold blindly.

Looking back in the history it can be seen that silver was able to hit highest

spot price of US$50.36 on January 17, 1980. On contrary Gold climbed

to an historical high of US$875.00 in the same month. Depending on these

numbers, silver investment does appear to be second to gold. But closer

analysis shows and proves that silver has been a better investment at

times, and has given investors a higher return than gold ever has.

S

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If we focus on the bull run of silver and gold in decade 1971-80 we can

find that silver started its gigantic price run-up in 1971 from a base price of

US$1.39 per ounce. Over the time silver reached its peak of US$50.36 in

1980 silver investors had realized a shocking cumulative return of

approximately 3,600 %. During the same period Gold also did well but

not as well as silver. One troy ounce of gold was priced at US$40.80 in

1971. It reached its price peak of US$875.00 per ounce in 1980 which

resulted in a return on investment of approximately 2,100%. Thus there is

a profit difference of 1,500 % which can be a good reason for any

investor’s to buy silver over gold. Past is past and also people would

attribute the silver rally to the market cornering strategy of Hunt Brothers.

If we look at the recent past in the first quarter of 2006 among the

commodity pack highest returns were given by silver, this hints that

whether a brisk bull run foreseeable in near future. In the current scenario

when so many investment options are open, the question is whether an

investment in silver bullion, today, is a wise decision to make and is this the

time to enter the precious metals game. This report analyses the long-term

and short-term fundamental factors expected to move silver prices. It is

believed that the short-term weakness and sideways movement going on in

silver is a great opportunity for the late-comers to join the great silver rally.

This report would be of use for serious investors to understand the

fundamental front of silver and understanding the intrinsic value of silver.

This would also help them a bit to make an informed decision while

investing in silver and creating wealth.

But the fact always remains is that no investment return can be

guaranteed. Never has, never will be. The idea is of investing in the

markets, is to capitalize on the growing fortunes of various asset classes.

With the availability of innovative financial instruments like derivatives it

possible for an informed investor to capitalise not only on the growing

fortunes of assets by going in for Long positions but also on the dooming

destiny of assets by short positions on the reversal of the bull run trend.

In the particular case of precious metals and silver bullion, signals are such

that there is a huge prospect of silver Bull Run in near future and beyond.

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Price history

Silver Prices 1975 - 2006 (Weekly Average)

Source: Bloomberg Service Significant Events Affecting Silver Prices Since 1950 (Source: USGS)

2006 Launch of Silver ETF by Barclays at American Stock Exchange.

1985 U.S. Mint authorized to begin minting a silver bullion coin

1979-80

Attempt to corner the silver market by Hunt Brothers

1968 Redemption of silver certificates for silver could only be made until June 24; thereafter, silver certificates would be exchanged for Federal Reserve Notes

1967 Announcement by U.S. Government that all silver coins would be withdrawn from circulation

1965 Silver eliminated from all U.S. coins except the half dollar, which has its silver content reduced from 90% to 40%

1963 Silver Purchase Act and various other legislation repealed; U.S. Treasury authorized to print Federal Reserve Notes, which were not redeemable for silver, for circulating currency

1950-68

Huge U.S. Government silver holdings largely depleted

US$50.36 on January 17, 1980

US$14.27 on April 19, 2006

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Silver Prices Jan 2006 - April 2006

Source: Bloomberg Service

Silver prices in 1st four months of 2006 have averaged $10.42, with a rise

of 42.53% rise year-on-year in spot markets and 19 year high. Annual

average price of silver in 2005 was $7.31 as per London Silver price

fixings.

A rush in investment activities in silver drove much of the rally though a fall

in net government sales and higher industrial demand were also important.

Silver prices staged a rally in the first 4 months of 2006 with a whooping

rise of 57% compared to the opening price on 2nd Jan 2006.

Gold, Silver Prices Jan 2006 - Apr 2006

Here it can observed that both gold and silver prices are moving upwards

but till 2nd week of March Gold leads the rally where as in the later part

silver lead the rally in the precious metals pack.

+5

7.1

%

Silver Price

Gold Price

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Real Price of Silver for past 600 years

600 year real prices if considered to evaluate present silver prices, silver

seems to be highly undervalued. The current fundamentals do not agree

with the present day prices of silver. Therefore understanding the

fundamentals of silver and finding potential signals that may spark of an

unstoppable silver rally becomes very important.

As silver has given highest returns among the commodity pack in the 1st

four months of 2006, it has attracted the attention of most of the investors

and the question to whether there still there exist the potential for silver to

grow or has its bull run is to subside in near future. Thus the timing of this

report becomes very important to understand this unusual commodity

and so that this understanding can aid little bit in taking informed decisions

about investments in silver.

Source: www.goldinfo.net\silver600.html

All time high $806

All time low $4.73

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Silver Supply Dynamics Like all metals or precisely precious metals, silver cannot be created. It

occurs naturally. The source of silver are mine production, government-

central bank reserves (which is also termed as above ground supply of

silver) and recycled scrap. Delay, interrupt or reduction in any one of these

supply sources result into big market price hikes, as daily demand for silver

bullion begins to surpass supply.

Classification of Silver Supply Sources

Mine production of silver is the largest component of silver supply. It

can be seen that mine production accounts for nearly 72 % of silver supply.

Other sources of silver being scrap and sales by government bodies also

play their role in meeting the ever increasing demand of silver. Government

sales are most done to stabilise the price of silver or in crisis situations like

war or natural disasters. The detailed trend analysis of the various source of

Silver Supply

Below the ground Above the ground

Mine Production Net Govt. Sales Old Silver Scrap

Primary Silver Mines

Lead / Zinc Mines

Copper Mines

Gold Mines

World Silver Supply 1992

World Silver Supply 2004

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silver will facilitate in predicting the future movement of silver production

and its repercussions.

Mine production registered a 4% increase year-on-year to achieve a

record high of 634.4 Million ounces that amounts to 19,731 tonnes in year

2004. Statistics of 2005 are yet to be released in World Silver Survey 2006,

but are estimated to increase by 2% year-on-year in 2005 and the

expectations for 2006 are 658 Million Ounces.

It is quite evident that mine production is increasing where as old silver

scrap and Net govt. sales are stable over time and they also contribute less

to the total supply of silver.

As per the latest available World Silver Survey 2005 it has been seen that:

• The global mine production has registered 4% rise year-on-year

and reached 634.4 Million ounces (or 19731 tonnes)

• Net Government sales have declined by 30% y-o-y1 due to

significant fall in release of silver from Chinese stocks.

• Scrap supply has fallen to four year low of 181.1 Moz2

• Higher prices also encouraged producers form increasing their hedge

covers, leading to accelerated supply.

1 Year-On-Year 2 Million ounce

Total Supply

Mine Production

Old Silver Scrap

Net Govt. Sales

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Mine production of silver has registered strong growth and it is estimated

that it will further add to supply in near future. Accurate figures for the year

2005 and 2006 can be got only when world silver survey-2006 is published

in august. But the secondary data suggest that there won’t be much

fluctuation in the mine supply of silver.

The increase in mine production was at record high in year 2004 at

634.4 Moz. This was due to growth in production in primary silver mines

and also due to increase in production of Lead/Zinc and copper mines. Fall

in production was registered only in the category where silver is a by-

product of gold mining. The output of silver got from gold mining decreased

by 2% on year-to-year basis. Increase in silver production was due to bulk

increase in production at Mexico, Peru, Australia and China. Significant

increase was also seen in Russia and Chile. Additional boost in production

was given by the increase in throughput at Cannington mine in Australia

which is the largest silver producing mine of the world. Its capacity

increased by 20% and reached 46 Moz in 2004. Similar developments in

mines of China and Russian mines added up to the supply.

Decrease in production was observed in Kazakhstan, Bolivia and

Indonesia. Closure of several mines in Bolivia accounted for decrease in

silver production. Moderate declines were seen in Canada, Sweden and

Poland. Individual supply dynamics of each nation affected the supply of

silver but the net effect was increase in mine production of silver.

Silver Mine Production 1992 - Region wise

Silver Mine Production 2004 - Region wise

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By-Product analysis

When considering the supply of silver from mines it is very important to

have a look at the break up of the various source metal mines and their

contribution in silver supply. Around 30% of silver comes from mines where

the main source of revenue is silver. Such mines are called primary silver

mines. As per the graph shown below, same amount comes from Lead/Zinc

mines. This is important as price of silver will have impact on primary

output, which means that amount of silver mined is more a function of the

price of other source metals.

Thus the prices of Lead, Zinc and copper will have a major impact on the

amount of silver mined from these mines. There exist a strong correlation

between the prices of silver and these metals.

Correlation

(Daily Prices for last 10 years)

Copper Zinc Lead Gold

Silver 0.930 0.823 0.898 0.869

Thus the prices of Lead, Zinc and copper will have a major impact on the

amount of silver mined from these mines. For example right now the prices

of copper are rising high and everyday new milestones are achieved by

copper. This leads to motivation for more production of copper in copper

mines. With increase in copper mine production the supply of silver is bound

to increase as no miner would like to part with such a precious by-

product. Thus the prices of these metals become important parameter to

predict the outlook of silver prices.

Silver output by source metal

Output / Year 2000 2001 2002 2003

Primary 25.45% 25.54% 28.74% 28.56%

Lead/Zinc 34.74% 33.53% 31.76% 32.79%

Copper 23.67% 25.73% 25.28% 26.18%

Gold 16.14% 15.19% 14.22% 12.46%

Silver output By Source Metals - 2004

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Supply from above the ground

Supply from above the ground constitute of Scrap and Government

sales. Together they constitute of around 25% of silver supply. Scrap is

recovered from industrial waste or existing goods such as photographic

chemicals, jewellery, discarded electronic goods such as computers etc.

Disinvestments and government sales comprise of old coins and bars of

silver that return to market. Another minor component of supply of silver is

producer hedging or early sale one by mining companies of future

production by entering into forward contracts. This is done to hedge against

the price and quantity risk associated with silver. Like hedging there can

also be de-hedging and the effect on supply will be on net basis.

Scrap

Silver Price

In 2004 net government sales were

observed to have declined by 30% on y-

o-y basis. This was mainly because China

decreased its sales of government

stocks. Whereas Russia showed an

increase in government sales, while India

has given intentions to sell part of its

silver stock starting from 2005 in phases.

Fall in global scrap was seen in 2004 is

continuing. The decline was seemed to

by mystic even while the silver prices

saw an increase by around 30%. Scrap

supply from photographic industry was

also reduced due to the significant fall in

use of silver halides in photographic

fabrication. This decline in silver scrap

was due to high penetration of Digital

photography and injects printers across

the world. Also increase was seen in

scrap due to tighter environmental

legislation which has facilitated

additional recycling.

Silver Price

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Long Term Supply Outlook

Factor Outlook Effect

Silver Mine

Production

Longer term, silver mine production is

likely to rise; 22 million ounces of new

capacity could come on-stream in 2006 from

six mines. In late 2007, Apex Silver's San

Cristobal mine will produce 22 million

ounces annually when it comes on line.

Barrick's Pascua Lama could produce 18

million ounces annually when it commences

production in 2009.

Increased mine production

would increase the silver

production and also offset

the decline if any due to

closure of mines.

Silver

production

in mines of

Lead, Zinc

and Copper.

Silver as a by product in mines of Lead, Zinc

and Copper is expected to increase by 5%

and more as the demand and prices of these

metals especially copper have seen huge

increases in 2006.

Silver production to increase

with base metals production

increase.

Silver

production

in Gold

Mines

Silver production in Gold mines is expected

to decline following the past trends.

silver production will be not

much affected as amount of

silver got from gold mines will

be offset by base metals

Net Govt.

Sales

Recognizable government sales of stocked

silver are expected only from Russia and

India 2006 onwards.

Govt. sales could act as price

stabilisers but the effects on

prices are temporary.

Scrap

Supply

Net Scrap supply is expected to decline

independent of price increase due to declining

photographic scrap.

Decreased Scrap supply of

silver will not affect the

prices but will add to the

supply demand deficit.

Silver

Stocks

Silver stocks are declining rapidly as they

are the only sources to overcome deficit of

silver and the trend is expected to continue.

But silver stocks will be replenished due to

the launch of Exchange Traded Funds

which are expected to store 10% of annual

silver demand

ETF would lead to increase in

stocked silver which has

caused price rally and same

will continue further.

Total Supply The net effect of silver supply is slightly

positive due to increased mine production

and expected to increase not more than 4%

considering the conservative use of silver

stocks and certain stock that cannot be used.

Supply in 2006 would follow

the patterns of past three

years and expected to reduce

the deficit for 2006 to 50

million ounces compared to

200 million ounces of 1997.

The analysis of literature and statistics of various sources of supply of silver

give positive picture for the silver supply but the deficit between the supply

and demand is expected to stay and the repercussions of this deficit would

be felt only when the inventories fall to zero.

CO

PP

ER

CO

PP

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Silver Demand Dynamics

Demand of silver has three main components namely:

• Jewellery & Silver ware

• Industrial Fabrication

• Photographic Fabrication.

Another minor component is Coins and medals. Other avenues of demand

that are on rise are government purchases and investment. These two

are taken on net basis as there can be government sales and

disinvestments of silver also. Since 1992 net purchases by government are

not significant but the role of investments in silver has seen dramatic

changes. Silver investment is the reason for the recent rally of silver prices.

The components of silver can be classified as:

Classification of Silver Demand

Silver demand is governed by various application of silver. Sale of the goods

in which silver is used like silver batteries; tableware, etc determine the

demand of silver in the market. Events like declaration of decline in sales of

analog cameras affect the prices of silver. New applications of silver like in

medicine and RFID tags used by retail stores also affect the demand and

price dynamics of silver.

Main Uses For Silver

Batteries Electroplating

Bearings Jewellery and Silverware

Brazing and Soldering Medical Applications

Catalysts Mirrors and Coatings

Coins Photography

Electrical Solar Energy

Electronics Water Purification

Silver Demand

Industrial Fabrication Investments

Govt. Purchases Personal Investments

Indst. Application

Photography

Jewelry, Silverware

Coins & Medals

Most of the industrial

applications of silver, the

demand is price inelastic as

there it is required in minute

quantities where as the demand

of silver in jewellery is highly

price sensitive.

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It can be noted at very first glance that the demand for Industrial

applications has increased with time and demand for photography has

declined due to the advent of digital photography.

Here the net implied investment is the balancing figure that that balances

the supply and demand and it is also evident that the government

purchases do not exists and demand due to investments is on rise.

World Fabrication Demand of Silver

Demand of physical silver is mostly due to industrial demand and the

sudden increase in industrial demand during year 2000 is due to the IT

bubble. Statistics of 2005 are yet to be released in World Silver Survey

2006, but the fabrication demand is expected to be stable for 2005 and

the expectations for 2006 are 850 Million Ounces.

World Silver Demand 2004

World Silver Demand 1992

Total Demand

Industrial Applications

Jewelry & Silverware

Photography

Coins & Medals

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As per the latest available World Silver Survey 2005 it has been seen that:

• Total fabrication demand for 2004 fell by 2% to a six year low of

836.7 Moz

• Increase in industrial applications rose by 5% especially because

of electronic goods.

• Jewellery & silverware fabrication demand fell to a nine year low at

247.5 Moz by 10%

• Photographic demand fell for 5th year in row, reached 181.0 Moz

• Coin and medal demand increased by 15% in 2004 reaching its ten

year high at 41.1 Moz

• Implied investments rose by factor of five to reach 42.5 Moz in

2004

In 2004 acceleration in

global GDP growth lead to 5% increase in industrial fabrication. Mostly all

countries saw growth except India saw substantial fall mostly because of

losses in industrial areas. Much of the growth in industrial fabrication was

fuelled by electronics sector which recorded the growth of 15%. The

growth in electronics can be attributes to plasma display revolution in

Japan and United States. It is expected that in electronics China should

record a faster growth but the fact is that China specializes in assembling

the components and not fabricating them. In assembling silver is only used

in soldering and brazing. In consumption of brazing alloys China has shown

a growth of 11% and tops the list of countries consuming highest Brazing

and Soldering Alloys.

World Fabrication Demand by Region - 2003

Top 5 in consumption in Electronics 2004 Rank Country

1 United States (28%)

2 Japan (23%)

3 Germany (11%)

4 China (8%)

5 Taiwan (6%)

Top 5 in use of Brazing Alloy & soldering 2004 Rank Country

1 China (25%)


3 Japan (9.6%)

4 Germany (8%)

5 UK & Ireland (7%)

World Fabrication Demand by Region - 1992

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Photographic fabrication saw a decline due to advent of digital

photography but this decline is uniform. Other areas of photographic

fabrication paper consumption also saw a modest reduction but this

reduction was offset by motion picture sector which has shown a higher

silver consumption than last year.

Demand for Jewelry and Silverware fabrication fell by 10% in 2004. This

was mainly due to slump in Indian consumption which amounts to nearly

30% of world’s Jewelry demand. Indian demand for silver fell due to 30%

rise in local prices and poor monsoon. If India is excluded then global

Jewelry and silverware fabrication demand has shown 3% increase mainly

because of exports from Thailand and China.

Top 5 in Silver consumption for Jewellery and silverware Rank Country 2003 2004

1 India 28% 18%

2 Italy 16% 17%

3 Thailand 14% 16%

4 Mexico 5.5% 6.3%

5 United States 5.4% 6.3%

Implied Net investments of silver have shown 400% increase in year 2004.

Sudden boom in investment activities due to funds, futures exchanges and

heavy purchases by high net worth individuals have lead to this rise.

Coin & medal fabrication rose in 2004 by 15% due to increased buy of

commemorative and souvenir coins in Portugal, Spain, Canada and

United States.

Top 5 in Silver consumption for Medals & Coins Production Rank 2004 Country


2 Germany (32%)

3 China (7%)

4 Australia (3.6%)

5 Spain (3%)

World Photographic Fabrication Demand by Region 2004

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Thus all these components have their share in creating demand for silver.

Along with these components there exist new technologies like RFID and

anti bacterial medicines may also impact silver demand. Along with this

there is a need to give a special attention to the silver demand of India

because the main factor for fluctuation of silver demand is Jewellery and

Silverware as it is highly sensitive to price and India dominates with around

1/3rd of the jewellery demand of the world.

Indian Industrial Fabrication Demand 2003

Indian industrial fabrication demand comprises mainly that of Silver

plating, Pharmacy and Jari. Still the role of photography in silver demand

of India is minute. An increase in the sector of electrical and electronics is

expected in near future as few multi nationals are looking forward for India

as their manufacturing hub for electronic goods. The demand of silver in

India is very difficult to analyse even for the Silver Survey as there are

many house hold units that use silver in the art of Jari. Due to many players

in the market and different tax regimes it is difficult to estimate total

imports of silver in India. The bottom line is that there have been no major

changes in the market since last few years. The demand side of silver in

India is ambiguous when it comes to “non -industrial” use of silver. This

demand is also very price sensitive especially in India. In India silver

jewellery and silver ware are scraped if there is requirement of money for

agri-business requirements. Even year round fluctuations are seen in

demand depending on the marriage season in India where there is

sudden upsurge is seen in demand of silver. Thus this unpredictability of

silver demand has added to the volatility in demand and eventually prices of

silver.

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ETF might change the way we look at Silver

ETF’s (Exchange traded funds) are posing new demand shocks for silver.

This shock has lead to silver price rally in the 1st quarter of 2006. The ETF

shares are backed by silver stored on behalf of the trust. Silver ETFs made a

golden debut and started trading at American Stock Exchange on 28th

April 2006. Prior the start of trading, it was estimated that over 10% of

annual silver demand, or 100 million troy ounces, would be accumulated

by the silver ETF in the first 18 months, this estimation was done in lines

with the trading history of gold ETFs floated in U.S. If this ever happens

such a move would lead to a shortage of silver by 100 million troy ounces

leading to the abnormal price increase. This expectation has been

discounted by the markets and recent silver rally was seen and expected to

stay if the silver shortage further increases.

Silver Prices (Daily) for Jan-06 to April-06

More than expected uptake of silver ETF fund during its initial trading days

gives a hint of an "extremely tight" silver market in the longer term.

Though it is expected that the pace of silver accumulation by investors

would slow down as time passes but still it would result in market tightness

which would be irreversible.

According to the latest World Silver Survey the identifiable inventories of

silver have diminished over the last 16 years from several billion ounces

to less than 600 million ounces. Further accumulation of silver as in case

of ETF’s would result in the liquidity crisis in silver market and the industries

dependent on silver would have to pay heavy price for the white precious

metal for their survival. But at this stage it would be very nascent to talk

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about the long term effects of ETF on silver prices but all indications direct

to the continuity of the Bull Run for silver. The numbers of the last 4 days of

trading of silver ETF seem to be very promising. As these numbers keep

growing more and more silver will find its way from the market into the

vaults of the trust and affecting the prices of silver positively, and more the

silver prices rise more will be the NAV(Net Asset Value) leading to higher

returns and higher participation of investors. Thus this cumulative effect

may lead to increase in silver prices and value of Silver ETF hand in

hand.

Date NAV1

$ Close Price

$/Share

Fix Price2

$/Ounce

Premium/ Discount3

Daily Trading Volume

Total Shares

Outstanding

Silver in the Trust (Tonnes)

28th April 2006 125.55 138.12 12.6 9.96% 2343100 2100000 653.2

1st May 2006 125.55 138.7 12.6 10.39% 1244500 2100000 653.2

2nd May 2006 139.19 143.65 13.9 3.22% 1251100 3200000 995.3

3rd May 2006 144.19 139.3 14.4 -3.25% 1514100 3850000 1197.4

Demand of paper silver is the demand of silver in form of futures and similar

investment instruments in which the claims are settled in cash and mostly

there is no involvement of physical silver but there is a scope for delivery of

silver which adds to the demand of silver.

World Silver Demand with Price

Silver Price

Exp

ect

ed

Est

imate

d

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Long term Outlook for Silver Demand

Factor Outlook Remark

Industrial Fabrication demand

Industrial demand is expected to increase moderately by 5%. Electronics and battery sector is expected to drive this increase. Growing economies like India and China show a great propensity to consume and produce electronic goods.

Predicted increase in silver demand will depend heavily on how well the world economy performs. If real economic growth is pervasive and strong, then the demand for silver bullion could very well exceed current supply. Silver has no substitute in most of the industrial applications and hence its industrial demand is price inelastic.

Jewelry & Silverware

This is the most price-sensitive form of silver demand, yet you can see that the total demand, in dollar terms, actually rose more than 25% in 2004! Despite higher prices in 2004 and again in 2005, this sector may see an increase in demand for 2006 compared to 2005. Jewelry demand depends highly on Indian economy and indirectly on Indian monsoon. If the monsoon of India in 2006 fair well increase in demand would be justified.

Jewelry and silverware demand causes the fluctuations in the demand and most of it is compensated from the piled-up stocks if deficit occurs.

Photographic fabrication demand

Despite the surge in the use of digital photography over the past few years, photographic silver usage has dropped barely 10% from its 1999 peak. Still, photographic silver demand is expected to slide further as the years go by. It could fall by as much as 8% in 2006 compared to 2005 levels. Some of the fall would be offset by increase demand in motion pictures category and commercial printing. So the net effect would be fall by around 7%

Though a fall is seen in photographic demand but there is a tremendous demand seen in commercial printing of photographs as home printing is still not cheaper and hence silver demand depends on penetration of photography in underdeveloped countries.

Coinage

Silver used for coinage in 2005 rose 5% from 2004. As more investors and collectors purchase physical silver, demand in 2006 should show another increase.

Coinage demand is mostly observed in US, Spain and in India it forms the part of Jewelry demand. In India it is also an important gift item.

Investment Demand

Investment demand has grown multi-fold due to sudden attention towards silver investments. Silver demand is highly understated and in 2006 it is expected to increase by at least 1000%.

Due to advent of ETF and boom in commodity markets the demand for silver and paper silver is on highs. This demand is expected to keep fuelling the bull run.

Other uses

Silver has a wide range of uses, from catalysts, mirrors, brazing alloys, water purification systems, solders, paints, medications, and so forth. As more research is conducted on possible uses for silver, demand for silver for other uses is growing faster than any other segment - having doubled in the past 15 years! Demand soared more than 21% in 2004! Expect another 10% increase in demand in 2006

Due to less price of silver there was basically no research in the developing substitutes of silver and hence with the depletion of this non renewable natural resource. New inventions in medicine and products like RFID may revolutionise the demand for physical silver.

Total Demand Outlook

The strength of silver demand for new industrial applications will continue to push total silver demand higher in coming years, more than offsetting the decline in photographic usage. Because silver is such a small component of many fabricated products, rising silver prices have minimal effect on demand.

In past decade, the average annual silver price rose 250% (adjusted for inflation). Despite this soaring price, total silver demand only dropped 30%! The price of silver could triple or quadruple from current levels with only a modest effect on demand in this sector.

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Supply Demand Balance Sheets for Silver 1996 1997 1998 1999 2000 2001 2002 2003 2004

Supply

Mine Production 487.90 523.10 543.60 543.20 581.20 590.00 596.40 611.20 634.40

Old Silver Scrap 158.20 169.10 193.70 174.80 179.20 184.20 186.80 183.60 181.10

Supply from Industry 646.10 692.20 737.30 718.00 760.40 774.20 783.20 794.80 815.50

Net Government Sales 18.90 0.00 39.60 95.20 78.10 85.70 61.20 88.20 61.70

Supply 665.00 692.20 776.90 813.20 838.50 859.90 844.40 883.00 877.20

Producer Hedging 0.00 69.10 5.50 0.00 0.00 20.40 0.00 0.00 2.00

Implied Net Disinvestments 146.40 81.90 44.40 67.00 97.80 0.00 26.20 0.00 0.00

Total Supply 811.40 843.20 826.80 880.20 936.30 880.30 870.60 883.00 879.20

Demand

Fabrication

Industrial Applications 297.30 320.40 316.20 340.60 377.10 338.50 341.40 350.50 367.10

Photography 212.00 219.00 225.00 225.90 219.50 210.20 205.70 192.90 181.00

Jewelry & Silverware 263.70 274.30 259.40 273.30 281.40 287.60 265.90 274.20 247.50

Coins & Medals 23.60 28.80 26.20 27.60 29.80 27.20 32.80 35.80 41.10

Total Fabrication 796.60 842.50 826.80 867.40 907.80 863.50 845.80 853.40 836.70

Net Government Purchases 0.00 0.70 0.00 0.00 0.00 0.00 0.00 0.00 0.00

Producer De-Hedging 14.80 0.00 0.00 12.80 28.50 0.00 24.80 21.00 0.00

Implied Net Investment 0.00 0.00 0.00 0.00 0.00 16.80 0.00 8.70 42.50

Total Demand 811.40 843.20 826.80 880.20 936.30 880.30 870.60 883.10 879.20

Silver Prices (Lon US$/oz) 5.199 4.897 5.544 5.22 4.951 4.37 4.599 4.879 6.658 Source: World Silver Survey 2005

Surplus Deficit Mathematics of Silver

Silver Market Surplus/Deficit

Source CPM Group

2004 was the fifteenth consecutive year, when the silver market projected a

huge supply shortage. According to CPM Survey total supplies from mine

production, recycling, and government sales were 750.0 million ounces,

falling 55.0 million ounces (6.8%) short of covering industrial and

coinage demand of 805.0 million ounces.

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According to CPM Group the Supply and Demand for 2004 stood at.

Source Millions Oz %

Mines 518.3 69.1%

Recycling 216.7 28.9%

Government sales 15.0 2.0%

Total Supply 750.0 100.0%

Use Category Millions Oz %

Jewelry/silverware 242.5 30.1%

Photography 239.4 29.7%

Electronics/batteries 106.8 13.3%

Coinage 10.5 1.3%

Other 205.8 25.6%

Total Demand 805.0 100.0%

Source: CPM Group Survey

Inventories run to solve the problem:

Since 1990, almost 2 billion ounces of silver inventories have been

consumed to cover supply shortages. By the end of 2004, less than 1 billion

ounces of inventories remained.

Estimated inventories potentially available for industrial and coinage uses

Category (2004) Millions Oz

Comex 107.8

Tocom 0.4

U.S. and Japanese manufacturers 22.5

Bullion in private U.S. holdings 30.0

Bullion in Berkshire Hathaway 129.7

Bullion in private European, Asian,

and Latin American holdings

20.6

Silver coins (primarily U.S. 90%) 508.0

Government holdings 122.7

Total 941.7

Note: The above inventory figures exclude holdings which are consumed

domestically in China, North Korea, and nations forming part of the USSR.

Source: CPM Group Survey

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Identifiable Bullion Stock

Source: World Silver Survey 2005

The major source of inventories was consumed in 2004 to cover shortages

came from the Comex, and private holdings in the U.S., Europe, Asia, and

Latin America. These inventories dropped by 27% from year earlier

levels! These are the major sources of silver available to cover continuing

shortages.

Only a look at the inventories that are readily available to cover shortages,

suggest that there is only enough silver to last a few more years!

“One of the misunderstandings common in the silver market is that

there are hundreds of millions of ounces of silver in inventories in

London and Zurich. There is not nearly that much. There may be

between 75 and 100 million ounces in these bank vaults as of early

2006” - CPM Group

Silver is no longer a reserve asset and estimates show that at today's price,

all government holdings of silver combined are worth less than $1 billion so

there is a very little scope for governments to manipulate the prices. As a

result, the price of silver is free to respond to market signals much more

than gold.

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Correlation of Gold and Silver prices

Silver and other Precious metals

Prices of Precious Metals ($/Ounce) Year Platinium Palladium Gold Silver

1996 369.3 124.05 369.2 4.71

1997 370.8 203.15 289.9 5.18

1998 364.5 332.15 288.7 4.73

1999 430.2 449.2 292.9 5.17

2000 609.6 954.45 274 4.62

2001 493 448 277.1 4.11

2002 604.4 238 343.6 4.43

2003 811.3 197.5 418 5.305

2004 863.7 185.25 436.3 6.7

2005 973 261.5 519.7 9.02

Source: Bloomberg Service

Among the precious metals pack silver is the cheapest and hence the

potential to give higher returns is also more. It is very easy for silver to

double from $14 to 28$ in a very short time whereas it is not possible for

other metals to achieve such feat. Another important aspect that separates

silver from its precious cousins is that out of the total mined silver only

2% of silver remains in the stock where as in case of gold more than

85% still remains in stocks. This indicates that silver is consumed rather

than used, and consumption is such that it is not economical to recover it

back.

Stocks of Gold and Silver (billions of ounces)

Total volume mined throughout history Stocks in 2004

Gold 5.5 4.7

Silver 45 1

Source: IFSL estimates based on World Gold Council, GFMS Ltd, The Silver Institute, Charles River Associates and Silver-Investor data

Gold and Silver: Partners in rhyme

Gold and silver have always been

closely associated and so do their

prices. There has been a good

correlation in prices of gold and silver

this recant past. But as the

fundamentals of silver are coming to

forces silver is slowly discontinuing to

blindly following gold. The correlation in

the prices remains but is a decreasing

trend has been observed in gold silver

price correlation.

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Gold/Silver Ratio trading Strategy If we look at the historic ratios between gold and silver it is seen that before

1893 the ratio was fixed at 16:1. Sixteen ounces of silver equalled one

ounce of gold. In 1980 when the both the metals were at the life highs, the

ratio was almost exactly 16 to 1. In past 25 years it is assumed that 35 to 1

is a normal ratio in an unfixed market. This ratio was interpreted in way

that if ratio was under 35 to 1 one should buy gold and if more one should

buy silver. But today’s ratio is close to 60 to 1 which is a strong indication

in favour of silver. If gold/silver ratio merely returns to 35 to 1, silver would

rise 2.4 times faster than gold. If we look at the physical occurrence of

silver and gold in earths crust the ratio is around 17.5:1.

Gold/Silver Ratio and Silver Prices - Jan 2001 to April 2006

Since Jan 2006 it can be observed that when ever the ratio breaches the

mark of 60 a change in prices of silver can be seen moving in the opposite

direction of the ratio. Understanding the gold/silver ratio makes it possible

to make profitable arbitrage refinements to investments strategy.

• Timing purchases according to ratio. When the ratio is relatively

high silver is favored and when silver is relatively low gold is

favored.

• When the ratios are high gold is swapped for silver and when the

ratio drops again silver is swapped for gold.

• Ratio trading gives benefits like growth in investments, potential

out performance in bull markets.

Analysis of precious metals investments portfolio suggests that the

portfolio must not be skewed more than 70% towards silver. Always

around 30% of portfolio should contain 30% gold.

Gold/Silver Ratio

Silver Prices

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Fundamental differences between Gold and Silver Presently most the silver and gold fundamentals are treated in similar

fashion but there are certain striking differences between the two. These

differences would be surfacing slowly and then the fundamentals of silver

will come in to play and prices of silver will no longer follow gold. Gold is

truly a precious metal and silver is more of an industrial metal.

Factor Gold Silver Effect Stocks in 2004 / Total volume mined throughout history (In Billion Ounces)

4.7/5.5 1/45

98 % of silver mined till date no longer exists for reuse. Where as 85% of gold mined still remains o surface.

Mine Production

Gold is obtained from gold mines only

70% of mined Silver is obtained as by-product from mines of Gold, Lead, Zinc and Copper.

Demand and supply economics of other metals affect the supply of silver.

Production Cost

Production cost of Gold has been mostly less than the prices.

Silver has been priced since decades below its production cost.

If prices of silver increase the supply is expected to increase. Less price may lead to closure of silver mines.

Richness of Ore

Deeper the gold mine richer is the ore obtained.

Deeper the silver exploration poorer the ore obtained.

Most of the silver has been mined out from the surface and output decreases as the mine are dug deep.

Usage Gold is mostly used as reserves and in ornamentation

Silver is a key ingredient in electronic, electrical, photography and host of other applications with no substitutes.

Chances of getting extinct due to usage for silver are much higher than gold.

Market Size

Market size of gold including spot, futures and funds is much bigger than silver

Market size is small and relatively less number of player in the market.

Opportunities to make fortunes in small market are more.

Role of India

Indian economy and demand do not play most important role and prices are still governed by foreign markets

Indian demand and role in silver markets is significant. MCX (Multi commodity Exchange) records 2nd highest turnover in silver in the world.

Understanding of silver market in India can aid in capturing silver price movements better.

Thus silver and gold

can no longer be

treated same and the

fundamentals of silver

have started

overweighing that of

gold and that has been

evident from the

returns posted by gold

and silver in 2006.

Gold and Silver Prices - Jan 2006 to April 2006

Silver Prices

Gold Prices

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Black and White relationship - Crude and Silver

Crude/Silver Ratio and Silver Prices - Jan 2001 to April 2006

Pricing oil in silver certainly has some validity, but it’s just not as sound as

pricing it in gold. Since 1965, silver and oil have had a 0.698 positive

correlation. This is strong, but nowhere near as tight as the gold and oil

correlation of 0.816 over this same period of time. Nevertheless, silver and

oil have had strong positive relationships and correlations during certain

secular epochs in modern history. During the last secular commodities Bull

Run in the 1970s silver tracked oil nicely and so is the case now in 2006.

From the historic analysis it can be concluded that Silver and oil have a

strong positive correlation during oil bulls and their ratios have a propensity

to trade within reasonably well-defined trading ranges. If the conservative

ends of these ranges hold and even if oil corrects in future, silver prices

still ought to go a lot higher from here based on their historical

relationship with oil prices. And if oil doesn’t correct as much, the

silver picture is even brighter.

As the silver/oil relationship is certainly not the only reason silver prices

should continue their bull market, and it is not even the most compelling.

Yet, it offers one more perspective of analysis that confirms silver’s bullish

fundamentals. As many prudent investors have used the gold/oil

relationship to earn fortunes in the past, a similar opportunity exists

today in silver. And today in 2006 oil and silver are once again in such

secular bull markets. Oil has advanced far ahead of silver, but the

historical relationship between these two commodities strongly suggests

silver will close this gap by catapulting ahead sooner or later.

Crude/Silver Ratio

Silver Prices

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Long term Price Outlook

Silver is targeting $19-$20 per ounce or Rs. 28000-30000 per Kg by the end of accounting year 2006-07.

Factors that may support the Bull Run of silver

• Supply from mine production not able to meet the demand.

• Supply from net government sales on decline.

• Supply from scrap on decline independent of price increase.

• Liquidity of silver in market reduced due to launch of Exchange

Traded Fund (ETF)

• Industrial Demand increasing at greater pace.

• Jewelry demand on increase in India and Thailand.

• Coinage demand to increase.

• Other uses like medicine, water purification etc., add to the

demand considerably.

• Investment demand of silver is highly understated and expected

to grow by at-least 1000%

• Exploration of new silver mines is highly expensive affair and not

undertaken seriously.

• Richness of Silver ore decreases as deep mining is undertaken,

thus proving that the current mine will be exhausting in near

future.

• Increase in consumption of silver in the electronics and electrical

sectors from where the scrap supply is negligible so the scope of

recycling decreases.

• Silver inventories have declined sharply. Inventories that are

readily available to cover shortages, are enough only to last a

few more years.

• Silver's attractive fundamentals bring in substantial new

investment demand.

• Just like gold loves inflation, so does silver love inflation. As silver

bullion helps protect investor wealth and purchasing power. If

inflation ratchet upwards, silver demand will increase, too.

Greater demand means rising silver prices.

• In long term basis Silver, like all precious metals bullion, is

negatively correlated with bonds and stocks. If the prices of

bonds and stocks decline, the price of silver escalates. If this

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natural process occurs, it will generate further investor interest in

silver and a rising silver price.

• Precious metals bullion is viewed as an important price stabilizer

in portfolios comprised of bonds, cash and stocks. If stock

markets become volatile, investors will include silver in their

investment portfolios.

• Today’s commodities boom is expected to continue for the

foreseeable future as the Chinese and Indian economies continue

to expand and grow.

• It is an undeniable fact that it is easy for silver to double it price

of $12 to $24 compared to than hefty 3 digit figures of gold,

palladium, platinum and rhodium.

• Institutional investors have become more involved in silver in

2004 and 2005.

• Most silver consumed is also price-insensitive, because such

small quantities are used by industry, that rising silver prices will

not easily slow down the growing industrial demand.

• There are too many paper contracts on the futures exchange

world wide. With over 175,000 contracts for 5000 ounces, that's

875 million ounces of silver, promised to be delivered. The

exchanges have about 1/7th of that in real silver they have

promised. To cover these paper contracts and close them out,

will cause silver prices to move higher. If cash settlement

becomes impossible, then a silver futures default, (also known as

a bankruptcy, or a failure to deliver), will cause silver prices to

explode even higher.

• Due to a long period of low prices of silver there has been

decrease in silver substitution research making silver currently

un-substitutable.

• More silver mines are closing than opening. No silver mining

projects are in pipeline.

• For a long time silver has been priced below its production cost.

• Presently the paper commodity price is determining the prices of

physical silver. A price shock will occur when prices begin to be

set by physical silver availability.

• Total silver market is tiny. It would perhaps take $15 billion

dollars to buy all the remaining silver. Only a few dollars moving

in silver market can cause tsunami.

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• Super conductivity technology uses silver to achieve high

transmission efficiency, which is expected to increase the

demand.

• Electro-gas Hybrid cars would require silver in their batteries.

• Gold is accumulated but silver is lost due to its micro usuage

depletion.

It would not be fair to present one side of the silver story so the factors that

might contribute to lower silver prices are

• Due to high prices, price sensitive demand of jewelry and silverware

may drastically decrease.

• Increase in mine production of base metals like Copper, Zinc & Lead.

• Recession of depression would result in less industrial demand.

• Rapid increase in digital photography.

• Discovery of substitutes for silver.

Some important Factors that may affect silver prices positively & negatively

$13

$20 to $XX

Silv

er p

rice

s

High production Cost

Closing Silver Mines

Fewer Substitutes

ETF’s

Investment Demand

Increase in Prices of Gold, Copper, Lead

and Zinc.

New uses on increase

Supply Demand Deficit

Declining Inventories

Many other factors

Increase in Mine Production

Digital Photography

Recession or Depression

Increase in Base Metals production

Time Line

Negative effect on Price

Positive effect on Price

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Statistical forecast Statistical forecast generated from monthly averages of silver prices of

London Fixing support the fundamentals and forecasts the value of $20 with

in the time frame of 1 year.

Forecasting tool Double Exponential Smoothing is used. It is a Time Series

Analysis tool that smoothes out the noise in a time series and forecasts data

that exhibit a trend.

Result - Double Exponential Smoothing

Actual

Predicted

Forecast

Actual PredictedForecast

706050403020100

25

15

5

Time

MSD:MAD:MAPE:

Gamma (trend):Alpha (level):Smoothing Constants

0.162770.269694.30613

0.1351.310

References:

Multi Commodity Exchange (MCX) - http://www.mcxindia.com

National Commodities Derivatives Exchange (NCDEX) - http://www.ncdex.com

National Multi Commodity Exchange (NMCE)

Bloomberg service - www.bloomberg.com

Money line tele-rate - Charting Software

World Gold Council - www.gold.org

ECB Statistics - http://www.ecb.int/stats/html/index.en.html

Bank of England - www.bankofengland.co.uk

Reserve Bank of India – www.rbi.org.in

London Bullion Market Association - www.lbma.org.uk

Silver Institute - www.silverinstitute.org

Chicago Board of Trade - www.cbot.com

Jim Rogers - www.rogersrawmaterial.com

Kitco Charts - www.kitco.com

Reuter’s news service - www.reuters.com

Microsoft Encarta Encyclopaedia

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