Is Silver Bullion the same asset class as gold...?
A VETERAN strategic analyst at Mitsui Precious Metals in London, David Jollie covers all the precious metals globally for the company. He focuses not on short-term price movements but on more long term trends, as well as supply-and-demand issues.
Hard Assets Investor recently spoke with Jollie in his London offices and tapped his insight for a look into the Silver Bullion market, one of the most volatile and unpredictable commodities for investors. (Editor's note: The interview took place on May 30, two days before gold rallied back above $1600)
HAI: Why is Silver Bullion so difficult for investors to read properly?
David Jollie: If you compare silver to the other precious metals markets for platinum and palladium, you've got a relatively small number of users of those metals compared to silver, whether that's industrial users or jewelry manufacturers. So in terms of measuring a market, in terms of understanding the dynamics of the market, you can segment it relatively easily and build up your own standing or picture the market that way.
Gold is quite different. Gold is a lot of huge numbers of small jewelers in China and India. But you can view it almost on an economic level or a macroeconomic level, or a country basis as well.
Silver has huge numbers of industrial users, some of which may be relatively small. This segmentation is quite complex. The number of companies involved is so large that you can't go and see every silver manufacturer, which you can in some of the other metals. That just makes it quite difficult.
For a long period of time you had a Silver Price that was fundamentally not very exciting. That didn't encourage people to go and spend time looking at this and trying to understand the supply-and-demand fundamentals. What you've seen in the last couple of years is much higher prices, maybe much more reason to look at it. But still, people have to start from a kind of difficult position in terms of trying to understand it.
HAI: What then do you see as the biggest influence on Silver Prices right now?
David Jollie: The biggest influences are really the Gold Price and the situation in Europe. Rightly or wrongly, the Gold Price does affect the Silver Price. Not in a 1-to-1 ratio where they move in lock step, but gold clearly has an impact on Silver Prices.
At the beginning of last year when you saw the high prices, you also saw things that suggested demand was pretty good. The US Mint was selling record numbers of coins. You could see relatively high premiums for certain forms of silver and in certain locations, which again suggested demand, electronics demand, things like that were pretty good, particularly in Asia, but also in the US
And you could see investor interest in ETFs as well at various points. You could see physical investment, you could see decent demand and relatively low price sensitivity of recycling. Industrial users tend to recycle whatever because it's worth enough for them to do that.
Individual consumers don't recycle or resell silver jewelry in anywhere near the same levels as gold historically, because it's not worth as much. If you look at where we are today, you can still see some reasons why silver might move higher. People are particularly looking at gold as one of the spurs. So either a safe-haven hit in gold developing, or some more certainty over the Euro developing, or monetary easing out of the US in particular are some of the spurs that could send gold higher and might send silver higher.
HAI: Conventional wisdom would say with all that extra demand, silver would be more stable, but that's not the case at all, is it?
David Jollie: It's a really good question. Historically, silver is more volatile and will move further in percentage terms than gold, both on the way up and the way down. Some of that is explained by sort of risk tolerance.
If you accept that a moving Gold Price will provide some spurs to the Silver Price, then I think you can accept that silver might outperform one way or the other. Certainly if we see gold move, there are occasions when gold ought to be up and silver shouldn't. But if you see gold go up, I think the potential is there for silver to go up further.
You can also look at just the size of the markets in Dollar terms. Gold is a much bigger market in Dollar terms. If people want to come in, silver can move much more quickly. People are aware of that. And certainly as a trader, if something can move 3 percent in a day, your interest in holding big positions of it is probably less than it would be elsewhere.
That's one of the issues, because that's self-reinforcing to an extent. That is, if someone doesn't want to hold a position because of significant price moves in percentage terms, then what that does is probably take away a little bit of the risk appetite amongst the trading and investment community to try and hold onto this. And that just takes away a little bit of liquidity, and again probably reinforces to some extent the potential for those price moves.
HAI: Do you consider silver and gold to be in the same asset class?
David Jollie: I think it depends on what you're looking for as an asset. There are a lot of ways to view gold. As a fund you could be looking at it as something where you want the price to appreciate. So you can be looking at it in the same way that you would look at, say, an equity price or maybe bonds as well.
But you can also look at it as a diversifier. Bonds as part of a wider portfolio would play the same role sometimes. In a lot of ways, gold and silver are similar. They're Dollar-traded commodities effectively. They are safe-haven assets. And if you're worried about the health of your currency, then owning gold or silver would seem to be a not-unreasonable response.
But having said that, I think the fundamentals of the metals are quite different. With gold, you can see things like central bank buying, which you simply don't see in silver to any real extent. Silver has a lot more industrial demand as a proportion of the whole market. To an individual consumer, I think they play similar roles in a lot of cases. To an investor, I think they're quite different.
HAI: What are some of the indicators or metrics you keep an eye on when it comes to silver?
David Jollie: The first indicator you would look to for where silver's headed is the sentiment in gold, Gold Prices and the gold/silver ratio. You can see quite long-term trends in the gold/silver ratio. Of course it doesn't head in the same direction forever, but you can certainly see trends developing such as risk tolerance, things like that.
You'd have to then say that's your background picture. That's your assumption if you knew nothing about silver as to where silver would go. And the question is, if you know something about silver, how could you add to that? You can look certainly at ETF flows. Over a period of time, you'd expect ETFs to mature and to take less metal than they initially did. It's not clear whether we reached that point, but clearly we aren't seeing the same level of net-buying interest that we saw a couple of years ago.
Similarly, you can also look at things like imports into China, which will give you a sense of the health of Chinese demand, whether that's investor demand or jewelry demand or industrial demand for silver.
HAI: Clearly silver and gold have been in a downtrend. What's your feeling on where we're headed in the next three to six months?
David Jollie: At the moment, sentiment is clearly bearish on a wide range of assets, and a lot of commodities, gold and silver included. You can certainly see downside potential in the price. And I think there are various ways you can try and value silver. You can come up with silver's potential fair value, I suppose, for the metal, of $25 or $20 acting as some sort of substantial support.
You can certainly see downside potential, but you can see levels of support and levels of interest there for all sorts of different reasons. The question is, what could turn that around, what could make us move higher? I think the most obvious ones are really either macroeconomic in the short term, or risk related, which may account for the same thing. If gold is really a safe haven, if people are investing in it not because they expect it go up necessarily, but because they're worried about the value of other assets, then as the Euro crisis intensifies, there's the potential for gold to outperform, for people to be Buying Gold just because of that. I'm really talking Western investors particularly there.
HAI: The flight to the Dollar has been driving yields down today. We have a new low for the US and German 10-year bonds. Is there a point when those falling yields will drive demand for gold and silver?
David Jollie: If you see bonds — government bonds particularly — as a form of safe haven, then I think at a certain point falling yields and rising bond prices have to be quite unattractive. When you're down to very, very low yield levels, the potential for price appreciation in a bond is low — and the return on your money is also low.
Whether they're an attractive investment is not clear at all. While precious metals are not paying a yield, there is the prospect of price appreciation. And whether that's driven by risk or risk aversion, you can certainly see if there's upside potential, that ought to conceptually make the precious metals more attractive as investments — if bond yields fall any further.
HAI: Are you kind of surprised you haven't seen more of a shift away from the bonds and into precious metals with all the uncertainty that seems to be growing?
David Jollie: Certainly the bond market is vastly bigger than the gold market. A big investor can put some money in gold or silver if they choose to do that, but there's a limited amount you can do. You're still going to have to be in the bond market or the equity market to keep most of your money.
Last year, if you looked at gold, you could see it as a very interesting investment because it had aspects of insurance and safe-haven status. If everything went wrong you might make money or you might save your money. But you were paid to hold it because the price was rising. At that point, it was quite easy to buy for a lot of people. No one is going to criticize you for buying insurance and being paid to hold it.
This year we've seen falling prices. And that just makes it a little bit more conceptually difficult. You have to be willing to accept that you're now paying for insurance. That's not impossible for people to do, but it takes maybe a little bit more risk aversion to drive that. And certainly if we see further risk aversion and further decline in bond yields, then I think you should be seeing strengthening interest for gold, and probably also for silver and potentially the rest of the precious metals from a range of investors who are able to hold them.
Buying Gold or Silver Bullion?...