by Rhona O'Connell 08/04/11 London Source:  mineweb.com

While 2009 was a year of physical bar disinvestment (driven by heavy Indian sales) there was a net positive swing of over 70M ounces between 2009 and 2010 which has helped hold prices at all time records.

The recently-released annual "World Silver Survey" from GFMS Ltd has added a fresh element into the break-down of supply and demand this year; that of "Physical Bar Investment".  The house notes that it included Indian bar investment in its tables last year, but has broadened this to a global figure this year as a result of widening silver investment in China and Germany in particular, along with sustained investment in the United States.

While 2009 was a year of physical bar disinvestment (driven by heavy Indian sales) there was a net positive swing of over 70M ounces between 2009 and 2010.  In its analysis, GFMS points to a slight drop in the Implied Net Investment figure, reflecting the fall in the "investor" net long position on COMEX, a smaller increase in ETF holdings (although this as still a very strong sector with investment in ETFs running at 85% of the previous year) and a "relatively restrained" full year contribution from the Over the Counter market on a net basis.

The spread of physical bar investment was an important component of the jump in investor activity, which was the dominant driver of silver's price rally in 2010.  World Investment rose by 40%, including a dramatic surge in coins and bars, along with the strong inflows into silver ETFs and accounted for 26% of total silver demand, with a strong emphasis on the final four months of the year.

Early in the year the demand for silver as an investment medium was noticeably down year-on-year on the back of growing confidence in world economic growth, allied to the stabilisation of the financial system.  While silver continued to make ground in the middle of the year on the back of optimism over its improving industrial usage, the investment in the final four months of the year was driven by the resurgence in investor interest in the precious metals sector.  This was in response to the now well-rehearsed arguments over quantitative easing, US dollar weakness, negative real interest rates and European sovereign debt concerns.

This was not the whole story, however; other elements include the use of silver as a cheaper alternative to gold, allied to its higher volatility (and smaller market) that frequently drives professional investors to take silver exposure in order to add gearing to rising gold prices; plus a perception among some investors that silver was historically undervalued against gold.

This was underpinned by strong physical demand for bullion bars in important Asian markets, predominantly India and China, while there was also a shift in the final months of the year that took some investors away from the Chicago Mercantile Exchange and into the OTC market, partly in reaction to raised margin requirements.  The OTC market also benefited from an overall move towards higher-risk assets (derivatives, in silver's case) in the latter months of the year.

A particular feature of interest in the physical market was the demand for silver bullion bars in Europe, reflecting local fears over sovereign debt and driven particularly by investors in Germany (this was also aided by high gold's prices, which put the yellow metal beyond the reach of some would-be purchasers); bar demand grew rapidly, although (partly due to VAT considerations), it was outpaced by interest in coins.  The picture was different in North America, where the low premia on investment bars gave them precedence over coins.  Bar demand actually fell in the United States in 2010, but 2009 had been exceptionally strong and 2010 demand in North America substantially exceeded that of 2008.  In China there was a significant increase in demand for bars, reflecting not only the silver market's dynamics but the fact that local investors have only been allowed to hold silver bars since July 2009.

Coins and medals offtake reached a new record last year, and over the past three years the growth has averaged 38% per annum.  The driving force here has been Europe and the United States, reflecting the economic and financial concerns outlined above, with Germany commanding a high market share within the European sector (memories of hyperinflation live long).  The United States accounted for 41% of the total silver coin fabrication last year, while Canadian fabrication was up by 72% last year, and more than double that of 2008.  Growth has been sustained this year, now resulting in some apparent strain on supply of coin-grade silver.

This year's Silver Survey carries its usual exhaustive coverage and analysis of the supply and demand fundamentals in the silver market.  An important conclusion is that GFMS is conscious that a "fair proportion" of the recent investment in silver is from more speculative money that could leave the market rapidly should conditions change.

This is an important characteristic of the silver market.  The history of silver is littered with tales of investors or speculators who have fallen foul of the speed with which the price can recoil and if ever there was a case for Caveat Emptor, this is it.  GFMS is of the view that monetary policy is "unlikely to be tightened that much " in 2011 and that "inflation and sovereign debt concerns will most probably grow further", leading to a positively cautious price outlook.  The warning is that the group would be wary of any signs that industrial demand is faltering, as this could trigger a major short term correction in prices, thus more closely aligning silver's path with that of gold