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December 18, 2008

Feedback on High Silver Premiums
by Silver Analyst

This article is intended as a follow up to the large number of emails I received after my article on high premiums on retail bullion silver. Needless to say, not everyone was in agreement with me and that was the majority!

But first, I was in contact with a large bullion provider in London with whom I have dealt with in the past. Like other dealers they have experienced high demand and they too have had to put the "Sold Out" sign on silver bar products. I put the obvious question to them, "Is this a silver shortage?" to which he replied "Don't believe the hype!". As he further elaborated, they could acquire silver" by the ton" from the London Bullion Exchange, the problem was fabricating it fast enough to meet this unexpected demand. Note that the London Bullion Market (unlike the COMEX) is a wholesale OTC market where silver and gold are intended to be bought for physical delivery by major customers such as central banks, refiners and fabricators. This market gives a better idea of physical silver availability than the COMEX. Note that the minimum bargain for silver is 50,000 ounces and in September alone nearly 144 million ounces were transferred between members.

In fact, if one looks at the daily clearing statistics for silver at the LBMA since January 1997, the average amount of silver transacted comes out as 144.93 million ounces. So September's daily rate is bang on the 12 year average. If there was a real shortage of silver I would expect this number to be lower as organizations retain their silver either because they perceive a shortage may hamper commercial operations or they hold it in anticipation of future profits. But no, the clearing rate does not suggest a supply squeeze.

The number of average daily transfers between members for September was 576 which are well above with the 12 year average of 374. Again, if there was a supply squeeze one would expect far less transactions than what we are witnessing just now.

But let me now address the various comments and questions submitted by various readers. Sorry if I did not get back to anyone by personal email but I hope any answer is contained below.

First is the case of investors who have not been allowed to take physical delivery off the COMEX even though this was not a problem in the past. I think the explanation that delivery priority is being given to large silver users such as industry, institutions and ETFs is probably the correct one here. That does not mean there is a universal shortage of silver (as the LBMA above shows) but rather that an artificial shortage is potentially being created. Consider the scenario where there is a perception of a coming shortage of silver and a classic case of self fulfilling prophecy is created as people rush to empty the warehouses. I think we are seeing some of that situation recently but this does not apply to non-1000oz items for which there is a genuine shortage due to refining/minting bottlenecks.

Then we have the suggestion that there is little or no silver in the ETFs thus bolstering the shortage case. What can I say about this? Barclays published the serial numbers of all their bars in response to such accusations but it did not placate everyone. If the only way one can be convinced is by visiting all of their vaults then I cannot convince such a person with any words!

For those who say the COMEX is a price discovery scam and $9 or so does not reflect the true price of silver all I will say is this: Where they as vociferous when silver was roaring to $21 on the COMEX?

One reader suggested that some buyers at high premiums do not care since they see an economic cataclysm coming and such coins may be the only means of barter or medium of exchange for goods. That is a fair point if you hold to that scenario. I always advocate holding gold and silver "just in case" so I take your point, sir!

On a similar point it is suggested that if you don't pay the premium you don't get the silver. This is true but as I said unless you see silver going quickly above $25 you may be sitting on a medium term loss. You have to set your price objective and live with the consequences be they good or bad. If there is a real shortage coming then paying 50% over $10 when silver goes to $100 won't look so bad - I accept that.

Another person asked why the retailers don't just increase production to take advantage of these high premiums? The answer is twofold. Firstly increasing production will decrease premiums as more items hit the markets hence defeating the purpose. Secondly, retailers have done their cost-risk analysis and the overhead of adding more machinery and manpower is deemed unwise once this period of high demand has past and they find themselves with idle men and equipment.

Now here is an interesting suggestion I got from some folk. One reason premiums may be so high is because for a time Microsoft's live.com were running a cashback promotion on certain eBay items with up to 30% off the Buy It Now price. That meant that bidders were quite happy to bid over the odds because they knew they would only be paying perhaps 10% or less on the final payment. Now I can't say how much small silver demand is being driven by eBay and how that affects ultimate premiums on the retail market but if it was a substantial influence then one must conclude that premiums are high not because of a silver shortage but because of a temporary cashback deal from Microsoft! Conversely, if this influence is minimal then it does not affect the overall argument.

Another reader said that the premiums will remain the same on the upswing and so one will recoup the initial hit and more. A good point but how valid is that assumption? I produced a chart some while back on the premium offered on American Silver Eagles during the aftermath of the 2006 silver price spike which is a similar scenario to now. That chart is reproduced below.

The black line tracks the discount or premium being offered on SAEs compared to the silver spot price in red. When the number is negative, Eagles are being sold below spot and when they are positive they are going for above spot. Note that when the price of silver rises, premiums tend to drop while during price troughs we see spikes in increased premiums. This is a natural state of affairs. When silver bottoms we see investors pile in to grab silver at low prices. Demand rapidly increases and premiums go up. As silver rises and a trend is established, the rate of demand diminishes and is spread out more.

From this graph I see no evidence that premiums must stay the same. Note that the premium paid in dollar terms may be recovered but not in percentage terms. This implies that at best you get your premium back but it had an investment return of next to zero.

I hope that addresses some of the questions asked and do not hesitate to ask me for clarification or vilify me!

Further analysis of silver can be had by going to our silver blog at http://silveranalyst.blogspot.com where readers can obtain a free issue of The Silver Analyst and learn about subscription details. Comments and questions are also invited via email to silveranalysis@yahoo.co.uk.

Silver Analyst
http://silveranalyst.blogspot.com

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