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Silver – Ripe for Recovery
ETF Securities – Silver – Ripe for Recovery
Converging trends point to a higher silver price
- The silver price has more than halved from its high in 2011, presenting good value in our view.
- With industrial demand turning up, supply falling, inventories declining, the gold price stable and volatility at a near decade low, we believe conditions are building for a silver price rally.
- Chinese silver imports have increased 17% YOY in 2014.
- Silver fabrication demand increased 6% in 2013 – the largest increase since 2000.
- Speculative shorts in the futures market are elevated, indicating scope for a short covering rally.
Silver is brewing for some shine
Silver is the one of the world’s most versatile commodities. Also classified as a currency, silver is one of the world’s best conductors of electricity and heat. Its versatility is exemplified by its use in products ranging from electronics, antiseptics, solar panels, silverware and jewellery. In the commodity ETF world, silver ETF’s have among the lowest expense ratios, notably because silver is a quasi-currency with very low storage costs yet the majority of its demand is for industrial purposes. Demand is increasing rapidly along with increasing global per-capita incomes and rapid electronization.
Total silver supply has been stagnant the past few years and, unlike gold, total silver bullion inventories have been declining for years. Often viewed by investors as a leveraged play on gold, silver is an attractive longer term portfolio diversifier in our view, with a low correlation to most other major asset classes yet offering protection from currency debasement risk and inflation.
History indicates the recent decline in silver price volatility to the lowest levels in over a decade (at the beginning of May), as measured by 30-day volatility, may be a precursor to a strong price move. In our view, downside risk is limited with industrial demand picking up and supply in decline. With the silver price less than half its 2011 peak and futures shorts already elevated, we believe the next strong trend price move is likely to be up.
Very low silver volatility indicates a brewing trend
Chinese silver imports have been strong in 2014
Demand is increasing rapidly. Q1 data on China demand showed a 22% YOY increase in silver imports, the largest quarterly gain since Q2 2010. China demand through April showed a 17% increase YOY. Every major area of silver demand is expected to increase in 2014, with the exception of photography.
In 2014, the amount of demand for silver used in solar PV panels is expected to equal the demand for photography for the first time. Exemplifying the changing demand landscape for solar, in some parts of the world, solar power is near parity on a cost-per-watt basis with conventional forms of electricity production. This trend is likely to accelerate in our view, and more so as electricity storage technology improves, notably with potential help from people like Elon Musk and his plans for battery giga factories. Silver for solar will likely consume about 78 million ounces of silver in 2014, or 8% of total demand including investment, up from less than 1% in 2007 (CPM Group estimates).
Electronization is rapidly changing our lives, notably for the the 4 billion people identified by the World Bank from roughly 70 countries in the rapidly growing US $4,000 to $11,000 per-capita income category, where consumer product consumption often increases more rapidly than per capita income enough to make it impractical to recycle, thus most silver used in electronics is removed from the market permanently, unless prices reach such levels to make such recycling economical. In 2013, about 288 million ounces of silver was used for electronics and solar; about 1/3 of total demand. In 1999, only about 11% of total silver demand was for electronics and solar.
Silver fabrication demand has shifted towards electronics
Silver futures trading in China has soared. In 2013, silver traded on the Shanghai Futures Exchange (SHFE) exceeded COMEX/CME traded silver futures in terms of total trading volume. Only open since 2012, SHFE traded silver futures were responsible for 49% of total futures trading in 2013, which was about 84 billion ounces.
Fabrication demand in 2013 increased the most since 2000. The single largest category of demand for silver is for jewelry and & silverware, making up about 31% of fabrication demand and 27% of total demand and investment in 2013. Total fabrication demand increased 6.3% in 2013 to 866 million ounces, led by jewelry, silverware and solar. It was the largest percentage increase in fabrication demand since the year 2000. Compare this to mining supply of 741 million ounces, which increased 4.1% in 2013. Recycling and inventory depletion are therefore necessary to meet the supply and demand imbalance in the silver market. A key question is, was 2013 a one-off or is it potentially the beginning of a trend? In our view, the longer-term demand trend is likely to accelerate, based notably on global per capita income and GDP growth, rapid electronization and more recent investment trends in silver. The CPM Group expects fabrication demand to increase about 3% in 2014.
Investment demand continues to grow. At the end of 2013, the total holdings of silver in ETPs (exchange traded products) stood at 623 million ounces, which although was down about 2% from the peak, was the greatest year-end amount ever for silver ETP’s holdings. Although gold ETP holdings have declined about one-third from the peak at the end of 2012, silver investors in coins, ETP’s and jewelry have been much more resilient. At the end of April 2014, silver ETP holdings increased 1.4% from the end of 2013 to 632 million ounces.
Silver ETF holdings have been steady
Led by India, identifiable investment in silver leaped 75% in 2013 to a new high of 246 million ounces. Demand for silver was boosted in 2013 in India, notably due to the sharp price decline and gold market restrictions.
Global demand for silver coins increased to a record 136 million ounces in 2013. The US mint alone sold 43 million ounces of silver coins in 2013. It was record year, with sales increasing 27% from the previous year, likely supplemented by the sharp decline in the silver price but the amount of demand exceeded the total of 35 million ounces of silver mined in the US in 2013. Although many of the coins sold by the US Mint are to non-US citizens, the Mint must purchase silver from only US miners. Currently, the US Mint alone is consuming over 100% of all silver mined in the US. As of the end of April 2014, US mint silver coin sales were on pace to match the record year of 2013, whereas gold coin sales were down about 80%.
Demand must be offset by recycling and inventory depletion
Total supply has been stagnant. A key factor holding back silver prices the past few years in our view has been increasing mining supply. The majority of silver is produced as a by-product of gold, zinc, lead and copper.
About 25% of silver was from primary silver mines in 2013. Global mining supply increased 4% in 2013 to 741 million ounces but total supplies actually declined about 2.5% to 971 million ounces due to a sharp reduction in recycling. Secondary supply, notably recycling, in 2013 was the lowest since 1999 indicating the second most significant source of supply, next to mining, is not likely to increase unless the silver price increases. Total silver supply is expected to increase only about 0.7% in 2014 unless higher prices spur increased recycling.
The total market supply of silver in 2013 was essentially the same as in 2009; only 2% above the 952 million ounces of 2009 total market supply. Unlike gold, there is not a massive amount of stored silver to call upon when demand is strong, or supplies constrained. Silver is notably a demand story.
The 2013 year was the first that total silver demand and investment demand exceeded total supply including recycling since 2010. In 2014, the supply/demand deficit is expected to widen.
2014 supply is likely to be unchanged from 2010
Inventories are quite low relative to history. In 1990, estimated total silver bullion inventories were about 2.8-billion ounces, roughly equal to about 7 times global annual mining supply. A the end of 2013, estimated total silver bullion inventories were about 890-million ounces, which is only about 1.2-times global annual mining supply. Compared to the end of the year 2000, total silver bullion inventories at the end of 2013 were down 28%.
70% of silver inventories are in ETP’s
At the end of 2013, silver ETP holdings accounted for about 70% of estimated readily available silver bullion inventories, compared to a fractional amount in the year 2000. Due to their transparency, efficiency and cost effectiveness, ETPs are increasingly becoming a larger part of the silver market, yet as 2013 proved, ETP silver holdings may be more sticky than previously expected. Governments have sold off most of their silver reserves and much of the silver has been used for industrial purposes, unlikely to ever re-enter the marketplace.
Silver inventories have been depleted by 2/3’s since 1990
The silver price is the lowest vs the cost of production since 2005. Due to the nature of silver mining, most of it is produced as by-product from the production of other metals, it is difficult to estimate total all-in production costs but we can properly measure the cash costs of the primary miners.
For the first year since 2002, primary silver cash mining costs declined in 2013, to approximately US $9.7/oz. according to the CMP Silver 2014 Handbook. The Silver Institute World Silver Survey 2014, indicated a lower cash cost amount of US $9.27/oz. Cash mining costs declined in 2013 notably due to reduced research and exploration expenditures which has negative implications for future supplies. Partly because cash costs are only a portion of total all-in costs, the silver price has historically traded a fair amount above this cost measure. At the end of 2013, the silver price was 145% above the primary miner cash cost average, which was the lowest percentage since 110% at the end of 2005.
Silver price has declined sharply relative to production costs
Silver appears cheap relative to gold. Just prior to the big silver move beginning in 2009 near US $20/oz. and ending at US $48/oz. in 2011, the gold/silver ratio was about 70, which is near current levels. This period was also preceded by a sharp decline in 30-day silver volatility similar to levels reached at the end of April this year. For the few years prior the 2008 crisis, the gold/silver ratio hovered around 50. Since 2008, the ratio has reached a peak near 85 and low near 32. With a median near 59, as the global economy continues to recover, the 50 area in the gold/silver is an area that is likely to be revisited in our view, with silver price upside the key driver.
Gold vs silver has reached the highest level since 2010
Silver – a leveraged play on gold. Silver prices have a history of moving with a higher volatility than gold but with a high correlation. Among all precious metals prices, the correlation between silver and gold is the highest. From January 2000 to April 2014, the gold silver correlation was .75. Gold’s average annual volatility was 17.5% compared to 32% for silver (measured on a monthly basis). On a volatility weighted basis, silver has moved approximately 1.8 times gold, thus it has offered a similar exposure as gold but with more return (and loss) for a given level of investment. From 1971 to 2013, the beta of silver to US CPI was 9 compared to about 5 for gold (measured annually). When gold is the main price driver, as measured during the top 20% and bottom 20% of gold return months from Jan 2000 to April 2014, silver has moved on average 1.4 times gold. When silver is the driving force, it has moved about 2.4 times the price of gold, as measured by the top 20% and bottom 20% of silver months (see table).
Due to its larger industrial demand base, silver has a higher correlation to global GDP growth and the S&P 500 than gold, but the overall correlation to both remains quite low. During positive months in the S&P 500 coinciding with global PMI above 50, silver has increased on average about 3% per month, compared to 1.4% for gold and 3% for copper. During negative S&P 500 months coinciding with global PMI below 50, silver has on average declined 0.3% per month compared to an increase of 0.6% for gold and a 1.0% decline for copper.
Summary
In our view, the silver price is potentially poised for a strong upward move. Supply and demand indicators are turning price positive. Increasing demand from China, increasing investor demand and strong fabrication demand are being met with falling supply and dwindling inventories. The gold price decline last year weighed heavily on silver due to its high correlation to the metal and its much higher volatility. However, we believe the gold price has found a bottom and this weight should be removed from silver’s performance in 2014. Unlike gold, above ground available supplies of silver have been declining for years as fabrication demand has increased. The recent rise in US and China industrial indicators, a clearing of silver longs in the futures markets and elevated shorts increases the likelihood of a short covering rally that potentially sparks a more sustained upward rise of the silver price.
Monthly performance table
Table note – End of month data is from Jan. 2000 thru April 2014. Gold and silver are spot changes. Copper is the COMEX/CME front futures change. Storage costs are not included. Total return is used for the S&P 500. The JPM Global PMI measure was used for global PMI.
Source: ETF Securities, Bloomberg.
Important Information
This communication has been issued and approved for the purpose of section 21 of the Financial Services and Markets Act 2000 by ETF Securities (UK) Limited (”ETFS UK”) which is authorised and regulated by the United Kingdom Financial Conduct Authority (”FCA”).
• Bitcoin Weathers Macroeconomic Storm
• Heightened User Activity, Soaring Transaction Fees, While Miners Sell Less
• Runes Protocol and Bitcoin’s Ever-Growing Ecosystem
Navigating Macro Headwinds, On-Chain Optics, and The Rise of Runes
This newsletter will be a Bitcoin-centric edition as we dissect the impact of recent macroeconomic events on Bitcoin’s price, followed up with an on-chain analysis of the network’s behavior post-halving. Additionally, we’ll explore some of the exciting innovations emerging within the Bitcoin ecosystem that were timed following the latest halving.
Bitcoin Weathers Macroeconomic Storm
The past two weeks have presented a challenging market environment for the crypto industry. As mentioned in our last newsletter, rising inflation in the U.S. remains, as evidenced by the higher-than-expected CPI print on April 9. Additionally, escalating conflict in the Middle East poses a significant threat to regional stability and added stress on the U.S. The potential of wider involvement from additional militant groups such as Lebanon’s Hezbollah, coupled with Iran’s control of a crucial maritime passage for commodity trading, the Strait of Hormuz, raise concerns about potential energy price hikes, steepening inflationary pressures and their effect on various asset classes.
Bitcoin initially reacted negatively to these events, experiencing an 8.22% drop in the immediate aftermath. Despite the 24/7 nature of crypto markets, which could have amplified the initial price shocks, Bitcoin’s underlying resilience shines through upon closer inspection. The S&P 500 fell by 2.03% on the market reopening last Monday and continues to tumble, while Bitcoin has recovered over 3.28% since the drawdowns, evidenced in Figure 1. This suggests a potentially more robust response to geopolitical turmoil compared to traditional assets, which is unsurprising given Bitcoin’s narrative as a flight to safety.
Figure 1: Bitcoin vs. Gold Price Performance Amid Geopolitical Tension
Source: TradingView
Examining Bitcoin’s market data, we see clear evidence that the futures market played a significant role in the initial price drops, which were attributed to the macroeconomic events of the last few weeks. A significant spike in long liquidations on the day of the attack, at $168M, suggests that some leveraged traders exited their positions, as shown below in Figure 2. Additionally, the high open interest at $35B leading up to the CPI print was followed by a recent $5B cool-off, indicating a correction in the futures market, reflected in the consolidation of the Bitcoin price.
Figure 2: Bitcoin Futures Long Liquidations, Short-Term and Long-Term Holder Supply
Source: Glassnode
Importantly, the spot market paints a more optimistic picture. In the last 10 days, which includes last week’s turbulence, long-term holders displayed minimal selling activity. Their holdings decreased by only 0.05%, while short-term holders continued to accumulate BTC, increasing their holdings by 0.5%. Notably, “Accumulation Addresses,” characterized by having no outbound transactions, holding more than 10 BTC, and not being affiliated with centralized exchanges or miners, have capitalized on the recent market dip. They currently hold over 3.17M BTC, accumulating over $2.3B since the CPI print, as evidenced below by Figure 3.
Figure 3 – Total Balance in Accumulation Addresses
Source: Glassnode
Further bolstering the positive outlook, the 90-day due diligence period for U.S. spot Bitcoin ETFs has now concluded. According to Bloomberg, over 100 fund managers have disclosed their ownership of these products, signifying the growing institutional appetite for Bitcoin exposure, adding another layer of support to the asset class.
Heightened Activity, Soaring Transaction Fees, While Miners Sell Less
In the world of Bitcoin, transactions get logged onto a whiteboard-like structure, divided into cells called “blockspace,” where each cell represents a limited amount of space. Transaction fees play a crucial role in managing limited block space on the Bitcoin network. Users who pay higher fees get their transactions prioritized for confirmation within these blocks. This ensures smoother operation by preventing congestion and disincentivizing low-value spam transactions. Additionally, transaction fees serve as an important security measure. They incentivize miners to dedicate significant computing power to validate transactions and secure the network. Without these fees, mining might become less profitable, potentially jeopardizing network security.
Finally, transaction fees are at the core of Bitcoin’s economic sustainability as the mining reward gets halved every 210,000 blocks, transaction fees step up to fill the gap and pump miners’ revenue. We can already see the early innings of transaction fees rising against the issuance or block rewards since the launch of Ordinals in 2023, as shown in the chart below.
Figure 4 – Bitcoin Miners Revenue Breakdown
Source: 21co on Dune
It is no surprise that Bitcoin network activity has been high this year, with the amount of active addresses hovering between 700K and 1 million since January, up until the halving event. On-chain data reveals a lower-than-expected drop in active addresses following the halving, with transaction fees reaching new highs. While active addresses did experience a significant drop (43%) on April 19, falling from over 893K to 500K, they have already recovered 70K since then. Historically, the halving typically leads to a smaller decrease in active addresses (3-9%). This larger drop could indicate that rising fees are pricing some users out of the market for now, but as we’ll cover later, there are certain solutions being worked on to help alleviate this issue.
That said, transaction fees soared up to $128 on April 20, breaking $78M, tripling the previous all-time high, and making up 75% of Bitcoin miner revenue, as shown in Figure 4. The spike was primarily due to Ordinal-like inscriptions which have recently seen a spike thanks to Runes protocol, which we’ll delve deeper into in the last section. In line with this, the burgeoning Bitcoin ecosystem, expedited by Rune, has not only pushed Bitcoin out of its comfort zone unlocking new use cases, but also its transaction fees to surpass Ethereum’s since May 2023, as seen in Figure 5.
Figure 5 – BTC vs ETH fees (2 Years)
Source: Glassnode
The growth in transaction fees is appreciated even further, especially when we examine miner behavior following the halving event. Miners are now less motivated to immediately liquidate their freshly acquired BTC, as they can capitalize on an additional revenue stream apart from block rewards.
Let’s zoom in on miner activity after the halving. About 50 BTC were sold on centralized exchanges on April 20, which doesn’t compare to the sell-off of March 5 when approximately 1,154 BTC were sent to exchanges, pulling the asset to ~$64K, down from ~$68K, as shown in the chart below. The recent sale also doesn’t compare to the 307 BTC sold on the day following the previous halving in May 2020, when the asset was trading just below $9K.
Figure 6 – Transfer Volume from Bitcoin Miners to Exchanges in BTC (YTD)
Source: Glassnode
The rising importance of Ordinal inscription, akin to non fungible tokens (NFTs), can be seen with Bitcoin generating $475M in real NFT sales versus Ethereum, which helps miners rake in more revenue and become sustainable. That said, the growing adoption of the Runes protocol is expected to drive even more activity toward the miners over the coming months.
Runes Protocol and Bitcoin’s Evergrowing Ecosystem
To recap, Runes streamlines the creation and management of fungible tokens on top of Bitcoin. It addresses the inefficiencies of the BRC20 standard, which have burdened the Bitcoin blockchain due to its inefficient data handling approach. That said, Runes achieves this in two key ways. Firstly, it optimizes transaction fees by consolidating multiple Unspent Transaction Output (UTXO) transactions into one bundle, leveraging Bitcoin’s accounting UTXO model. Additionally, it utilizes Bitcoin’s script, OP_Return, to inscribe data directly onto the blockchain, which serves to assign and transfer Runes balances within the network’s UTXOs. By minimizing data usage to 80 bytes, compared to BRC20’s 4MB, Runes prevents unnecessary bloat on the Bitcoin blockchain.
Ultimately, Runes presents an innovation aimed at bolstering Bitcoin’s security budget, offering miners an alternative revenue source to reduce their dependence on Bitcoin’s subsidized rewards over the long term. In fact, miners have earned about 1,500 BTC, valued at close to $100M in less than three days of trading activity, as seen below in Figure 7. To that end, Runes has garnered widespread support from the outset, with multiple Tier 2 exchanges such as OKX and Gate.io already announcing the listing of early collections like UNCOMMON.GOODS and MEME.ECONOMICS, which were among the first collections minted. Additionally, Binance appears to be hinting at support for meme tokens like Wizard and Pups, which were also among the first tokens to migrate from the BRC20 to the Runes standard. Meanwhile, NFT platforms like Magic Eden and Bitcoin-focused wallet provider Unisat are also joining the trend to capitalize on Runes’ growing popularity.
Figure 7: Fees Paid by Users to Mint Tokens Using the New Runes Protocol
Source: CryptoKoryo on Dune
Following the pattern of past hype cycles, we anticipate that the initial excitement surrounding Runes will gradually subside, followed by a surge of heightened activity in the long run. This trend is often observed because the initial wave of interest tends to be on meme tokens, which can be quickly deployed and attract the masses’ attention, but often don’t add substantial value. However, as time progresses, sophisticated primitives like exchanges, automated market makers, and other DeFi lego blocks will begin emerging. These advancements will bolster Bitcoin’s capabilities at the application layer, streamlining the process of token trading on the Bitcoin network, much like ERC20/ERC721 did for Ethereum. In fact, when considering Bitcoin’s untapped market potential to establish its own fungible market ecosystem compared to other smart contract platforms, it becomes evident that there is substantial room for growth for this new generation of tokens, as illustrated in Figure 8 below.
Figure 8: The Market Opportunity for Bitcoin’s Fungible Tokens Ecosystem
Source: FranklinTempleton
That said, Ordinals and Runes aren’t the only source of excitement pushing the boundaries of Bitcoin. For one, Bitcoin’s scaling solution Stacks began the first phase of its Nakamoto upgrade, called the instantiation stage, on April 22, while its final phase is expected to culminate by the end of May. As part of the upgrade, Stacks will introduce faster block processing times, enabling transactions to be finalized in under 5 seconds, a significant improvement from Bitcoin’s average of 10-30 minutes. Additionally, Stacks will leverage Bitcoin’s robust security guarantees, making transaction reversals on the Stacks network as challenging as those on the Bitcoin network. Furthermore, the upgrade will introduce a 1:1 BTC-backed asset (sBTC), enhancing the utility of Bitcoin by enabling its use across a diverse ecosystem of financial and gaming applications built on top of the scaling solution. The growing excitement surrounding its upgrade has pushed the total valued locked on the network to its highest point last week, reaching $170M.
On the other hand, there is a growing ecosystem of scaling solutions emerging on the back of BitVM, released last year. Standing for Bitcoin Virtual machine, this primitive is an operating system that allows for native smart-contract functionality on top of Bitcoin. It does so by introducing what’s known as a two-party provider verifier model that allows for complex computation to be executed off-chain, which can then be challenged on top of Bitcoin using fraud proofs, akin to how Arbitrum and Optimism function. To put it simply, BitVM enables Bitcoin to host more complex applications, which is giving birth to an embryonic L2 landscape, including Chainway, BitLayer, and Bob, amongst others, aiming to alleviate the issue of rising transaction costs. However, we will be closely monitoring this emerging sector, as there are numerous projects attempting to exploit the unprecedented enthusiasm for Bitcoin to launch potentially fraudulent protocols.
Bookmarks
Have you read our latest report, The Bitcoin Halving and Beyond? Click here to get a digital copy.
This Week’s Calendar
Source: Forex Factory, 21Shares
Research Newsletter
Each week the 21Shares Research team will publish our data-driven insights into the crypto asset world through this newsletter. Please direct any comments, questions, and words of feedback to research@21shares.com
Disclaimer
The information provided does not constitute a prospectus or other offering material and does not contain or constitute an offer to sell or a solicitation of any offer to buy securities in any jurisdiction. Some of the information published herein may contain forward-looking statements. Readers are cautioned that any such forward-looking statements are not guarantees of future performance and involve risks and uncertainties and that actual results may differ materially from those in the forward-looking statements as a result of various factors. The information contained herein may not be considered as economic, legal, tax or other advice and users are cautioned to base investment decisions or other decisions solely on the content hereof.
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