The Silver ETF and the Great Silver Shortage at COMEX

Because of silver’s recent run, much attention has been given to the rumored JP Morgan short silver story, which we have covered (link). However, the shortage of silver in COMEX inventories is potentially as conducive to the long silver story, and is also thoroughly verified.

As of December 10, the COMEX holds only 106mm ounces of silver, or roughly enough to cover 21,000 contracts (Go to: CME Group Link and click on “Silver Stocks”).  From the most recent Commitment of Traders report from the CFTC, there are more than 137,000 silver contracts outstanding.  That means if only 15% of silver long holders decide to take delivery of physical silver, a short squeeze unlike any other ever seen may result.

The reason the COMEX shortage could turn into such an explosive story is because of the lack of physical silver available to cover the existing futures obligations.

Courtesy of Eric Sprott and Sprott Asset Management, the above table shows the amount of silver being held by various silver ETFs, trusts and central banks.  As can be seen, 519mm ounces are being held by these entities, and with investment demand increasing, they are bound to hold even more as time goes on.
SLV, the US silver ETF, has become the most popular way for investors to gain exposure to physical silver.  From time to time, SLV purchases new lots of silver based on investor demand for SLV shares.  Since investment demand for silver increased 184% in 2009, SLV has been expanding their silver holdings rapidly.  With silver gaining even more popularity as an investment, 2010 figures to be another year in which silver investment demand skyrockets.

As SLV and the other entities hold more silver, there is less silver out there to be delivered.

Once these entities own the silver, it sits in a vault and is not expected to be resold except in very small portions to pay expenses and fees.  Shown above is a chart of worldwide silver demand, courtesy of the The Silver Institute.  As can be seen, investment actually comprises a very small amount of global silver demand, although that amount is skyrocketing (investment demand rose 184% in 2009).

In addition to the skyrocketing investment demand, much more silver is used for other purposes, and due to the miniscule amount used per unit, this silver will not reenter circulation.  Approximately 50% of silver demanded each year is consumed in industrial processes, with medical, photography, jewelry, and silverware usage comprising an additional large proportion.  The amount of silver used for these purposes is so small on a unit basis that there is no virtually no ability to economically salvage the silver used.

Therefore, silver used in industrial and other processes is essentially gone forever.

As the ETFs, trusts, central banks, industrial and other uses take silver out of circulation, the amount left for investment demand and, more interestingly, for delivery of COMEX short positions continues to dwindle. If 15% or more of the long silver futures holders decide to take delivery, our best guess is that the COMEX itself would be forced to purchase physical silver on the open market, driving up the cash price of silver greatly.

Due to the amount of silver constantly being taken out of global supply by the above mentioned factors, this could lead to an incredibly explosive short-squeeze that drives the price of silver up to and beyond the all-time high of 40 achieved in 1980.

In addition to the COMEX silver shortage, the fundamental thesis regarding purchasing silver is well intact and gaining momentum.  The dwindling supply of physical silver available globally coupled with COMEX’s woefully insufficient silver inventories are yet more kindling to power silver’s rally long-term.

We continue to be long silver in various forms for clients, as well as long SLW, GDX, and GDXJ.

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