Silver Is Getting Scarce In Shanghai

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Includes: SIVR, SLV
by: Jason Russ

Summary

Silver value in the vaults of the Shanghai Futures Exchange has fallen from over $1 billion in March 2013 to $57 million today.

In particular, silver inventory in Shanghai has fallen precipitously in the last six months, from 575 metric tons to 93 metric tons.

The current inventory level is so low that it may only be enough for a few weeks of withdrawals.

The Shanghai to London spot silver premium is rising.

Finally, the metal has been in backwardation for at least two periods of time in 2014.

The Shanghai Futures Exchange (hereafter referred to as SHFE) is often called a "physical market", as opposed to the COMEX and London markets which are often called "paper markets". According to David Jensen, the leverage in the London market is about 100:1. By the way, listening to the MP3 in that link is highly recommended.

Looking at the silver (NYSEARCA:SLV) inventories at Shanghai is particularly important for any investor in the metal. It shows real, physical draw down of silver. And at this time, it shows that physical metal is getting scarce.

Silver inventory has been dropping steadily for a year and a half at the SHFE. It is now so low that there may only be a few weeks worth of silver in the vaults.

Below is a monthly chart dating back to March 2013:

(Data from SHFE)

Below is a daily chart starting in the last days of August through today, September 5:

(Data from SHFE)

In the last few days, despite an increase on the 3rd, the stocks have been reduced further down to about 93 metric tons -- the precise figure is actually almost exactly 3 million troy ounces. Put another way, the value of the silver in the vaults is currently about $57 million. In comparison, the value of silver in the Shanghai vaults at the end of March 2013 was over $1 billion (using the silver price at that time).

Price Premiums in Shanghai

Naturally, when a commodity becomes scarce, a rise in price is expected. But the price of silver in the West has not risen in concert with the scarcity in Shanghai:

SLV Chart

SLV data by YCharts

However, the price in Shanghai vs. London has risen. As of September 1, the SGE (Shanghai Gold Exchange) price of silver was at a 9.3% premium to LBMA (London Bullion Market Association). Last week that premium stood at 8.1%. I calculate today's (September 5) spot price premium to be at 10.2%.

Those figures are up substantially from the typical 1% - 6% that was commonly seen over the last nine months:

(source: bullionstar.com)

Note that Shanghai prices include a 17% VAT fee. So the Shanghai spot price is actually a discount to the London spot. I will continue to call it a premium as that is the way 99% of the world reports it. It's all rather odd and perhaps the subject for another article. What is important is the trend of the rising premium (or falling discount).

Backwardation

Furthermore, the SHFE silver contracts have been in broad backwardation at least twice this year (end May/early June and on and off throughout August and early September -- in fact several contracts are in backwardation today). Backwardation is an unusual circumstance in which the spot price of the metal is higher than the future price. Silver usually trades in contango, which means that the future price is higher than the spot price. Backwardation is another indication of scarcity.

The Technical Picture

Below is a weekly chart of silver going back to early 2009:

(source: finviz.com)

We can see that for over a year, the metal has hit support in the $18.50 to $19 area. Bounce, bounce, bounce -- it goes like clockwork. Not coincidentally, that level is in the same ballpark as the resistance level that the metal encountered in late 2009 through mid-2010. That resistance has turned into support. More on the technical aspect below.

Conclusion

We can see that there are at least three indicators of scarcity of silver in Shanghai:

  1. Inventory levels. Inventory has dropped from well over 1000 metric tons to 93 metric tons today. The value of the current inventory is a paltry $57 million and the inventory literally cannot go much lower. Zero is not far away.
  2. Rise in premiums. Silver premiums in Shanghai have risen to 10.2% over London spot price. That is considerably higher than the norm and represents the highest premiums since at least December 2013.
  3. Backwardation. The last time backwardation became prevalent in the silver market was in early 2011. In the next few months the metal rocketed higher (followed by a crash). According to this article, the last time before 2011 that silver futures went into backwardation was 1997. That was when Buffett bought 130 million ounces (on July 25, 1997). Silver moved from about $6.50 in the summer of 1997 to nearly $9 early the next year.

The paper markets in silver are incredibly leveraged. At the top of this article I mentioned 100:1. By some accounts that figure may be as much as 250:1. In any case, it is the physical that matters in the long run, particularly for an industrial metal like silver. And the place to look for physical delivery is not the paper markets of the West, but the market in Shanghai.

In my opinion, the long term chart of silver prices shows that the metal has solid support since mid-2013 but has had no catalyst to push it substantially higher. The Shanghai data that I have put forth in this article shows that a bullish force is about to begin a push. How strong that push will be remains to be seen but it is possible that the next major catalyst to take silver out of its current range will hit very soon. I will be keeping a close eye on the SHFE this fall.

Disclosure: The author is long SLV.

The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.