The Silver Deficit Paradox

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Summary

Physical silver is in an impossible situation where deficits are coinciding with rising above-ground stocks.

There is a missing piece in silver's supply and demand puzzle.

There was virtually no correlation between the price of silver and physical surpluses and deficits over the last ten years.

Fundamental analysis is ineffective on predicting the future price of silver.

Silver caught the attention of the investment industry in the first half of 2016 as it saw some upward price action. Since then, it has given back the majority of its gains, which led me to analyze the commodity to see if there is value and upside potential once more.

I began with a fundamental analysis to see how the supply and demand of silver interacted with its price. After much research, I was forced to conclude that fundamental analysis is ineffective at determining the future price of silver as there is incomplete and paradoxical supply and demand information and its price is unaffected by surpluses or deficits.

The Silver Deficit Paradox

Silver has been in a physical deficit for eight of the last eleven years. Where has the excess demand over supply been sourced from? Certainly the three years of the last eight where there were surpluses don't make up for the deficits as they pale in comparison.

Aboveground stocks are the only explanation. Yet, when one looks at the above-ground stocks of silver, as provided by the Thomson Reuters Interim Silver Market Review , they have been increasing since 2013. But there has been a physical deficit every year since 2013. So we are left with a paradox: How can aboveground stocks be rising when they are supposed to be lowering as they provide the supply needed to service the deficit? Something isn't adding up. Clearly there is a piece of the puzzle missing.

This missing piece of silver's supply and demand cycle renders fundamental analysis ineffective and risky. No one seems to have information on the nature or size of this missing piece. Thomson Reuters doesn't mention the missing data or the paradox of rising above-ground stocks coinciding with supply deficits. They do, however, expect above-ground stocks to flatline going forward due to the deficits. So they admit to a relationship existing between above-ground stocks and deficits where one affects the other. But it seems that this relationships acts in an inexplicable yet unremarkable way to TR: Deficits should reduce above-ground stocks, not flatline them.

Since it is risky and unwise to draw inferences and conclusions from incomplete data, especially when one's money is involved, the missing information makes fundamental analysis on silver much less valuable.

Silver's Price Regarding Surpluses and Deficits

So why haven't the numerous deficits affected the price of silver? Looking at data from 2006 to present, the price of silver seems to have almost no correlation with its physical surpluses and deficits. Silver's price simply doesn't care about it's fundamentals. This further reduces the value of fundamental analysis on silver, and shows that silver's pricing is being influenced from somewhere else.

Silver's Surpluses, Deficits, and Average Price per Year

Year

Surplus/Deficit (Moz)

Average Price in Year US Dollars

2006

-19.0

$11.55

2007

-69.3

$13.38

2008

-176.6

$14.99

2009

52.5

$14.67

2010

38.8

$20.19

2011

-78.5

$35.12

2012

2.9

$31.15

2013

-148.7

$23.79

2014

-79.3

$19.08

2015

-124.0

$15.68

2016

-52.2

$17.15

Source: Silver Institute

The coefficient correlation between the price of silver and its physical surpluses and deficits is -0.031. This is so close to zero that I am forced to conclude there is almost no correlation between silver's price and its physical surpluses and deficits between this time period. This is conclusive evidence that fundamental analysis is ineffective in determining the price of silver.

Conclusion

The direction of the price of silver can not be determined through fundamental analysis. There is a missing piece of physical supply and demand information that is unaccounted for, which raises the risk of relying on the incomplete information. This was proven to be true by looking at the current impossible relationship between the deficits and above-ground stocks. Deficits should reduce above-ground stocks, not flatline them or allow them to increase.

Moreover, if physical demand is being met when there is a supply deficit and above-ground stocks aren't providing the difference, the excess demand is being sourced from somewhere else and no one seems to know where.

Lastly, there was essentially no correlation between the price of silver and its surpluses and deficits over the last eleven years. This means that employing fundamental analysis to determine the future price of silver is ineffective.

So what does set the price of silver? In my next article, I will explore the manipulation of silver's price to see who is manipulating it, why, how, and if it can continue.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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