What Is Wrong With Silver: Are Cryptocurrencies Killing Demand For The White Metal?

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Includes: BTC-USD, COIN, GBTC, GLD, PSLV, SIVR, SLV
by: Caiman Valores

Summary

Despite gold's rally which saw it briefly rise about $1,300 silver continues to perform poorly.

There are signs that supply and demand fundamentals have decoupled from the price of silver.

One theory for silver's dismal performance is the stratospheric rise of cryptocurrencies.

Silver continues to perform poorly despite the recovery in gold and this has led to claims that the traditional relationship between the two metals is breaking down. There are many reasons for silver’s extreme volatility and poor performance over the last year which has seen it fail to break through $19 per ounce since the start of 2017 despite gold’s solid performance.

Key among the theories being touted by pundits is allegations of price fixing and manipulation. There is certainly evidence of a long history of manipulation as I explained in the first part of this series of articles: ‘What Is Wrong With Silver: Is It Being Manipulated?’.

Nonetheless, much of the data is circumstantial and anecdotal with no clear ‘smoking gun’ evidence which undoubtedly indicates that depressed silver prices can be directly attributed to market manipulation.

Another issue is the tremendous volume of paper silver which dwarfs physical silver by up to 250 times according to some sources. While there is not conclusive evidence that paper silver is the reason for the prolonged slump in silver it does facilitate the manipulation of silver. It is also a reason for the decoupling of the closely correlated relationship between gold and silver as well as disrupting the influence of supply and demand fundamentals on the price making mechanism.

Yet again while there is considerable anecdotal evidence available as I discussed in my first article there is no clear indication that it alone is responsible for silver’s inability to perform.

Another interesting assertion made by several pundits is that the rise of cryptocurrencies and more specifically bitcoin has attracted investors who would traditionally have invested in silver bullion. One article on Seeking Alpha that touched on this subject was Ian Bezek’s ‘What's Wrong With Silver?’. Bezek discussed how crypto-currencies like Bitcoin, which in a short time has emerged with a market cap of over $60 billion alone, have become popular investments among investors who in the past would have invested in silver.

He went on to state:

. . . much of that potential speculative energy has gone into buying digital currencies instead of alternative metals.

This is certainly an interesting theory but is the rising popularity of cryptocurrencies the real reason for silver’s dismal performance and the unravelling correlation to gold since the end of the precious metals bull market?

Is silver an alternative currency?

Key to understanding the appeal of Bitcoin, Ethereum and other cryptocurrencies to investors would have invested in silver is understanding silvers role as an alternate currency that allows users to avoid government scrutiny. Silver like gold has long been considered to be currency because of its properties including rarity, durability and that it cannot be created by fiat.

It is also considerably popular among investors because it is perceived to be an incorruptible store of value store that can’t be eroded by inflation, economic crisis or political crisis like fiat currencies. This makes it like gold an ideal hedge against political and economic uncertainty.

These characteristics, especially its role as an incorruptible store of value, endows investors with a sense of anonymity in an age dominated by greater government control, regulation and surveillance. That means there is no requirement to utilize the traditional banking system and that users for whatever reason are able to avoid regulations such as transaction reporting.

Furthermore, because its value is lower than gold it is far more accessible making it a popular investment among alternate investors and giving it more flexibility.

The appeal that the anonymity provided to gold and silver becomes apparent when considering its use as a source of revenue and currency in organized crime.

You also only need to look at the world of illegal gold mining to get a sense of this. In Colombia, illegal gold mining became a significant source of revenue for anti-government and criminal armed groups that some organizations estimated to have exceed cocaine trafficking in its importance.

The stratospheric rise of crypto-currencies over the last four years now sees the top 10 having a combined market cap in excess of $120 billion of which $66 billion is attributable to Bitcoin and $28 billion to second ranked Ethereum.

There has also been a veritable gold rush to bring new currencies to market with initial coin offerings or ICOs cash raisings reaching $1.25 billion by August 2017 and expected to top $1.7 billion by the end of the year.

Arguably many of the investors interested in crypto-currencies would have invested in silver or gold previously and the massive surge in these currencies has been a drain on silver.

Cryptocurrencies are widely recognized as a store of value that can’t be monitored by governments and allows users to avoid the traditional banking system giving them a degree of secrecy that is appealing to many alternate investors.

According to data relating to demand for silver there is certainly some validity to these claims. For 2016 there was a 29% year over year decline in demand for silver coins and bars and that trend has continued into 2017. Sales data from the U.S. mint shows that during the first four months of 2017 there was a 54% year over year decline in silver coin sales.

Nevertheless, this can also in part be explained by the volatile nature of demand for silver among retail investors along with higher silver prices impacting demand. There has also been an ongoing drop in demand for silver bullion in India among other markets because of a cultural preference for gold and demand for the yellow metal continues to gain momentum.

Let’s also not forget that demand for bullion in the form of silver coins and bars almost quadrupled between 2007 and 2016 going from 62 million ounces in 2007 to 207 million ounces in 2016.

Can cryptocurrencies replace silver as a currency?

It also appears highly unlikely that Bitcoin, Ethereum or other electronic currencies will ever replace precious metals including silver.

You see, the explosion in demand for them which has led to what some analysts are calling a bubble of massive proportions has seen them garner considerable attention from governments and the traditional banking system. There is a push among governments globally to regulate cryptocurrencies. Given their existence essentially stems from a piece of code regulation is relatively easy if applied in the correct manner.

Already, there have been suggestions that regulators are seeking a master key for Bitcoin that would allow them to see all transactions. China also recently banned ICOs and the in the U.S. the SEC is actively investigating how it can effectively regulate cryptocurrencies. The push for regulation will only gain further momentum as they grow in popularity and use.

Then there are issues around hacking which has seen tremendous losses incurred by Bitcoin exchanges in the past. The Mt. Gox hack caused significant losses for customers and exemplifies the risk this presents to cryptocurrencies, especially the importance on exchanges and the risks this represents.

This highlights a key vulnerability of these currencies, the need for exchanges to exist which allow users to transfer between cryptocurrencies and fiat money. That further opens them up to regulation notably transaction reporting on transaction of a certain size or greater.

Exchanges are subject to and obliged to comply with anti-money laundering laws which along with the inaccessibility of cryptocurrencies without an exchange system significantly reduces their accessibility.

Many of these issues are covered in depth in a very interesting article from Seeking Alpha contributor; Truth Investor in ‘How The Bitcoin Bubble Will Pop’.

These dependencies and vulnerabilities certainly reduces their appeal to alternate investors who would find silver appealing because of its role as a currency that can’t be monitored. It also highlights the need for users to rely upon the traditional banking system to buy and sell crypto-currency, leaving them open to many of the vulnerabilities associated with fiat money.

Many of these issues don’t exist for silver and at $16.79 per ounce it is far cheaper to purchase than either Bitcoin or Ethereum which are trading at the time of writing for $3,946.68 and $290.65 respectively.

It is also important to note that silver also has a wide range of industrial uses which cryptocurrencies are incapable of filling and that industrial demand continues to grow. Because of its conductive qualities silver is an important element used in the manufacture of electronic components including touchscreens, circuit boards, light emitting diodes and electronic switches. It is also used in the fabrication of photovoltaic cells which make up solar panels, the demand for which is growing exponentially because of green energy targets.

Bottom line

Clearly, a growing range of cryptocurrencies and investment options does reduce the degree of interest in silver which could very well be weighing on its price.

Nonetheless, there is little in common between the assets, crypto-currencies will never become a store of value that is as secure as silver or gold. The threat of increased regulation, hacks and the need to engage the traditional banking system to be able to use digital currencies also reduces their appeal.

If anything, it appears to be a confluence of factors than any single event which is responsible for silver’s poor performance and the rise of cryptocurrencies is just another of those events. As I discussed in my first article in this series this is creating an opportunity for investors with silver fast approaching the point where it will rally. Since that article the gold-to-silver ratio has widened to 77 ounces of silver to buy one ounce of gold, up from 75 ounces, and this is despite gold weakening.

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.

Additional disclosure: I/we have extensive investments in physical gold and silver bullion as well as collectible antique gold and silver coins.