JULY 27, 2011
By Doug Hornig
Admittedly, it’s been a wild ride for the white metal this year, as it rocketed from below $30/oz. in February to $50 in late April, only to be slammed back to $32 two weeks later. As of this writing, it’s recovered to just north of $40.
With that kind of volatility, one can be excused for being somewhat skittish about the market. But the fact is, the future looks very bullish for gold’s baby brother. We’ve been covering supply and demand factors on a regular basis in this letter, but today marks the arrival of a singular event that should have a profound effect on prices going forward.
On this day – July 22, 2011 – dollar-denominated Chinese silver futures are scheduled to begin trading on the Hong Kong Mercantile Exchange (HKME), thus giving Asian (especially Chinese) investors direct access to the metal and offering an alternative to the longtime dominance the U.S. has enjoyed in silver-bullion trading.
This follows the HKME’s launch of trading in gold futures on May 18. Both metals will be priced in U.S. dollars, with physical delivery to specified depositories in Hong Kong – a major conduit for the flow of metals into China.
For one thing, the new market ends the hammerlock the Chicago Mercantile Exchange (CME) has had on silver trading. Because of the competition, the CME will have less leeway to change margin requirements – as it did when it raised them three times in a week – by nearly an aggregate 100% – in late April/early May, sending the silver price into its tailspin.
In addition, investors in China and throughout the far East will find it easier to buy into bullion. This will be the first time that Asia will be able to conveniently purchase silver futures contracts and if they wish, to take delivery. Previously, those investors had to purchase CME-based contracts (if they were allowed to at all) that traded through the Hong Kong Futures Exchange, according to CME rules.
Consider also the price differential between gold and silver. With the former trading at 40X the latter, silver presents less of a barrier to entry to smaller or first-time investors.
The HKME also offers another advantage compared to the CME. Its standard contract is for 1,000 troy ounces vs. the CME’s 5,000-ounce minimum. Once again, creating increased liquidity for the customer was the goal.
As Albert Helmig, president of the exchange, puts it, “The new contract will enable buyers and sellers in China to trade effectively with their counterparts across the world, while at the same time allowing investors to gain exposure to silver-price movements and broaden their investment portfolio.”
All of this should spark a silver rush that is already running full throttle. As the U.S. dollar has weakened, the Chinese – historically protective of their hard assets – have been running for cover. Demand for the metal soared by 67% in China in the past three years, and the country was responsible for 23% of global consumption in 2010.
That’s likely just the beginning. China has a staggering $3.2 trillion in currency reserves, and as the “value” of fiat money deteriorates everywhere, they’ll want to move out of it. Imagine the effect on metals prices if just a fraction of one percent of those reserves went into gold and silver.
Institutional investors have taken note. New York-based Newedge USA – which was the biggest futures-commission merchant by measure of customer assets on deposit as of May – cites climbing physical demand in Asia as the catalyst that will drive silver prices, by its estimate, to $70/oz. in the near term.
One final note: Helmig says that the HKME’s future plans call for trades priced in yuan as well. That would be in keeping with the exchange’s motto – Chinese access, Asian pricing, and global risk management – and it’s a move that could really throw the floodgates wide open.
No secret what a flood of new demand will bring: Higher prices.
If you’re not yet bullish on silver and the handful of companies that mine it, perhaps you should be.