(Kitco News) - Two investment tools for silver – coin sales and exchange-traded funds – are showing a divergence in investment activity this January as coin sales reach record levels and ETFs show significant outflows.

While the divergence is obvious, trying to get a sense of what this bifurcation may mean for the larger market is a little more difficult to map. Some market watchers said the division doesn’t matter because the one does not influence the other. Others said it’s important to keep an eye out because changes in these patterns could affect prices, while still others said it might be a sign the physical market could be growing in importance in contrast to the derivative, or “paper” market.

As of early Monday afternoon, the U.S. Mint’s Web site showed that 4,724,000 one-ounce coins have been sold far this month. This is higher than the previously monthly record of 4,260,000 set back in November, said Mint spokesman Michael White.

Sales for 2010 are listed at 34,662,500 ounces, which the Mint said is a record. This tally is more than triple the 9,887,000 sales from 2007, when precious-metals were already well into a decade-long bull market.

On the other hand, silver ETFs are seeing heavy outflows. As of Friday, Barclays Capital said another 132 metric tons came out of ETFs, bringing the monthly outflow to 497 tons, which would make January one of the weakest months for the funds.

The heavy ETF selling has put pressure on silver prices this month. This year prices peaked on Jan. 3, with March silver futures on the Comex division of the New York Mercantile Exchange reaching an intraday high of $31.275 an ounce and settling that day at $31.125. Since then prices have declined 12%.

Suki Cooper, precious metals analyst at Barclays, said last year when silver prices were at multi-decade highs last year, it was a combination of strong coin sales and heavy ETF inflows that lifted values. Last year, total ETF holdings for the eight products they track reached a record high of 15,265 tons and they estimated coin sales were 2,675 tons.

Total ETF holdings ended December at 15,188 tons and have fallen from that level with this month’s outflows, she said. The last time ETF outflows were this heavy was in April 2010, she said.

Right now, she said, the coins sales are putting a floor under silver prices, which is the main support for values. “If we look at the supply and demand balance for the past four years, supply is outpacing demand, so the fundamental balance is weak. Silver is very dependent on investment demand to drive the price higher,” Cooper said.

So, investors need to eye the pace of coin sales, especially if ETF holdings continue to soften. “If the mint sales and exchange-traded product sales slow, as well, prices will fall dramatically because of the poor fundamentals. Investment demand is key,” Cooper said.
Coin Sales Mostly Retail-Based, ETFs Appeal To Broader Class

Most market analysts said while the funds have both retail and institutional investors in them, coin sales are almost always retail-based. Because of that, trying to use one to infer what might happen in the other isn’t always realistic.

“These are two different markets; it’s like comparing apples to oranges. Coin market is mostly retail. The ETFs are the professionals. They don’t want to buy coins. They don’t want to buy anything that isn’t liquid. You can’t compare them, they’re totally different,” said George Gero, vice president and precious-metals strategist with RBC Capital Markets Global Futures.

Gijsbert Groenewegen, managing partner of Silver Arrow Capital Management, pointed out the coin purchases are suitable for someone who wants to buy and hold the metal, whereas ETFs are usually used as a short-term trading vehicle.

Plus, he said, the divergence between these two markets is the difference between the “paper” market and the physical market. “People want physical because there’s no counter-party risk,” he said.

ETFs are sometimes called “paper” silver because generally, no physical silver is traded between the fund and the investor, even though the ETF maybe be physically backed.

David Morgan, independent precious-metals analyst with Silver-Investor.com, said for a long time derivative silver markets have driven the price mechanism for the gray metal, but the separation between the coins and the ETF activity might be a sign that the physical market could start to drive prices.

“Both ETFs and coins have grown together, but there’s a day of reckoning. Someone somewhere will say hand over the product. And it’s getting harder and harder to meet demand. Some will take the substitute, some won’t…. I believe we’re close to having the physical trump the derivative. This could be the year. After, say, the summer months, someone may find it difficult to obtain physical silver in a time when there’s a real discrepancy. No one will default, but it could be timing or inventory issue,” Morgan said.

Morgan added that he’s not against ETF investing and added that it’s easier to click a mouse than deal with the added steps it takes to procure physical metal, but he said believes investors need physical metal first.

Both Morgan and Groenewegen said physical buyers could command a premium for their product versus ETFs if prices do fall. They point to the premium physical silver – and gold – commanded during 2008. When the financial markets fell sharply in the wake of the credit crisis, all markets fell, including precious metals. But they note there was a sizable discrepancy between prices shown in the futures market and where bullion was trading.

“The futures market was showing silver at $9. To buy silver rounds there was a 30% premium in the physical market. It’s the real thing that people will pay for,” Morgan said.

Allen Sykora contributed to this story.



By Debbie Carlson of Kitco News dcarlson@kitco.com

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