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Silver Investing 2013

Growing Supply and Demand


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Thursday, April 25th, 2013

The annual World Silver Survey released yesterday by the London-based metals consultancy firm Thomson Reuters GFMS gives silver bulls some encouraging data on where silver may be headed. Demand and price are seen rising in 2013-14, a welcomed transition from 2012.

silver barBoth gold and silver have been moving through a regular repeating pattern of surges and corrections over the past several years. If Thomson Reuters’ forecast is accurate, 2013-14 may deliver another installment of this serial pattern toward new all-time high spikes for both metals.

Growing Supply

2012 saw slowed growth and, in some cases, outright pauses in the vast majority of global economies—European, North American, and Asian alike. It’s not surprising that the World Silver Survey showed silver’s overall demand from industry, jewellery, photography, silverware, and coins falling some 7% last year.

Hurting the silver price all the more was increased mine production, which produced 4% more silver in 2012 than the previous year. Production is still expected to grow further in 2013.

From Forbes:

“’We hit a record (for output) last year, and we should get to the 800 million [ounces] mark this year, with various projects coming on stream and a couple of mines with suspensions last year back to speed,’ said Neil Meader, head of precious metals research and forecasts at Thomson Reuters GFMS, in an interview with Kitco News.”

The long lag time in ramping up production and preparing new mines that initiated in the mid 2000’s, when the metals bull run was still in its infancy, means that we are only now beginning to see the arrival of that new production.

Growing Demand

But the World Silver Survey is forecasting even greater growth in demand for both silver bullion and its miners. Meader presents five principle expectations supporting higher silver demand and a higher silver price.

Affordability:

The U.S. Mint’s silver coin sales from January to April this year have approached 17.3 million ounces, vastly surpassing 2012’s sales of 11.6 million ounces over the same months.

“If we stay on this track,” Meader projected, “silver coin and medals demand could be getting past the 2011 record of 3,679.5 tonnes.”

“Also, the appetite for silver ETPs [exchange traded products] remains strong,” he informed Businessweek.

Data compiled by Bloomberg confirms “a new record in silver ETP investment was reached in March at over 19,738 metric tons, while gold ETP holdings dropped 12%.” Reuters indicates holdings in silver ETFs are even now still “hover[ing] near their all-time high set in March”.

Profitability:

Silver’s abundance relative to other precious metals helps producers keep their costs down. Although labor costs are rising, the Silver Survey showed primary silver producers last year were able to mine silver for just $8.88 per ounce.

Silver’s current price, even at these corrected levels, continues to provide a much higher profit margin than other precious metals. Gold, for instance, is close to its all-in cost of $1,300 to $1,400 per ounce, while platinum is just at its all-in mining cost of the mid $1,450’s.

This higher profit margin makes silver producer stocks more attractive to investors who prefer to invest in companies rather than bullion.

Safety:

Silver’s role as a safety play is expected to continue to be, well, precious.

“We expect prices to rebound as the safe-haven buying will re-emerge because of global economic worries,” Meader expressed to Businessweek.

Regarding the U.S., he remains alert to any “wobbles” in the economic recovery that might strengthen the case for the Federal Reserve continuing its easy money policy much longer than is currently expected.

Meader also points out that there are still unresolved budget and debt ceiling issues that will be re-visited yet again this July, and this could trigger another rating downgrade.

“If we get any word of a U.S. credit rating downgrade,” he warned, “that could be quite significant for the price.” “You only have to look back to the summer of 2011 when the U.S. had a credit downgrade. That added $200 to the gold price,” lifting silver up as well.

How far up? “You could easily get a scenario where we get back over $30 and maybe even get to $32,” quotes Forbes.

Hedging Against Inflation:

“The unknown for the longer term is inflation,” Meader informed Kitco News. “If we were to move into a situation of modestly higher inflation, that is going to be supportive.”

Current monetary policies by central banks around the world are deliberate in trying to coax some inflation ranging from 2 to 4%, varying by country. While economists in general are quick to dismiss any inflation concerns at this early stage in the global recovery, Meader challenges, “I think it would be foolish to completely ignore the inflation question.”

The Gold-to-Silver Ratio:

Yet another enticing beacon luring investors into silver is its value relative to gold. Analyst consensus on a reasonable gold-to-silver price ratio is about 1:40, where 1 gold ounce can buy 40 ounces of silver. The ratio currently sits at roughly 1:62, meaning silver is grossly undervalued compared to gold on a recent historical basis.

“This is important,” Meader stressed, “as looking ahead we expect macroeconomic developments to feed through to a marked rally in the gold price and, with plenty of room for the gold:silver ratio to contract … it is easy to see decent scope for sizable gains in the silver price this year.”

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The Sling-Shot Effect

What Meader describes above regarding a gold-to-silver ratio contraction is the “sling-shot effect” common to two instruments that are closely related.

At numerous points along the way, the price of one of the pair will drift slightly out of its historical “orbit” around the other’s price. Yet because the two are closely related and follow similar supply/demand fundamentals, any prolonged distance between their prices will quickly attract knowledgeable investors to the laggard of the two.

This surge of investor interest suddenly propels the laggard’s price upward, like a contracting sling, narrowing the ratio between the two instruments. Invariably, this upward momentum sends the once-lagging member much closer to his partner than the historically accepted range.

When this happens, you will see a sharp sell-off that abruptly settles the two dancers back into their normal orbits around each other.

This is precisely what happened to silver during gold’s last two spikes, as seen in the chart below comparing the iShares Silver Trust ETF (NYSEArca:SLV) (beige) to the SPDR Gold Trust ETF (NYSEArca:GLD) (black), going back to the 2008 correction.

gold silver chart 4-25Source: BigCharts.com

At the lowest point of the ’08 correction, the gold:silver ratio reached approximately 1:77, where 1 gold ounce bought 77 silver ounces. The “% Compare” section at the bottom of the graph shows how much the gap between the metals’ prices increased (first red circle).

On the way back up, the gap between the metals gradually narrowed until reaching their closest point that year at approximately 1:63 (first green circle).

But notice when that happened? About 2 to 3 months before gold reached its new all-time high spike of $1,200 (first blue circle).

The pattern then repeats in its entirety yet again. The gap between the two widens, as silver falls more than gold, reaching a ratio of about 1:74 (second red circle). This coincides with the bottom of the 2009-10 correction just as it did the previous time at the bottom of the 2008 correction.

The gap between the two remains fairly steady until investors pile into silver yet again, this time with so much momentum that it reaches a ratio of approximately 1:32 in May of 2011 (second green circle).

And notice when that happened? Between 3 and 4 months prior to gold reaching its new all-time high spike in August 2011 (second blue circle).

Today, the ratio between the two precious metals is around 1:62, well on the outside of the 1:40 recent historical consensus that analysts believe is their fair relationship. We are at levels similar to where the previous two runs upward began.

And remember too that in both previous cases, silver catapulted first, with gold following some 2 to 4 months behind. The reason silver started moving before gold was because it had corrected more than gold, and investors saw it as a more attractive vehicle.

Here we are again today.

Joseph Cafariello

 

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