Silver Bullets by Gavin Wendt

Silver was one of the best-performing commodities of 2010, so let’s take a close look at the reasons behind it all and where things might be headed during the 2011.

To put things into perspective, just six months ago there were brave predictions that silver could surge to as high as US$23 per ounce during 2011.

Well, it didn’t take nearly that long, with the metal surging past the US$30 per ounce mark during late 2010 and currently settling around the US$28 per ounce mark.

Silver really has been an amazing performer in the precious metals space, with a strong outperformance of gold, particularly over the past half year or so. Spot silver surged by 80% during 2010 to a peak of US$30.50 an ounce, its highest price since September 1980.

This easily beat gold’s 24% increase to a recent peak of US$1,424.60 per ounce. And the metal has also outperformed most of the base metals, with the exception of tin’s 60% surge price surge during 2010.

What’s been driving silver? Silver’s attraction is best summated by this description we came across: “You buy gold when you think the world is going to hell in a hand basket. You buy copper when the economy is booming. In between those two, if you’re a bit confused, you buy silver.”

Figure 1: Courtesy of Kitco

The same key factors that have seen the gold price surge to record levels this year – weakness in the US$ that shows no sign of easing, combined with investor nervousness related to the ongoing ‘quantitative easing’ taking place in the US, are also driving silver. (‘Quantitative easing’ is a modern euphemism that refers to the money-printing, low interest rate-spending spree currently being encouraged by US authorities).

With money being pumped into the system, the inevitable questions that follow are how and when all of this ‘free money’ will be repaid. The answers are just too horrible to contemplate, with mammoth inflation being just one of the uncomfortable likely consequences.

As a result, many sensible investors have been loading up on gold since the GFC. But this is only part of the picture, as there were other sensible investors that saw the writing on the wall long before 2008’s meltdown. In actual fact demand for gold has been rising since 2000, which helps explain why gold recently registered its 10th consecutive year of price gains.

And as gold has become more expensive, investors have looked for cheaper alternatives, including gold’s relatively poor cousin, silver. For guidance we can look at the gold-silver ratio, or simply how many ounces of silver you can buy for each ounce of gold. Growing investor demand for silver over recent months is reflected in a decline in the gold-silver ratio.

An ounce of spot gold currently buys around 48 ounces of silver, which compares with the decade average of 62 ounces. Many investors obviously like the leverage factor that silver offers compared to gold, believing that any future gold price movements will be magnified in silver.

And it’s not only investor demand, but also an expected recovery of industrial demand for silver, with the metal used in solar cells, mobile- phone covers and photography, which underpins 80% of demand. Silver is a great investment because it doubles as a store of value for buyers concerned about the economy and as an industrial material for those bullish on growth.

New applications such as plasma screens are compensating for a drop in demand for film, now 9% of usage down from 24% in 2000, data from GFMS shows. Eastman Kodak Co said last year it would stop making Kodachrome film after more than seven decades.

Nevertheless, whilst we’re hugely positive on gold and as a consequence silver, we’re not as wildly bullish on price as some of the silver pundits out there. Price calls of US$400 per ounce in the near future by some wild silver bulls are quite ludicrous and impossible to justify, merely setting some investors up for inevitable disappointment.

Silver’s fundamental demand (excluding investment) should continue to rise this year, chiefly due to gains in industrial uses. However, this will be outweighed by gains in total supply as mine output rises (both scrap and government sales are projected to fall). Nevertheless, with key supports such as ultra-low interest rates, a weakening US$ and a buoyant gold market, we are confident that investors will be of a mood to absorb the resultant, growing surplus.

We believe that gold will comfortably surpass US$1,500 per ounce during 2011 and that silver has every chance of stabilizing around US$30 per ounce and perhaps pushing higher.