The major monetary metal
Silver has been used as currency and as a store of value for more than 4,000 years. It has been used as money more widely and for longer periods than gold, as noted by prominent US economist Milton Friedman: "The major monetary metal in history is silver, not gold."
A 19th century boom in silver and an accompanying flood of silver coinage drove many European countries (including the UK, whose currency is still called 'sterling') to abandon silver and adopt a gold standard. However, silver continued to serve as money well into the 20th century, by which time its industrial applications were growing.
Growing industrial demand
What sets silver apart from gold is silver's much wider and growing industrial usage, which exploits the metal's unique properties of strength, malleability, reflectivity and electrical and thermal conductivity. Silver is also widely used in jewellery and silverware. Silver demand for use in photography is finally bottoming out having been in sharp decline for around 15 years since the advent of digital photography.
The metal's vastly lower cost relative to gold and platinum when used in jewellery, and low per unit cost in most other applications, allow the silver price to rise substantially above current levels without threatening its competitiveness.
| Silver's main industrial uses include: |
|---|
■ Batteries ■ Catalysts ■ Electronics ■ Medical applications and purification ■ Mirrors and coatings ■ Solar energy ■ Water purification |
Silver supply muted
Silver is an unusual commodity in that it is generally produced as a by-product of mining other commodities. As a result, there are few primary producers offering pure exposure to silver. This leaves silver output vulnerable to the fortunes of other commodities.
As ever in a commodities story, China has a major role to play in silver's fortunes. Eric Sprott of Sprott Asset Management observes that Chinese net imports of silver totalled 112m ounces in 2010 compared with net exports of 100m ounces in 2005. "That's more than a 200m-ounce shift," says Mr Sprott. "Where's it all going to come from?"
John Wong, portfolio manager at New City Investment Managers, shares the view that a supply-demand imbalance will drive the silver price higher in the near term. He points to the aggressive growth plans of Hochschild Mining and Fresnillo, the London market's two large primary silver producers, but points out that while the companies have the deposits to back up their expansion plans, the new mines haven't yet been built. Construction could take three years, during which time supply will remain constrained. Even once the additional capacity is in production, the manager expects that the risks will be for a pull-back, not a collapse in the silver price.
Mr Wong believes that silver could touch $36 to $40 per ounce this year, although he is less certain it will hold such a level on the current outlook. The silver market is just a tenth of the size of the gold market, he explains, as a result of which silver is far more volatile than gold.
Gold-silver ratio
The gold-silver price ratio is closely monitored by many, although the volatility of silver in particular often makes it difficult to interpret meaningfully, unless the ratio is trading at an extreme of its range. The ratio typically trends higher during turbulent economic times when demand for both metals picks up, but industrial demand for silver weakens. Conversely, as industrial demand recovers, silver picks up and the ratio falls. The gold-silver ratio reached a recent high of 84.4 in October 2008, but has since slipped back to currently around 48.
The ratio illustrates that silver costs just a fraction of the price of an equivalent quantity of gold. This makes silver (in appearance at least) far more affordable for many retail investors who like to touch and feel commodities they buy, and wouldn't be able to do that with a speck of gold.
Silver on the charts
The outlook for silver on the charts remains bright and shiny. The tremendous bull market in the semi-precious metal is in healthy shape, even after having risen some 679 per cent from its last major low in November 2001. And there's no reason to believe that it's close to a major top yet.
Unlike gold – which made a new record high in December – silver remains far below its all-time peak of $49.45.
Admittedly, it didn't spend long up at those levels last time around. The metal spiked dramatically in late 1979 as a result of an infamous act of market manipulation. But I would not be surprised if silver equalled or exceeded that level before its current bonanza ends.
In the meantime, my projections point to further gains towards targets at $32.28, and thereafter $35.66. Subsequently, I am looking for $36.80, $37.50, and then $39.15. The price may well hesitate at some of these levels, but I ultimately expect them to be broken.
The final top in silver could well be a spectacular affair, if history is anything to go by. Peaks in commodity markets very often come by way of dramatic spikes followed by equally dramatic collapses. This makes them very difficult for traders and investors to take advantage of. The safest advice is probably not to try and hang on for the absolute top and to run a strict stop-loss on whatever position you have.
While tactical traders will probably want to try and go long on rebounds off, say, the 13-week exponential average, longer-term investors can reasonably go long around current levels of $31.
