What's Moving Silver's Price to $40?
By Alix Steel
via Yahoo Finance
Friday, April 8, 2011
NEW YORK -- Silver prices hit $40 an ounce. This was the bullish signal many traders were waiting for and price targets now range from $45 to $50 for 2011. Voracious investment demand and turmoil in the Middle East-North Africa region have been pivotal to silver's pop, but don't tell the whole story.
Silver prices have a reputation of being manipulated, volatile and less liquid. Silver hit a record high of $50 an ounce in 1980 after the famous (or infamous) Hunt brothers bought the metal aggressively for seven years -- at one time owning more than 200 million ounces of silver.
The silver bubble burst soon thereafter shedding 50% of its value almost immediately, and over the last 30 years the metal has traded as low as $4 and as high as $36.74 an ounce.
Along with gold, silver prices are at the mercy of investment demand, safe-haven buying, inflation fears, momentum trading and price manipulation. Silver prices are also cheaper than gold offering cash strapped buyers a cheaper safe haven alternative. But the one thing that silver prices have going for them that gold doesn't are oodles of industrial demand. Indeed, silver can be found in a plethora of products, from iPads to cars to solar panels, making it the perfect metal for those wanting a hedge against currency debasement as well as exposure to a global economic recovery.
David Morgan, founder of Silver-Investor.com, says he could see silver prices as high as $45 in 2011 "and if things get really crazy we could go beyond that."
Silver is also at the mercy of stocks. When equities plummet, investors are often forced to sell silver for cash, but any significant dip can trigger a wave of buying as investors purchase silver at "cheaper" prices, resulting in a strong tug of war. Because fewer people own silver than gold, the market is smaller, which results in violent price action.
Here are five fundamental factors that will contribute to silver's strong price moves in 2011 and why many analysts think silver's bubble is far from bursting.
... 5. Price Manipulation
Price manipulation is the most controversial theory that has circulated among gold and silver bugs for 20 years. Some argue that precious metal prices have been illegally suppressed over the last two decades by central banks, governments and trading houses. The Gold Anti-Trust Action Committee, or GATA, is the biggest complainant and mainly points to the "hugely disproportionate short positions," according to Chris Powell, secretary and treasurer of the organization.
The manipulation headline has been gaining traction of late after trader Brian Beatty filed lawsuits at the end of October against JPMorgan and HSBC for conspiring to "suppress and manipulate" silver prices on the Comex.
The allegations are particularly noteworthy because HSBC and JPMorgan are custodians of the physically backed exchange-traded funds like the ETFS Physical Silver and iShares Silver Trust, which means the big banks, in charge of storing the metal investors are buying, are being accused of manipulating the prices.
The drama continues. A Chicago law firm, Cafferty Faucher, filed a lawsuit at the end of December against HSBC and JPMorgan accusing the two of using their positions as silver holders to purposefully suppress the silver price so they could profit from their short positions.
The Commodity Futures Trading Commission is now investigating the possibility of criminal activity in manipulating the silver futures market, particularly at JPMorgan.
JPMorgan had been trying to combat these allegations by reducing its huge silver short position. However, in the latest bank participation report, short contracts on the Comex have risen by 6,762 in 2011 as banks bet against silver's crazy rally. Subsequent unwinding, forced or otherwise, could trigger more rallies.
The opposition, however, is just as passionate. "There's no vested interest on anybody's parts to suppress prices here," says Jon Nadler, senior analyst at Kitco.com. "The allegations remain at that level, simply allegations."
Nadler argues that despite the rumored manipulation, prices have still climbed. "If this is suppression, I think it's completely ineffectual, and let me have more of it," Nadler says.
Philip Klapwijk executive chairman of GFMS Research Group, says there is "nothing to these allegations." He thinks they will continue to be chatter for silver prices in 2011 but that they will just be a lot noise. "If there was a massive short position, the degree to which those shorts are under water is now quite extraordinary."
... 4. Gold and Silver Ratio
Many investors use the gold/silver ratio to determine where silver prices will head. The ratio refers to how many ounces of silver it takes to buy one ounce of gold. If the ratio is high it means that silver prices have slipped. If the ratio falls, silver prices are outperforming gold.
The ratio has come down from over 60 to 36.75. According to 2010 closing prices, the ratio was 46, meaning it took only 46 ounces of silver to buy one ounce of gold. At the beginning of 2010, the ratio was 65.
In 1980, a previous high for both metals when gold was $850 an ounce and silver was $50, the ratio was as low as 17. Some bullish experts say that if gold and silver were to reach that ratio again, silver should be north of $80.
"If you moved to even 30:1, you would have a considerable swing in the value of the silver properties relative to gold," says Rob McEwen, CEO of U.S Gold, who, with two silver and gold deposits in Nevada and a silver deposit in Mexico, has a vested interest in higher metal prices.
Klapwijk says that the current ratio makes silver expensive in comparison to gold. This ratio is "not sustainable level in the long run" and will move up over time to up to 50. That doesn't necessarily mean that silver prices have to sell off, it just means that silver might not outperform gold but instead will lag the yellow metal.
Randall Warren, chief investment officer at Warren Financial Service, also thinks this ratio could correct. He argues that the 100 year average is about 50. If that ratio were to resume at today's prices, silver should trade around $30.
Warren is much more bullish on the ratio over the long-term. He thinks the ratio could hit 30 by the end of 2011, which would imply "longer-term higher silver prices by the end of 2011."
David Morgan argues that the ratio could fall as low as 16:1, which would put silver at $90, but says once that happens silver's bubble could be ready to pop.
"Most of us think it will do similar to what it did in 1980. When silver really accelerates during the final phase of the market, which we're not in by the way, we're actually in the second phase" and the ratio falls to 16:1. "That could suggest strongly that that's it for the metals for a while." Morgan says this could happen anytime between 2012-2015.
... 3. Currency Debasement
The most popular reason to own silver is as a hedge against inflation.
The theory is as paper currency loses value, silver will retain its purchasing power, making it a safe place to preserve one's wealth.
While many investors talk about silver's inverse relationship to the U.S. dollar, BullionVault's head of research Adrian Ash prefers to categorize it more broadly as "anti-currency."
The same applies to gold. "They are stateless, they don't have the burdens of debt, which any multinational currency has. They are a long-term story," Ash said, in describing their attributes.
Echoing Ash, Philip Klapwijk says that all three major internationally-traded currencies: the euro, yen and dollar, have generated some degree of "suspicion" from investors amid sluggish economic performance, "very" unattractive short-term interest rates and growing, massive sovereign debt obligations.
Chuck Butler, president of EverBank World Markets, expects the U.S. dollar to show another round of weakness in 2011, providing continued support for silver. Some analysts like Oliver Pursche, portfolio manager of the GMG Defensive Beta Fund, are even calling for the possibility of QE3 and QE4.
Even 'dormant' inflation is picking up in the U.S., with core consumer prices up 1.1%, versus a year ago, 2.1% if you count food and energy, which every other country does.
Despite the European Central Bank's recent rate hike, real rates are still a negative 1.35% in the eurozone, which means the euro is still worth less in the bank and hard assets are worth more. Silver prices have shrugged off rate hikes from the EU and emerging market economies. as well.
Ash was unfazed by rate hikes arguing that central banks would have "to raise interest rates by a long way before it really makes a difference for cash savers."
... 2. Industrial Demand
The industrial demand behind silver prices grew 20.7% in 2010 and is expected to be strong in 2011 but not remarkable.
Industrial demand staged such a big comeback as the global landscape recovered and was the first catalyst for higher gold prices, according to GFMS' recent Silver Survey.
"This year, this type of news will not be quite as unequivocally good," GFMS' Klapwijk said. "We've had such a significant rebound in industrial demand for silver that gains will be somewhat harder to come by this year compared to 2010."
Meanwhile, BullionVault's Ash has heard complaints about high silver prices from industry representatives, because the pass-through of these high prices are hurting their customers.
Ash wonders whether the industry will begin looking for silver substitutes, especially in newer uses such as solar panels and chips -- if prices become unfavorable.
"Has silver gotten over the fact that it's an industrial metal primarily?," asked Ash.
EverBank's Butler sums up his expectations of industrial demand for silver this year as "steady -- nothing phenomenal, but nothing that's weak."
The one thing silver does have going for it is a slew of new products never before imagined that use the metal, like iPads. "We've seen in the last year the growth in that type of use increase about 18%," says Phillips Baker, CEO of Hecla Mining, one of the largest silver producers in the world.
Baker, in fact, credits steady industrial demand with keeping silver prices afloat as investment demand ebbs and flows.
Japan's devastating earthquake and its repercussions could also provide a floor for silver prices as there will be high demand for the metal as the country is forced to rebuild itself.
... 1. Investment Demand
Silver investment popped 40% to 279.3 million troy ounces in 2010 led by a 24% increase in ETF holdings and coin and metal demand, which popped 28%. This trend looks set to continue in 2011.
Traditionally, silver investing was reserved for the fringe precious metal buyer, who thought global wealth would be eradicated and that silver and gold would be the only currencies left standing.
However, as the financial crisis rocked global markets at the end of 2008, a trend started to develop of regular investors allocating a certain amount of their portfolios into precious metals, although mostly gold, silver was included.
The biggest physically backed silver exchange-traded fund in the U.S., SLV, held 6,524.93 tons the Friday before Lehman Brothers declared bankruptcy and how holds 11,192 tons, or 360 million ounces.
The SLV added 1,428.60 tons just in 2010 alone while its smaller competitor the SIVR grew its holdings 81% to 16,627,688.2 ounces.
The advent of physically backed silver ETFs over the past five years has given investors an easy way of speculating on silver. One share of the SLV is equal to one ounce of silver.
If investors start piling into the ETFs, the funds must add more silver, taking more silver out of the open market and triggering higher prices. But the reverse is also true.
There have been reports of shortages of silver backed up by backwardation on the Comex, where the spot month trades higher then future months. The shortage is said to be a combination by strong demand as well as production shortfalls.
Short contracts on the Comex increased 24% in 2011 and if silver prices keep rallying, the shorts might be forced to cover their positions, which could be a catalyst for higher prices.
Klapwijk thinks $50 is a realistic price target for 2011.
But the fun might stop there. "One would expect to see fairly significant profit-taking at $50 an ounce," says Klapwijk, "because I do think that is a target for ... early investments in the metal. That could lead to a lot of volatility."
But the thing with silver is that most retail investors still don't own it, most news outlets don't even write about it, which is one of the fundamental reasons silver bulls think the price will skyrocket.
"We're going to go into a period like the high tech market where there is a mania," says Rob McEwen, CEO of U.S. Gold, who thinks the market is about half of the way there.
There have been other signs that investment demand is on the prowl, which was critical to silver's killer rally in 2010.
According to Patricia Cauley, director of metal products at the CME, open interest in contracts for silver grew 9.2% in 2010 versus 8.6% for gold. Open interest contracts illustrate the new buyers in the market.
Average daily trading volume was 76,000 contracts for silver in the fourth quarter of 2010 , which doubled from the third quarter and is up 82% from the same period a year earlier. Cauley says this points to a "renewed interest in silver.... As we see the price of gold keep going up. The poor man's gold has come back."
The silver trade might hit some more snags over the long-term.
First of all, investors are paying almost three times as much for an ounce of silver than they did in the beginning of 2009, so the "easy" money has already been made. The monster rally might scare off those who haven't bought the metal yet.
Silver prices are also very volatile. Because the market is thinner, a big buyer or hoarder can really affect prices. Silver's industrial component can also leave it vulnerable to signs of an economic slowdown especially in emerging market countries.
There is also a lot of pressure on investor demand to support high silver prices. The above ground supply of silver is increasing annually, mine production grew 2.5% in 2010.
Although industrial demand and new products are sopping up some supply, "heavier lifting is called for this year from the investor community just to keep the game alive," says Klapwijk. He estimates that several billion dollars of investment inflows are needed.
Billions of dollars of new investment inflows at recent record prices isn't impossible just daunting and puts a heavy burden on investors and traders to keep silver prices afloat.