Commodities, more than any other variable, are dictated by the laws of supply and demand. And, when it comes to the bull market in precious metals since 2001, some metals are now poised to reach new all-time highs amid production deficits while others remain increasingly hostage to an onslaught of new supply.
Silver falls in the latter camp. More than any other precious metal this year, silver will face the tacit test of price resilience under the growing bombardment of new production.
Over the last five years, silver prices have surged more than 250% to just under $17 an ounce currently. On May 20th, my Commodity Trend Alert (CTA) signature investment service, turned “neutral” on silver after earning big profits for my members on several existing open positions since 2003. Rising supplies now threaten to trigger a sizable correction.
While gold production peaked in 2001 and continues to decline this year – highly bullish for prices – that’s certainly not happening for silver and, to a lesser extent, palladium.
Is Divergence Possible?
Like gold, silver fabrication demand for jewelry has declined since last year as prices continue to head higher. Indian gold demand has declined sharply since roughly $750 an ounce. But unlike gold, primarily a monetary metal, silver is more of an industrial metal. Both metals generally follow each other in a bull or bear market, but, in this case, a divergence might be possible, if only temporarily.
In the base metals arena, a similar price divergence has already occurred following seven years of generally spectacular gains for the complex – namely copper, lead, tin, nickel, iron-ore (steel), aluminum and zinc. Over the last 18 months, nickel and zinc prices have crashed while tin, lead and copper prices have posted gains. It’s not impossible for metals to break away from the primary uptrend if supplies begin to saturate individual fundamentals.
Over the last 12 months, gold prices have risen 37% while silver has gained 31%. Both metals continue to track each other on a total return basis. But thus far in 2008, gold prices have risen just 8% while silver has rallied 15%. The fundamentals, however, don’t support silver’s superior returns this year.
Will Investor Demand Support Silver?
Gold is rapidly approaching its first year of net supply deficit while silver is increasingly becoming a net surplus commodity. And according to textbook economics, rising supplies eventually dilute a rising price trend to the point of exhaustion.
The bulk of global demand for silver going forward will have to come from investors – mainly from exchange traded funds like SLV, or the iShares Silver Trust in the United States, and other silver ETFs traded in London and Zurich.
I have serious doubts investor demand will continue to support silver at these levels without suffering a major correction first.
The iShares Silver Trust has already seen a massive increase of silver accumulation since 2006 – over 180 million ounces. Silver supply has surged since 2001, according to GFMS, a precious metals consultancy firm, rising to 670.6 million ounces; unless investor demand consumes this rising supply – and more is projected in 2008, then prices will decline. That’s because industrial demand has probably peaked.
Last year, industrial demand for silver increased 7.2% to a record 455.3 million ounces, according to the 2008 World Silver Survey. That offset the long-term decline in demand for traditional usage, mainly in photography, jewelry and silverware. But another survey by Barclays Capital points to alarm bells emerging as new supplies hit the market this year. Barclays believes mine production will grow by 6.5% in 2008, faster than last year’s increase of 3.6% and possibly the largest surplus of silver in over 20 years.
A disappointing initial public offering (IPO) in London is another bearish signal for silver bulls. Mexican silver company, Fresnillo PLC, went public in London earlier this month and declined 7.5% on its debut – a bad sign. Despite stronger silver prices this year, the IPO was not well received.
Gold and Platinum: Precious Metal Kings
Though I’m not bearish on silver longer term, I think it’s time to reduce your exposure amid current price strength. The big picture for sister metals, gold and platinum, however, remains incredibly bullish as supplies tighten.
Platinum is by far the only precious metal threatened by a severe shortfall in production in 2008. Prices can double over the next 12-24 months. South Africa, where most of the word’s total platinum supply is mined, continues to suffer from severe production bottlenecks. Strikes, power outages, a plunging rand and soaring input costs have hammered platinum production since 2007.
Gold is also rapidly approaching a net deficit situation.
Gold supply is not keeping up with rising demand – mainly from investors, exchange traded funds and even central banks in the emerging markets. The devastating gold bear market of the 1990s resulted in little new mined production, especially as central banks in the industrialized economies went on a dumping binge depressing prices until 1999. Mine production peaked in 2001 and continues to decline following a 3% reduction in 2006 and a 1% decline in 2007.
Recently, Newmont Mining and Barrick Gold both warned of rising production problems as gold mining becomes a challenging business, even in the midst of record high prices. According to Newmont’s CEO, Richard O’Brien, “It’s more unlikely that we’ll find big deposits, near the surface, that are economic to mine. We see a continued decline in production – not just ours, but everybody’s.”
Barrick Gold’s Chairman, Peter Munk, recently addressed a shareholders meeting in Toronto, Canada, claiming “mining is a very challenging business as input costs surge.” Barrick forecasts mine supply will decline 10-15% over the next five years because of a lack of new production coming online.
Stick to Companies that Grow Production
I’m confident that mining companies that can grow their production will make the most money for shareholders. I’ve avoided Newmont Mining since 2006 and don’t hold a stake in Barrick Gold, either. Instead CTA is glued to those producers that have an ability to grow production and increase gold output. That’s where the real price leverage lies.
We also generally avoid hostile foreign governments or companies that mine in Latin America (excluding Mexico) and parts of the Caspian Basin where nationalization continues to threaten operators.
Silver remains a viable long-term speculation. But it’s not primarily a monetary metal and worse, supplies are no longer in deficit. I’m still holding my silver positions and would advise investors simply lighten up in favor of gold and platinum, where fundamentals are far more bullish amid falling production and tightening supplies.
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