The bear camp has had firm control of the silver market for the past three months as the U.S. dollar has made gains. Commodities bought in the dollar tend to move somewhat inversely to the U.S. Dollar Index (see chart). Unlike gold, silver has many industrial applications other than primarily constituting a means of storing wealth in tumultuous economic times. While it is impossible to know for sure where prices will go from here, I am looking for the silver bears to run out of steam.
Supply and Demand Story
On Nov. 6, 2014, the U.S. mint suspended the sale of U.S. Eagle coins citing a lack of silver supply. This news follows a break in gold prices to their lowest in more than four years, which produced a spike in demand for silver and gold coins. According to the Silver Institute, scrap supply to the market in 2013 experienced the largest year-on-year reduction since the 1980s and was due to a combination of softer silver prices and a lack of recycled coins and jewelry. Scrap silver has been a key aspect of the physical deficit in 2013 as scrap provided less than 20% of total silver supply in 2013 after averaging 25% in total supply the previous two years. Total physical demand for silver stood at a record 1,081 Moz last year.
Asia experienced a 3% increase in silver industrial demand led by solar panels that use a lot of silver. China has seen a recovery in the electrical and electronics sector spurred by government support for the solar movement throughout the country. Deutsche Bank published a report this week that solar electricity is on track to be as cheap as or cheaper than average electricity bill prices in 47 U.S. states by 2016. With the current tax credit on system costs set to expire in 2016, even if the current 30% tax credit was reduced to 10%, Deutsche projects that 36 states would still reach solar reach price parity with conventional electricity over the same time period.
At the moment it seems that the supply deficit in silver has people focused on getting a hold of as much physical silver as possible. With paper prices of silver at four and half year lows, it will be interesting to see how the price reacts to a lack of physical silver to be passed around. As our trade deficit with China sets new highs, alternative stores of money may see renewed interest. The chart below shows the December daily silver contract on the year. As the price of silver is already below the cost of production for higher cost mines, with the consensus cost of production hovering around $18 to $22 per oz., there should be support around $15. While past performance is not indicative of future results, the gold to silver ratio is currently at 75:1 and historically has not been wider than that for very long. A 14.4% retracement from July 2014 highs would push silver back above $17 where this downdraft started as noted in the chart.
While the market look strong, trading silver is risky and the white metal is extremely volatile. The technicals remain negative for silver so use caution when entering this market.