Silver: Riding on the coat-tails of gold

Silver’s dual role makes it a prized possession for users and investors alike and drives its market prices. Silver is used in a range of sophisticated industrial applications and for jewellery and investment purposes, too.

The metal occurs naturally in its pure, free form as native silver. But most silver is produced as a by-product of copper, gold, lead and zinc refining.

Prices have yo-yoed in the last five years from an average of $14.6 an ounce in 2009 to the peak of $38.8/oz in the third quarter of 2011, only to settle at $20.8/oz in end-2013. The world silver market has been in a state of surplus for many years now.

Yet prices escalated because of the metal’s haven status, riding on the coat-tails of gold.

Silver prices have been strongly correlated with those of gold, most often moving in tandem.

But now that global growth signals are picking up momentum under the lead of the US and the excess liquidity that drove commodity prices higher is sought to be gradually withdrawn, the silver market’s fundamentals are coming to the fore.

Both total physical supply and total fabrication demand are unlikely to show any significant changes in 2014 and 2015.

Output from the world’s largest producer Mexico followed by China and Peru is set to remain nearly unchanged.

While China is seen using more advanced recovery techniques for increasing the by-product yield, a fall in output of mined lead and zinc has meant slowing silver production in the Asian major. As scrap supply is positively correlated to the price of silver, falling silver prices are set to shrink the scrap availability.

Historically, the share of recycled silver out of total supply has been around 20 per cent.

Industrial demand traditionally accounted for over 60 per cent of the total demand for silver. However, following the financial crisis of 2008-09, investment demand picked up markedly, as a result of which silver prices escalated sharply in tandem with gold prices. Even now, industrial demand accounts for over half of total demand.

Within industrial demand, electronics is one of the biggest sub-categories. Smartphones that are witnessing booming sales require a higher content of silver than normal mobile phones.

Silver is also used significantly in solar panels used for generating power. Europe, China and Japan are the three largest sources of demand for solar panels.

Investor demand is expected to remain the most important driver of silver prices.

ETP (exchange-traded product) inflows have supported prices. Interestingly, silver did not face the heavy outflows that gold ETPs faced recently.

If that were to happen for whatever reason, silver prices could potentially crash because a source of demand will turn into a source of supply. Importantly, an improvement in the US economic outlook represents a very specific risk to silver prices, given that US investors have been one of the principal groups of investors purchasing the metal over the past few years.

So, the underlying market fundamentals are set to remain unaccommodating this year.

A 6,000-tonne annual surplus for the third year in a row representing a quarter of total fabrication demand or a fifth of total physical supply is burdensome to the extent of tightly capping any significant upside price surge.

For 2014, silver will likely average $19/oz, down from 2013 actual average of $24/oz. Prices are likely to suffer downward pressure in the coming quarters and into 2015 towards $17/oz.

Alternatively, but in a less likely scenario, silver prices can face upside risks should global economic growth flounder or geopolitical risks were to escalate.

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