Silver's split personality feeds steep price drop
SAN FRANCISCO (MarketWatch) -- Silver's split personality as an industrial and precious metal contributed to a steep drop for the second quarter, as the metal's economic demand prospects and safe-haven appeal duel for investors' attention.
"Silver had more froth in the price to work off versus other commodities," after its "'bubble-esk' run up in 2011, where it almost doubled over the course of three months," said Elliott Orsillo, co-founder and portfolio manager at Season Investments LLC.
Futures prices for silver (SIU2) peaked above $48 an ounce in April of last year. It traded above $37 at their peak this year so far.
But after the September contract closed Thursday at $26.29, silver's on track for its biggest quarterly loss in almost four years, down 19% quarter to date, according to data from FactSet Research, as of Thursday. That compares with a 7.2% decline in gold futures over the same period.
"The slide in silver prices mirrors the stubbornly sluggish global economy, and the strength of the U.S. dollar," said Keith Newcomb, portfolio manager at Full Life Financial LLC. "Both have led investors to be more willing to sell silver than buy it."
And analysts are divided on whether the metal is fairly priced or undervalued at current levels and which of its identities, industrial or precious, has been driving it the most.
The metal's "slightly schizophrenic," said Christopher Ecclestone, a mining strategist at Hallgarten & Co. "The bulls oscillate between the two different uses in touting silver's attractions."
The metal's also, "mainly, a creature of retail investor interest," he said. "As other assets get cheaper (such as property, mainstream equities and bonds), then investors have more choices. Metals are not the only assets in times of doubt because other things you were waiting to get cheaper suddenly do."
'Schizophrenic'
Silver's dual uses sometimes add to the metal's volatility -- and clouds its outlook.
It's been "very susceptible to following base metals this year, all of which have felt the burden of coping with a very weak economic recovery in the U.S. and economic data which [show] a contracting economy in China as well as several European countries," said Roy Friedman, executive vice president of business development at Dillon Gage Metals.
So it "would be true to say that silver has been both acting and reacting as an industrial metal this year," he said.
But Julian Phillips, a South Africa-based editor at SilverForecaster.com, believes that silver is "moving with gold as a monetary asset, despite not being recognized as such." Industrial demand for the metal is "strong because its uses fall into the 'need' category," where it's used in electronics, solar panels and the medical field, Phillips said.
"With the monetary stresses now and for the next few years at current levels, there is little reason why prices should fall," he said. "Gold will react more and more as a monetary metal and the silver prices will move with it, not with economic conditions."
In fact, silver's industrial component may not have any influence at all on the metal's price at these levels, said Brien Lundin, author of the Silver Bullet Strategy report, published by Gold Newsletter.
Silver's rise from $10 in late 2008 to about $30 two years later was "purely due to monetary factors -- the massive monetary reflation following the credit crisis of 2008," he said. "Until silver gets back down below $10, I don't think its industrial supply/demand dynamics will have any significant effect on the price."
Fair bargain
At under $30 currently, silver may be a bargain but it's also close to its average value versus gold over the past two decades.
The gold-silver ratio, which is the price of gold divided by the price of silver, sits at around 59.
"In the last 20 years, this ratio has been trading between 30 and 90, so we are right in the middle of that range," said Michael Arold, a Covestor model manager. "Silver is neither expensive nor cheap."
Edmond Bugos, director of mining finance at Strategic Metals Research & Capital considers silver to be "relatively cheap" when the gold/silver ratio is above 65, and expensive when it is below about 55.
"Both gold and silver are fair value today, neither cheap like the days before 2006, nor expensive like a bubble," he said. "Both assets are likely to provide relatively good returns in the current financial environment, but volatilities are now higher."
On the other hand, Dawn Bennett, founder and chief executive officer at Bennett Group Financial Services LLC, said that so far, "silver has been acting like gold's ugly step-child this year," and based on technical analysis, silver is cheap.
Prices may rebound to $30-$50 an ounce by the end of the year and over the "longer-term horizon," become an $80- to $100-an ounce commodity, she said. "Silver, along with gold, are beginning to act as the safe-haven trades again."
Indeed, "silver is cheap right now, when you consider the downside risk is likely limited, while the upside potential is really quite remarkable if we get quantitative easing in Europe, the U.S. or both," said Lundin.
"Europe should continue to move in a slow-motion fashion, but eventually Germany will have to accede to some sort of additional easing if there's any hope of preserving the euro zone, or anything even vaguely resembling it," he said. "This would be very bullish for gold and silver."
Best approach
Looking ahead, some analysts warn of the potential for near-term declines for silver, but the long-term picture is bright.
"The bottom line is that silver is very cheap and very underpriced at these levels," said Paul Mladjenovic, author of Precious Metals Investing for Dummies, who expects silver to "zig-zag" to $100 during the next few years."
On a technical level, silver has a lot of room to fall if prices complete "the current technical formation," by closing below $26, according to Covestor's Arold. "Every trader is watching this level and a break could trigger a lot of stops. After that, we could see a quick move to the $20 level."
As for which precious metals he'd prefer, Nick Barisheff, founder and chief executive officer of Bullion Management Group, said he'd "recommend gold, silver and platinum in a blend of physical precious metals for a safe-haven investment."
And investors "must shun paper promises for bullion in the form of derivatives, futures contracts, options or certificates," he said. "We like the analogy of 'when there is a fire, which would you rather have -- a fire extinguisher or a picture of one'."
"The same applies to purchasing precious metals. You want the real bullion," he said.
But for those wanting to invest in other ways, there are silver equities and exchange-traded funds.
"Silver stocks, like all the metals stocks, are bombed out right now," said Gold Newsletter's Lundin.
"At these low levels, the upside potential is particularly enticing when balanced against the potential downside risk," he said, with
Meanwhile, ETFs are "typically the lowest cost option for investors when factoring in commissions, spread cost, storage costs and expense ratio on the fund," according to Season Investments' Orsillo.
For the quarter, however,
"For the average investor I think that keeping an eye on SLV is a good idea," said David Laidlaw, president of Clarus Wealth Management, but "I would not be likely to invest in silver at this price."
"As an investment class, I would rather own a silver mining company as any new vein or influx of inventory will raise cash flow better than owning, say, a bullion index fund like SLV, would," he said.
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