SILVER: Punished by recession concerns and price links to gold

SILVER: Punished by recession concerns and price links to gold

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Until very recently in 2011, silver’s precious metal status and, therefore, its links with gold have been strongly reinforced by investors’ preference for hedging systemic financial risk, rising inflationary pressures, and resurgent political risk in MENA through a cheaper vehicle with characteristics similar to gold as a store of value.
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However, successive increases in the Comex margin requirements for investors in the silver futures market in May 2011 and mounting concerns about the threat to industrial demand for silver from a possible policy-induced recession in Europe have put silver’s price relationship to gold under increasing pressure.
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A spectacular rally in the silver price between late March and May, led by retail investors, caused the gold:silver ratio to narrow sharply, reaching its lowest point since October 1980 in early May 2011 at 30:1. Following successive increases in the Comex margin requirements, the gold:silver ratio stabilized at around 40 to 45:1 until the third week of September when a 23.4% fall in silver prices pushed the ratio back close to the long-run average of 54:1 despite an 18.5% fall in gold prices. Consequently, the “normalisation” of this price relationship once again has led us to adopt a 52:1 ratio for price forecasting purposes. This has resulted in quite large falls in our silver price forecasts for 2012 and 2013 but an increase in our long- term silver price forecast by 12%.

Gold Silver ratio

SILVER: Physical investment demand remains supportive, but industrial usage wanes

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In our view, the worst of the falls in the silver market are probably over for now. As with our gold price forecasts, we expect the recent sharp decline in prices will again attract bargain hunters, especially if renewed concerns over the sovereign debt crisis in Europe prompt a strong revival in silver’s safe-haven status.
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Furthermore, as with gold, an expected lengthy period of negative real interest rates in the US should reignite investment demand for silver as a non-yielding asset, even in the absence of a renewed round of QE in the US.
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An extended period of negative real interest rates will also be critical in quarantining the risk of large outflows of silver from physically backed Exchange Traded Funds (ETF). To date, recent evidence suggests that long liquidation pressures have been stronger in the paper silver market than in the physical investment market.
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The key downside risks for silver are that the weaker economic outlook in 2012 and 2013 will cut fabrication demand but not enough to take prices back to levels that would deter anticipated strong mine production growth and a rising surplus.

SILVER GLOBAL SUPPLY AND DEMAND