Nouriel Roubini's Global EconoMonitor

RGE’s Wednesday Note – Will Silver Sparkle in 2010?

In this week’s note, we examine the price drivers of silver, the least “precious” of the precious metals. The following content is drawn from an RGE Analysis by Mikka Pineda, “Will Silver Always Be Second to Gold?” which was released to clients last week. For more related analysis on silver, gold, the base metals and other commodities, please see RGE’s extensive Q1 2010 Commodities Outlook.

Though silver‘s long-term fundamentals point to a life of underperformance versus gold, RGE thinks the metal might well outperform in the short-term. Both technical and fundamental drivers have built a case for a silver rally. Silver may never reach the price level of gold but it will gain more than gold relative to their respective 2008 troughs.

From a technical perspective, a deeper liquidation of long positions as a share of open interest gives silver more upside potential than other precious metals. Silver’s higher price volatility compared to gold opens up short-term opportunities for higher capital gains.

From a fundamental perspective, silver is better placed than gold to enjoy the global recovery in industrial production. While non-investment demand accounts for 94% of total demand for silver, non-investment demand accounts for only 62% of total demand for gold. Silver has several large-scale industrial uses—photography, silverware, solar panels, etc.—whereas the physical use of gold lies mostly in jewelry.

A few other factors could boost silver’s performance. From a supply perspective, known government stockpiles have fallen to 72 million ounces as of end-2008 as governments have been coining them or slowly off-loading their silver reserves to the market since moving off the silver standard. It is unknown precisely what other preexisting supplies of silver remain.

Meanwhile, alternative uses for silver have been rising, particularly as demand from the photography industry dwindles due to the shift toward digital cameras. The establishment of new silver exchange-traded funds (ETFs) could also tweak the metal’s price drivers. As of February 4, 2010, eight silver ETFs held a combined 467 million ounces of physical silver, equivalent to 53% of the annual world supply in 2008.

Even if silver outperforms gold in the near term, however, it doesn’t seem at all likely to approach gold’s price levels, and RGE expects gold will always be more precious than silver in the long term. Silver is 16 times more abundant in the earth’s crust than gold, and world mine production of silver has been increasing since 1999. The supposed silver shortage applies only to large speculative investors in the futures market. Physical users of silver do not face position limits in the futures market or physical market. Finally, gold is the first stop for investors seeking an alternative store of value not tied to national fiat currencies, including central banks in search of moderate diversification.

All rights reserved, Roubini Global Economics, LLC. Opinions expressed on RGE EconoMonitors are those of individual analysts and may or may not express RGE’s own consensus view. RGE is not a certified investment advisory service and aims to create an intellectual framework for informed financial decisions by its clients.

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