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Silver linings may only be short term

Silver may appear to have many short-term prospects but there is talk of a possible bubble in the longer term

By John Kenchington | Published Sep 24, 2012 | comments

When it comes to public perceptions of precious metals, gold is king.

The yellow metal grabs headlines on a daily basis, and the asset management industry reflects this by offering a plethora of gold-themed investments.

In a sign of investors’ increasing conviction that gold prices are in a long-term bull market, in August 2011, IndexUniverse.com calculated that the SPDR Gold Shares exchange-traded fund (ETF) had become the largest ETF in the world.

With all this focus on gold, a report published on September 15 by Lloyds TSB could have come as a shock for many investors. The bank’s second Private Banking Commodities Monitor, which tracks the movements of 20 major commodities, calculates that the price of silver sharply outperformed that of gold in the decade to August 30 2012.

In 2002, the report says, the price of a troy ounce of silver was $4.57 (£2.82 in today’s money), but 10 years later, at the end of August 2012, this had reached $30.66 – meaning silver prices gained a staggering 572 per cent. This was “significantly greater than any of the other commodities tracked”, the report says.

Gold, which rocketed up 428 per cent, was only the second-biggest gainer over the period, followed by tin, which rose 414 per cent, copper, which increased 406 per cent, and lead, which appreciated 344 per cent. But silver has also been far more volatile than gold, particularly as commodity prices have fallen sharply in the past 12 months, according to the report. It shows that from the start of the year to the end of August, the gold price shed 10 per cent, but silver plummeted by 25 per cent.

Further demonstrating the metal’s ferocious volatility, the price at the end of August was also sharply lower than the metal’s all-time high at $49.84, reached in April 2011, according to Bloomberg data. This equates to a devastating 38.5 per cent slump in the space of 16 months.

By way of explanation for the longer-term gains in silver prices, the Lloyds TSB report points to “high demand for industrial uses” of silver, in addition to its status as a ‘safe haven’ asset – which it shares with gold.

“Commodity prices have risen significantly over the past decade, partly reflecting strong demand from emerging markets over the period,” says Lloyds TSB Private Banking’s head of investment Ashish Misra.

“Precious metals were the best-performing commodity, with their perceived position as a safe haven investment reinforced over recent years amid the financial market turmoil. However, with continued global economic uncertainty, commodity prices have weakened somewhat over the past year.”

But which industrial properties in particular have given silver the edge that has seen it outperform gold by 144 percentage points in the past decade?

The research team at The Silver Institute, a global non-profit association that represents the silver industry, believes it has the answer.

“Silver enjoys a number of technological benefits, which makes it ideal for a range of industrial applications,” says the Institute’s March 2011 report on ‘The Future of Silver Industrial Demand’.

“In particular, the metal is one of the best electrical and thermal conductors, which makes it the ‘metal of choice’ for a variety of electrical end-uses, including switches and contacts.”

The report lists so many industrial applications for silver that they are too numerous to mention here. In particular, the report focuses on uses in electronics including circuit paths, capacitors, membrane switches and electronically heated car windscreens and conductive adhesives.

In addition, the metal is benefiting from government incentives supporting the generation of clean energy – with silver forming a fundamental part of the technology in ‘photovoltaic cells’, which make solar panels possible. But perhaps most significantly, silver’s properties position it ideally to benefit from the growth of emerging markets.

“Silver conductive inks are also now used in the area of printed electronics, to meet the need for low-cost processing in high growth and emerging markets such as organic light emitting diodes and sensors, as well as for radio frequency identification tags,” the report says.

Looking to the future, silver’s unique properties mean it is often difficult to substitute other metals in most areas of industrial use, although in bull runs for the silver price companies do devote research efforts to other areas to ease costs, the report notes. In terms of the investment outlook, the usual gold and silver bulls – such as Sector Investment Managers’ Angelos Damaskos and BlackRock’s Evy Hambro – have been relatively quiet in recent months amid warnings that the metals’ prices have reached ‘bubble’ levels.

In a fund manager report, written at the end of July this year, Mr Hambro did reveal he was boosting his weighting in silver developer Tahoe Resources after “the political risks associated with their key project in Guatemala alleviated”. Other-wise, commodity gurus have been quiet on silver.

There are immediate price drivers which could justify a short-term positive outlook for the metal. The most significant was US Federal Reserve chairman Ben Bernanke’s recent announcement of a $40bn a month open-ended programme of quantitative (QE) easing to fuel recovery in the world’s biggest economy.

The Fed’s QE announcement comes on top of existing monetary easing measures in all the world’s major currencies, which are positive for precious metals including silver because their inflationary effects cause investors to trade out of global currency and into ‘safe haven’ commodities.

Overall, the Fed’s recent QE3 announcement is an exciting short-term driver, and silver’s increasing scarcity of supply and its unique properties – which give it a role in the clean energy industry and relevance to emerging market growth – certainly make for a tempting long-term investment story.

However, silver may have outperformed gold in the past decade, but past performance is, of course, no guide to the future. Ultimately, talk of ‘bubble’ valuations and the commodity’s extreme volatility are likely to see silver fail the due diligence test for most financial advisers for the foreseeable future.

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