Silver Price October Correction

By: P_Radomski_CFA

With less than three months left until the end of the year, let’s do a quick recap. Silver may not be as shiny as gold, but it has been no pushover to the yellow metal. So far in 2012, silver has been the top performing precious metal with a gain of nearly 24 percent. The gold/silver ratio, the number of ounces of silver needed to buy one ounce of gold, fell below 52.0, from closer to 52.5 earlier this week, reflecting silver's outperformance relative to gold.

The silver market is often volatile catapulting higher or fainting in a swoon with little volume. This scares a lot of investors away. But here are a few things to consider. The makers of solar panels consume about 11 percent of the world’s supply of silver, the material in solar cells that conducts electricity. It seems easy to make the argument that global demand for solar panels will rise along with concern for the environment and demand for green energy. This need alone could sustain much higher prices. The output capacity of the metal is hardly keeping pace with the industrial demands for silver that also includes batteries, cameras and medical equipment. Many investors scared away by the volatility of the silver market may miss the boat.

The second runner up in the precious metals hit parade is platinum. The price of platinum rose by 20 percent in the space of two months after a series of violent strikes in South Africa shut down much of the country's production and left about 50 people dead. Almost 80 percent of the world's platinum comes from South African mines. Even with the fragile supply line, analysts are less optimistic about the price prospects for platinum this year and next, according to a Reuter’s poll this week. Platinum is used in the automotive industry, which has been hard hit by the economic downturn. This poses enough of a threat that analysts expect a median platinum price of $1,559.50 in 2012, compared with forecasts three months ago for an average price of $1,572, according to the survey.

Much has been written about platinum’s decreased potential due to the 2011 tsunami and earthquake in Japan, but we believe that this metal will be able to move up strongly in the following years, once again exceeding the price of gold.

With much focus of today’s essay on silver, let’s see how the white metal may fare in the coming weeks. We turn to the technical part starting with analysis of silver itself (charts courtesy by http://stockcharts.com.)

In the long-term chart for silver this week, no conclusive outcomes are provided. Silver has corrected somewhat, but this could simply be part of a sideways trading pattern similar to what was seen at the end of 2009. Short-term declines do not say anything about whether additional moves to the downside are coming or not (like in the final months of 2009).

In the short-term SLV ETF chart, we have a rather negative picture this week. Prices have moved below the 20-day moving average and since this has provided support and resistance several times in the past, such a breakdown is a clear negative factor.

The white metal is tricky from a technical perspective. If the rest of the metals rally, then silver could move higher as well, similar to what we saw in February 2012. We cannot rule out this type of performance once again in the weeks ahead.

The points made above are largely consistent with what we wrote on silver in our essay on the possible correction in silver on October 2, 2012:

(…) silver looks like it’s about to correct, and this correction may or may not be seen immediately. A few days of consolidation is possible before a price correction, and it seems best to wait before entering any speculative long positions at this time. Also, when the rally resumes, the white metal may yield better returns than the yellow one.

All in all, based on the current technical picture for silver, we can infer that the white metal is likely to correct significantly in the following weeks, but we are not that certain about the following days.

Today’s Premium Update (the full version of this essay) included a reply to several questions regarding gold & silver portfolio structure and two them were about silver. You will find them below.

Q: As far as holding physical metals, it appears that you recommend 30-60% of total physical assets held be in silver. Is that correct?

A: Yes, we are speaking of the ratio of physical silver to all physical metals (gold, silver, platinum). Depending on individual circumstances, our suggested silver share is mostly between 30% and 60%. Generally, the higher one's risk tolerance, the higher the share of silver.

Q: I realize all of the arguments one could make in favor of silver. Still, I can't see gold going to $800; I can see silver going to $15 though; so does it really belong in the 'insurance' category?

A: Yes. You can imagine silver going to $15 and so can I. Silver is more volatile, so if both metals correct more than half of their prices then silver will probably correct more. This is highly improbable in my view, but yes, it is something that could happen. What's even more unlikely is that silver would move to $15 and stayed there for months. The chance of that is very low and can be viewed as a kind of cost of owning silver in the first place. However, the whole idea of insurance per se is to pay a little now (the cost of insurance) in order to make sure that some serious event will not hurt you in the future. Insurance is meant to be a cost. If it wasn't, it would generate no revenue for the insurance companies and in this case, they would not exist in the first place.

In the case of standard insurance, you pay a fixed amount in cash. In the case of silver, you don't really pay anything for insurance. You take a small risk (small based on the fundamental situation) that you will lose on your silver investment and that is your cost. However, unlike standard insurance, you are not simply paying the insurance fee without any profit. Silver has huge upside potential and is very likely to provide substantial gains in the coming years.

What does silver insure you from? From the monetary crisis in which the value of fiat currencies will likely collapse. This is an event that we, unfortunately, view as quite probable in the coming decade. In this case, silver and gold will, in all likelihood, soar as people recall that these two metals have effectively been money throughout history.

Summing up, the picture remains bearish for silver in the medium term, but very bullish in the long run.

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Thank you for reading. Have a great weekend and profitable week!

P. Radomski
Editor
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