Analysis: Silver defies bears to target $40 and beyond

By Amanda Cooper and Jan Harvey

LONDON (Reuters) – Silver has not shaken its bad-boy image of an unpredictable metal with high volatility and chronic oversupply, but this is unlikely to deter investors who seem set on driving prices beyond their current 31-year highs.

Silver is the top performing precious metal so far this year, having risen 28 percent against a 2.8 percent rise in gold

and a 2.5 percent loss in last year’s darling, palladium.

Investors have flocked to precious metals since late August, when the Federal Reserve signaled it would resume buying government bonds to support the U.S. economy, undermining confidence in paper currencies and stoking inflation fears.

But silver has comfortably outperformed bellwether precious metal gold. The gold:silver ratio, which shows how many ounces of silver are needed to buy an ounce of gold, fell to its lowest since 1983 this week below 37, against around 63 a year ago.

Many investors rail against the metal’s volatility, and say they do not believe silver has either the safe-haven properties of gold, nor a favorable enough ratio of supply to demand to compete as an industrial commodity bet.

But it is proving increasingly difficult for even the most silver-skeptic money managers to remain impassive.

“We’ve been of the opinion that silver is overvalued for some time now and we’ve been consistently been proven wrong,” said Thomas Benedix, who helps manage the $2.4 billion in commodity assets at Swiss fund manager Tiberius.

“We are trying to find out where the blind spots are in our analysis and we haven’t found them yet. What we do know is that investor-related demand is probably higher than we’ve been anticipating, as is demonstrated by skyrocketing U.S. Eagle coin sales and strong ETF demand.”

Flows into silver exchange-traded funds (ETFs), which issue securities backed by physical metal, are worth about $360 million so far this year.

Some investors are clearly buying into the argument for silver as a more affordable proxy for gold. In the current uncertain economic climate, precious metals as a safe store of value and a hedge against inflation can seem attractive.

DEVELOPING MARKET GROWTH

Silver bulls also cite the potential for growing industrial demand, especially in the fast-growing developing world, and for newer applications like solar panels. Surging prices may curb demand growth in some areas, but it is still expected to grow.

As a particularly malleable and ductile metal, it is widely used in a range of industrial applications, chiefly in the electronics sector. Metals consultancy GFMS estimates that silver industrial demand could grow by to 40 million ounces this year from 487.4 million ounces last year.

It is the two-pronged support of a rise in industrial offtake and ongoing support from investor nervousness in western markets that is expected to continue driving silver prices.

“If you want to capture the two themes which will be with us for the next decade — population and GDP per capita growth in emerging markets, and low growth and a lot of stimulus in developed markets — you cannot ignore the silver story,” said Pau Morilla-Giner, portfolio manager at London & Capital.

But some investors, analysts argue, are simply being caught up in the euphoria surrounding precious metals investment.

“There are good fundamental reasons supporting silver,” said Mitsui Precious Metals analyst David Jollie. “What is difficult to know is the balance between those, and a normal investment flow, and an investment flow that is driven by the price.”

Bullish and bearish views aside, few believe silver is set to return to a more historically usual price below $10 an ounce, where it spent much of the last decade and the entire 1990s.

But some fallback may be due after the metal’s spectacular price rally of the last year — analysts have only to look at the recent correction in last year’s biggest riser, palladium, to see how vulnerable even the best-supported commodity can be.

And silver, which is in ample supply and far more a hostage to investor whims than other industrial metals, is no palladium.

“What really makes us a little bit cautious about silver is if the prices are rising just because everyone is buying,” said Carsten Menke, an analyst at Swiss private bank Julius Baer.

“I don’t want to base my investment decision on the behavior of other people so we are more focused on metals that have a sound fundamental backdrop like platinum and palladium.”

Nonetheless, the rise in silver prices is showing few signs of slowing down, and as long as gold is continuing to hit new highs, silver too will go along for the ride.

The precious metal is closing in fast on the $40 an ounce level, and many analysts say silver may realistically be set to challenge $50 an ounce — a new record high, and above its current record high LBMA fix of $49.48 an ounce, set in 1980.

“It could make new nominal highs and then absolutely crash,” said Bache Commodities analyst Andy Smith. “I was uncomfortable at $20, but I don’t see many fading it.”

“Of all the precious metals, silver is the only one that has really added to positions since (the) Jackson Hole (meeting),” he added. “It’s that craps-table casino appeal that is keeping it going.”

(Editing by Alison Birrane)

Analysis: Silver defies bears to target $40 and beyond