Silver Looks Good, But Collapse Earlier this Year Continues to Weigh

LONDON (Reuters) – Silver prices look set for further gains after rallying more than 15 percent this month on gold’s coat-tails, but the metal will struggle to revisit this year’s record high near $50 an ounce after investors were burnt by May’s heart-stopping price correction.

Silver was one of 2010’s best-performing commodities and surged to a record $49.51 an ounce in April as investors favoured precious metals as a safe store of value during the euro zone debt crisis.

Those highs were swiftly followed by a sharp correction, however — in the five sessions after it hit its record, silver shed a third of its value.

“That whole experience is part of the explanation as to why silver hasn’t continued to highs on this particular run,” said Philip Klapwijk, executive chairman of metals consultancy GFMS.

“It overshot last time around, and there are still people who are licking their wounds.”

Silver has, as usual given its lower liquidity, outperformed gold this month as the yellow metal hit record highs after worries over sovereign debt spread to the United States. But that outperformance has been less notable than before.

The number of silver ounces needed to buy an ounce of gold has dropped to only 40 — during gold’s last rally to record highs, in late April, it fell to just above 30.

The fact that silver remains more than 20 percent below April’s record has suggested to some analysts that it represents an excellent buy at current levels.

“Gold has always preceded silver in hitting new record highs (due to liquidity and popularity of investing options to the public), but silver’s subsequent catch-up has rendered this pattern an attractive investment reality,” said Intermarket Strategy Chief Executive Ashraf Laidi in a report this week.

“The fact that silver is 20 percent below its high despite improving metals fundamentals presents a notable opportunity for silver.”

EACH-WAY BET

Silver has a much higher industrial offtake than gold, which some have suggested makes it an excellent each-way bet, with prices supported by its haven appeal if the economy struggles, and industrial buying if it recovers.

However, while demand from end-users like electronics manufacturers is likely to cushion any fall in silver, it is unlikely this demand would be enough to lift prices significantly higher.

Price gains to above $40 an ounce have been driven by rising investment in the precious metal. Implied net investment accounted for nearly 17 percent of silver demand last year, compared with less than 1 percent in 2001.

Interest in silver-backed exchange-traded funds has risen sharply, with holdings of the largest, the iShares Silver Trust, climbing by 165 tonnes in the first quarter of this year.

Chinese buyers also leapt into the market, with silver daily trading volumes on the Shanghai Gold Exchange shooting up to a then-record 2.178 million kg on April 26, shortly before spot prices hit record highs.

They had dropped to 404,183 kg by July 27, however.

“When I was in Beijing recently, I found a lot of the banks that had put investors into silver won’t now, because their customers had lost a lot of money in the crash,” said Credit Agricole analyst Robin Bhar.

“So investor wariness does play a part. Because of that I think you’re unlikely to see silver getting up to the recent highs,” he said. “However, all bets would be off if gold goes to $1,650. Silver will follow gold, and it could make new highs.”

GOLD AWAITS FRESH MOMENTUM

For the moment, gold remains steady above $1,600 an ounce, awaiting fresh news on the progress of the U.S. debt talks.

While any progress on these could spark a short-term drop in both precious metals, plenty of supportive factors remain.

Interest rates remain near historic lows — cutting the opportunity cost of holding non-yielding precious metals — the prospect of rising inflation in emerging markets is unsettling investors, and concerns linger over the outlook for paper money.

These factors are likely to cushion falls in gold and silver prices, while putting the metals in a strong position to benefit from further risk-based rallies. But this does not necessarily mean silver is set to re-challenge $50 an ounce imminently.

Investors have learned to be wary of viewing silver as just a cheap and cheerful substitute gold, and their caution is likely to take the heat out of near-term buying. Some investors are happy to bank on silver’s future being rosy, but for others, that may not be enough to override fear of its volatility.

“If you say, shall we reduce exposure to silver or increase?, I would say, make sure you increase,” said London & Capital’s senior portfolio manager Pau Morilla Giner. “But do it knowing that this is not going to be a quiet ride.”

“If you are happy to have that volatility allowance, then go for it — because it’s a good place to be.”

(Reporting by Jan Harvey; Editing by Alison Birrane)

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