Neither recession, nor recovery, nor green or brown shoots can stop gold and silver bugs from their relentless conviction that the precious metals are on the verge of the greatest rally ever seen in the history of markets. Of course, this rally has been "imminent" since 1982 when the Hunt brothers cornered the silver market and prices of the white (and yellow) metal soared.
I saw a commercial on television recently that stated, and I quote verbatim "if the gold market only goes to $2,000 per ounce, your investment would be worth xxx!"
Two thousand dollars per ounce? That seems a bit extreme. The gold bugs, of course, will tell you that this will be the going price when we are all living underground, protecting our last bag of rice with a shotgun as a result of a global meltdown.
But we've seen a global financial meltdown and at the peak of the crisis, gold and silver prices were falling, not rallying. Granted, gold surged to all-time highs in 2008, but it was earlier in 2008 and was a result of a collapsing US dollar. When the credit crisis really heated up, investors sold gold as demand plunged and the dollar found renewed strength in flight to quality buying.
I've read several recent articles regarding the coming boom in silver. One addressed a theory that silver prices were being "artificially" depressed and that when true supply is revealed, silver prices will surge to well over $25 per ounce.
While fringe (and a surprising amount of mainstream) investors may buy into these theories, they are merely myth and are not based on factual data. They are, however, very good for option sellers as they create a market for distant call buyers, which means there are solid premiums to be had for investors willing to do a little homework.
There is no shortage of silver. Comex silver warehouse stocks stand near 117.5 million ounces - below 2008 levels but still above where they have been for most of the last decade.
World silver demand has fallen steadily the last three years and could fall below 850 million ounces in 2009, down more than 5.5% from recent highs in 2006.
Silver, however, does not derive all of its value from commercial demand. Although the majority of demand originates in the industrial and retail sectors, silver is still considered a precious metal - thus taking on the properties of a financial instrument. This is more true at some times than others.
Silver rallied impressively back in May and has shown some renewed strength in recent weeks after revisiting the 12.50 level earlier this month. These recent price moves have the silver bugs rumbling again.
No matter which way you spin a bullish metals argument, however, the underlying demand necessary to fuel a sustained rally just isn't there.
The silver market rallied recently for several reasons:
- A springtime wave of economic enthusiasm that may have been a bit premature
- Spillover strength from US equities markets
- Weakness in the US dollar
Granted, these factors can bring investor buying into silver that can support prices for short periods. However, the investment sector makes up a very small portion of overall silver demand. Industrial and retail consumption of silver (including photography and jewelry) make up approximately 90% of demand for silver (see Chart 1 below).
Chart 1: World Silver Demand
Chart courtesy of Hightower Research 2009
Despite the doomsayers and conspiracy theorist, the best thing for silver prices would be a global economic recovery. This would spur lagging industrial and retail (jewelry) demand.
In the meantime, demand, while not collapsing, is stagnant. India's recent announcement of an increased import duty on silver could make matters a bit worse. India is the world's second largest consumer of silver. In a stimulus effort to spur consumption of domestic goods, India doubled the normal import duty on the white metal. It is estimated that Indian demand could drop by 25% as a result.
Chart 2: Major World Silver Consumers
Bulls will argue that ETF demand and a falling dollar will drive prices on. But ETF demand is not new demand. It is simply silver changing hands from one investor to another.
If the US dollar continues to decline, it could be a supportive factor for silver prices. However, while the US certainly has a massive federal debt to deal with, it is generally accepted that the US was much more proactive than Europe and Japan in addressing the current economic crisis. Most now believe that the US will emerge from the recession first while the former will lag behind. This belief in and of itself should begin to support the dollar in the coming months and at the very least, prevent a spiraling currency.
While silver could continue to see sporadic price rallies, these rallies will most likely be speculative and short lived in nature. Traders are buying a handful of commodities lately in anticipation of a global recovery. However, until demand can improve in earnest, prices will have a hard time sustaining any longer term strength. By most estimates, that won't be until at least 2010.
In fact, it is our opinion that silver attained its highs for the year back in June. For this reason, limited rallies in silver over the next few weeks should be viewed as opportunities to sell calls well in excess of the 2009 highs.
Strike prices for call sellers are currently available at levels nearly twice the going value for silver. You can thank the silver bugs and the Hunt brothers for that.
Chart 3: Silver 2009 December, 7 28 09
James Cordier & Michael Gross
Contributing Writers, Liberty Trading Group/Optionsellers.com
Optionetics.com ~ Your Options Education Site
Note: The opinions presented here are that of Liberty Trading and not necessarily shared by Optionetics and/or its instructors.
