Short Supplies Set To Lift Prices As High As $50

Short Supplies Set To Lift Prices As High As $50
By Myra P. Saefong, MarketWatch
Last Update: 9:16 AM ET Sep 16, 2005

SAN FRANCISCO (MarketWatch) -- After suffering from a huge supply deficit for more than a decade, silver may be primed for a big rally.

The financial market has simply put too small a price on the much sought-after white metal that's often seen as a sidekick to gold.

Silver, which is used in a wide variety of applications in several industries, including the electronic, jewelry and photographic sectors, currently trades around $7 an ounce on the New York Mercantile Exchange.

That's a far cry from the peak level around $50 in the 1980s, but that may change soon enough.

"No other commodity exists in such short supply as silver," said Ned Schmidt, editor of the Value View Gold Report, and "silver demand has exceeded production for 15 years now."

Indeed, the physical silver market operated in a deficit for the fifteenth-consecutive year in 2004, according to the CPM Group, a commodity research and consulting-services provider based in New York.

In its Silver Survey report released in late August, the group estimated that newly refined supplies of 750 million ounces fell short of industrial demand by 44.5 million in 2004. And the deficit, though not quite as high, will likely reach 31.4 million this year, with total supply estimated at 774.3 million.

The supply deficit could spell more gains for silver on the futures market, which posted a climb of around 40%, or $2 an ounce, over the past two years.

"As you analyze silver's potential, the fundamentals become powerfully bullish," said Paul Mladjenovic, a New Jersey-based certified financial planner at PM Financial Services.

The "chronic silver shortage ... is becoming more acute," he said.

Demand factor

Overall demand is growing as silver is used in cell phones, military technology and a range of new applications in the healthcare sector and alternative energy technology, said Mladjenovic.

But John Person, president of National Futures Advisory Service argued that while production costs are rising, demand is actually flat.

The market saw total demand in 2004 at 794.5 million ounces, according to the CPM Group. For 2005, it's estimated to be 805.7 million.

Person doesn't believe the lows are in for the year, but December silver prices should find their support level close to $7 to $6.95 and that "should be the next buying opportunity investors can take advantage of," he said. December silver closed at near $7.08 an ounce on Thursday. See Metals Stocks.

Taking gold's lead

Silver has been riding off the back of gold futures, which recently traded at their highest level since March.

And with gold expected to climb, don't expect silver to stay behind.

Peter Grandich, editor of the Grandich Letter, believes that the poor man's gold will continue to "play second fiddle to its namesake and while it can have its own moments in the sun, it will continue to need a higher gold price to help lift it up."

Gold's move into the $450s will be an "important signal to investors that the metals are still alive and ready to march upward," said Schmidt.

Indeed, Philip Klapwijk, executive chairman at precious metals consultancy GFMS Ltd., expects gold to climb toward the $480 mark before the year is over because of rising investor demand for the metal.

"A similar phenomenon is likely in silver, a metal that historically tends to follow gold," he said.

It's true that silver is an industrial metal and is affected by economic demand, but even during the depression of the 1970s, "silver tracked gold because the Fed was creating 'money' -- actually, banking system credit -- out of thin air," said John Stafford, editor of Stafford's Investment Strategy Letter.

"More 'money' and credit was created 'out of thin air' by the Fed and world central banks in the single decade of the 1970s than the entire cumulative total in all the world's previous history," he said, citing an academic study done in the early 1980s.

So it's no wonder that silver went to $50 from $1.29 an ounce, and gold to $850 from $35 in early 1980.

And in the framework of a rising gold price, silver is actually the "coiled spring," Schmidt said.

Traders "will move to silver for the unrealized opportunity it represents," he said, noting that the silver market simply "cannot take incremental demand without its price being moved materially higher."

"The developments with gold's price will spill over into this market," he said.

Remember also that "silver is a much smaller market than gold, and speculators can usually get a bigger bang for their buck in more volatile silver than in the larger and deeper gold market," said Klapwijk.

Price outlook

Against this backdrop, there's no denying that silver will end the year -- in the very least -- above the $7 mark.

The key levels for silver to watch are $7.25 and $7.50, Schmidt said. "As they are taken out, silver will move on to $9 this fall."

Klapwijk would only go as far to say that "another spike above the $7.50 mark is very likely before year-end."

Stafford sees prices reaching $8 or more this year and maybe even trading in the $12 to $15 range in five years.

Given silver's growing uses, Mladjenovic expects prices to see a "very strong upward movement" during 2006 to 2008, with silver having a "great" chance to top its recent April 2004 high of $8.50 by the end of 2005 or early 2006.

In fact, it should be trading in the $8 to $10 range in the fourth quarter of this year, or no later than the first quarter of 2006, he said.

And "realistically, I expect silver it to hit $50 in 2-5 years," Mladjenovic said.

Myra P. Saefong is a reporter for MarketWatch in San Francisco.