Investment Demand Is Key To Rising Silver Prices

 |  Includes: CEF, PSLV, SIVR, SLV
by: Mark Thomas

It is my view that the outlook for silver prices in 2013 is simply higher. I say "simply higher" because the trend for silver prices in 2013 will be higher as the year moves on. More importantly, I say "simply" because the reasons that will drive silver prices up are very simple to understand. This article outlines a conclusion that I always thought might be the underlying reason for rising silver prices, but hadn't yet come to a final conclusion. It has taken me over two years of research, reading probably about fifteen hundred articles and reference materials from over a hundred different sources. What is more incredible, after all this time has passed and how much the price of silver has increased, is that there is still so much potential for even more profits to be made.

I have always known that new access from investors in exchange-traded funds, net new investment, and the rising price of gold were all leading to higher silver prices. However, I thought it was a combination of rising demand from investment, industrial demand, and a tight supply demand situation that drove prices higher. Those factors are all part of the story, but now I have come to the conclusion the real driver of silver prices over the longer term is the trend in silver investment more than consumption.

It has always been my theory about the silver market that the one of the main influences on price was probably investment demand. However, until I saw all of this research compiled in a single article and so thoroughly researched, I wasn't sure to what degree investment demand dominated future pricing. Now I have no doubt that the real key to understanding the fundamentals in the silver market -- and therefore being able to predict what will happen with silver prices over the long term -- is to focus on the trend in regard to investment demand for silver. That means quarterly and annually, not focusing on last week or last month. It also means you have to try to inoculate yourself from the gyrations in the daily spot price that you see quoted. (Please read this article about the investment demand effect longer term on the silver market.)

Now, for my 2013 price predictions and what I expect to see in the silver market. Silver averaged about $30 per ounce in price in 2012, lower than the record average price of $35.11 set in 2011. It is my strong opinion that silver will probably average about $37 during the course of 2013, while silver trades in a price range of $31-$42. That average would be about 13.5% higher than current silver prices as of Nov. 30, 2012, of $33.50. If it reaches $42 like I predict it will sometime in 2013, you could be up 25% from its current price, even more if you buy on pullbacks from the current price. The main difference in 2013 is the corrections will be much shallower, and I don't think the price will drop below $30 or 10% from today's prices.

Silver will, of course, be volatile and offer many opportunities to trade around a core position, take profits and then buy back again. The silver miners are much more difficult to predict. However, if silver performs well, they eventually will too. The sentiment swings in the miners are even more irrational than in the physical silver market. Now that I have laid out some specific price predictions, I want you to simply focus on what is actually behind the forces that will drive silver prices much higher in just the next 18 to 24 months.

The following are the reasons that the fundamental strength in the silver market has actually increased since then:

1. The real driver of higher silver prices is investment demand, not industrial demand. If you go back you will notice that while the bull market started for gold in 2000, the silver market started taking off in 2005. It is no coincidence that the larger silver ETFs were created in 2006-07. Silver ETFs since 2005 include the iShares Silver Trust (NYSEARCA:SLV), Sprott Physical Silver Trust (NYSEARCA:PSLV), and the Central Fund of Canada (NYSEMKT:CEF). Since the inception of these ETFs in 2005, silver prices have averaged a 27% compound return compared to stocks and real estate that are still below their all-time highs. I think silver prices will go higher until the end of 2014 to score one of the largest 10-year increases in investment history. Looking back at the period of 2005-14 will be the decade of silver, like gold was beginning to see about five years earlier.

2. It is becoming clearer every day that the available silver inventories available for delivery in the commercial inventories held by the metals exchanges are shrinking. The ounces available in commercial grade deliverable form are shrinking as more large investors begin to distrust the paper silver futures market and want exposure to actual physical silver. Except this time they are requesting actually delivery to custodians other than JPM and HSBC or even to themselves to ensure proper ownership. That is one reason I'm advocating silver investors sell any positions in SLV and ETFS Silver Trust (NYSEARCA:SIVR) and purchase new positions in PSLV or CEF.

3. You have heard of a negative feedback loop causing declining asset prices where forced sales lead to lower prices, which lead to additional forced sales. However, the silver market currently is the opposite -- it is a positive feedback loop causing rising prices. That leads to more new silver investors who purchase exchange-traded funds and physical silver. Every new ounce purchased in physical form or in a truly secure physical ETF form (PSLV and CEF) removes another ounce from the available market which lead to rises prices. Those ounces will remain off the market until those owners decide to sell at significantly higher prices. The higher prices attract more investors and the process feeds on itself. This is especially possible because the overall size of the silver market is so small relative to the gold market.

4. The ounces owned in all-silver ETFs just hit a new record, even with silver prices down 31% from their 2011 highs. The current investors in silver now have survived a parabolic rise, a subsequent plunge in price, and some extremely dramatic wide trading ranges. Therefore the current owners of silver are very solid, committed long-term investors!

5. A more important structural imbalance in the silver market will eventually force the price to surge much higher than you would even think possible. That is an incredibly huge multihundred-million ounce short position in the silver futures market. If prices start rising, these investors will face potential unlimited losses, so they will begin to frantically bid prices much higher to induce sellers to meet their demand to put an end to their losses. You will have probably another blow off parabolic move that will make the run from $30 to $48 in 2011 look tame in comparison. In fact, I have a price target of $60 in the next two years, which would equal a massive 80% return on your investment at today's $33.50 price level.

Because of the reasons I have outlined in this article, I have come to the conclusion that the evidence is clear that investment -- not industrial demand -- is what is driving silver prices higher. In fact, at various times I have over 50% of my total investment assets exposed to physical silver and silver mining stocks.

Disclosure: I am long SLV, SIVR, PSLV, CEF, AG, CDE, PAAS. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.