Will Silver Decline Further?

Includes: GLD, SLV
by: Lior Cohen

The silver market isn't showing signs of a recovery: Since the beginning of the year, the price of silver fell by nearly 5%. The silver ETF, iShares Silver Trust (NYSEARCA:SLV), also declined during the year at a similar rate. Is the big silver rally over? What's ahead for the silver market? Let's explore these issues further.

In order to understand the developments in the silver market, let's first turn to the recent changes in the gold market. The news of the high redemption from the SPDR Gold Trust ETF (NYSEARCA:GLD) has already been discussed in detail. Since the beginning of the year, the total amount of gold (in tons) in the ETF fell by nearly 7.8%. This decline shows a sharp drop in the demand for this ETF. The decline in demand for GLD suggests the demand for gold is also falling.

One the main reasons for holding gold is to protect against a potential devaluation of the U.S dollar, in case of a rise in inflation or a depreciation of the USD against leading currencies. Silver, much like gold, is also considered a safe-haven investment. I have shown that the correlation between gold and silver is strong and robust. Since the gold market is much bigger and more prominent than the silver market, it's very likely that where gold goes, silver will follow. So where are gold and silver going?

The Fed's Monetary Policy

Since the beginning of the year, the Federal Reserve started its augmented asset purchase program of purchasing $85 billion a month of long-term securities (aka QE3). The speculation when the Fed will conclude this program continues to fuel the precious metals markets. The upcoming FOMC meeting on March 19-20 might shed some light on this matter. Up until now, it seems as if the Fed wouldn't put a time limit on this program. In his testimony on the Hill, Bernanke didn't hint that the Fed plans to slow down its purchase program in the near future.

Even if the Fed keeps this asset purchase program for a long time, it might not help rally gold and silver. In the past several months, the asset purchase program raised the U.S. money base, but didn't pull up gold and silver. This could be because QE3 isn't enough to raise the concerns of investors against a potential devaluation of the USD. Moreover, U.S. inflation remains contained, which also lowers the demand for safe-haven investments.

Currencies War

The ongoing currencies war, in which leading central banks are pushing to devalue their respective currency in order to help jump-start the local economy, is among the factors keeping the U.S. dollar from plummeting. The little signs of recovery in the euroarea are also keeping the euro weak against the USD. The result of this war is that the USD isn't declining against leading currencies. If the USD remains robust, then the demand for gold and silver is likely to fall.

Road to Recovery

The U.S. economy isn't out of the woods, but it is showing signs of recovery. The manufacturing sectors are expanding, the housing market is recovering, employment is slowly rising, and the Dow Jones has recently reached an all-time high. These factors are causing investors to pull out of safe-haven investments and into riskier investments.

Therefore, if the U.S. economy keeps showing signs of growth, if the currency war continues, if U.S. inflation remains low, and if the Fed's QE3 won't raise the demand for safe-haven investments, then silver is likely to dwindle further.

For further reading, see "Gold And Silver Outlook For March."

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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