Does Silver Have A Silver Lining?

Includes: GLD, SLV
by: Lior Cohen

The price of silver tumbled down the past few days to its lowest level since October 2010. Since the beginning of the month, the price of silver fell more than 17%. Moreover, the silver ETF, iShares Silver Trust (NYSEARCA:SLV), plunged during the month by nearly 18%. The plunge in the price of gold is most likely pulling down other precious metals, including silver and platinum. Does silver have a silver lining? Will it continue to go down?

The main issue is likely to be the shift in market sentiment. The ongoing decline the gold holdings of SPDR Gold Trust ETF (NYSEARCA:GLD) and the recent recommendation of Goldman Sachs to short gold have contributed to the bearish market sentiment in precious metals markets. Even in India, one of the leading countries in terms of importing gold, is cutting down its demand for gold. The rise in import tax on gold and the deprecation of the rupee against the USD may have contributed to the decline in demand in this country. Wherever gold is heading, silver is likely to follow. So what's up ahead for silver and gold?

The Minutes of the Last FOMC Meeting

The recent publication of the minutes of the FOMC meeting in March may have been among the instigators for the recent tumble in the prices of precious metals. The minutes raised speculation that the Fed might end or perhaps slow down its current asset purchase program. The upcoming meeting of the Fed at the end of April might provide some additional insight as to the future steps the Fed will take.

The recent weak employment report and decline in retail sales may raise the odds of the Fed keeping, for now, the current asset purchase program. On the other hand, it seems as if the QE program has diminishing returns on the progress of the U.S economy. Moreover, the risk QE3 poses vs. its benefits might nudge more FOMC members toward moving away from the asset purchase program.

The asset purchase program is augmenting the U.S. money base, but this doesn't translate into a rise in concerns for inflation (for now). In the past, QE1 and QE2 contributed to the rise in the price of silver as a safe haven investment in case of the devaluation of the USD. But since the start of QE3 in 2012, the money base has been rising while the price of silver hasn't.

The chart below shows the developments in the U.S. money base and average monthly price of silver.

Click to enlarge image.

USD Isn't Falling

Despite the rise in the money base, the USD isn't pulling down against other leading currencies. The recent decision of Bank of Japan to substantially augment its asset purchase program in order to reach its annual inflation target of 2% dragged down the Japanese yen against the USD. The debt crisis in Europe persists (mostly recently Cyprus), which also keeps the euro weak against the USD. If the USD remains strong against these leading currencies, precious metals are likely to suffer.

The Fundamentals of Silver

Even though the big silver rally in recent years wasn't related to the rise in demand for silver for physical use, let's examine the developments in silver's supply and demand.

According to the USGS, the global silver production rose in 2012 by 3% (year over year). The global silver reserves increased by 1.8%. From the demand side, the demand for silver in fabrication declined in 2011 by roughly 1.5%; the silver demand in the industrial sector, which accounts for 55% of the total demand in fabrication, may have declined by 6% in 2012. China is one of the leading countries in using silver. The recent publication of China's GDP growth for the first quarter that showed a drop in growth rate may suggest the demand for silver won't grow in 2013. Based on the above, the silver market is loosening up, which won't hold back the price of silver from falling further.

Silver ETF Raising Its Holdings

Despite the fall in the price of silver, the silver ETF iShares Silver Trust continues to raise its silver hoards (PDF). In 2012, the ETF raised its silver holdings by 5% (year over year); in 2013 the ETF raised its holdings by more than 4%. In the coming weeks, however, we might see a reverse and a decline in the ETF's silver holdings.

I think the big silver rally is behind us. Silver will keep following gold, which isn't expected to rally anytime soon. Unless the FOMC surprises in its next meeting with an augmented QE3 program, which isn't likely, silver isn't expected to recover from this downfall.

For further reading, see " Will The Gold Market Continue To Cool Down?"

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.