Could Silver Bounce Back?

| About: iShares Silver (SLV)

The price of silver declined in the past month. Will silver bounce back in the coming weeks? Let's examine the recent news that may affect silver (NYSEARCA:SLV).

The drop in silver price has also reflected in the decline in demand for leading precious metals' ETFs including iShares Silver Trust. During December, the Silver Trust's silver price declined by 2.8%. The recent FOMC meeting may have partly affected the direction of silver price. Let's take a closer look at this subject.

FOMC's monetary policy

The FOMC's decision to taper QE3 from $80 billion to $75 billion a month of long-term asset purchases has pressured down the price of silver. But has QE3 positively affected the price of silver in the past year?

The chart above shows the changes in the U.S money base and the average price of silver. As you can see, the ongoing rise in the U.S money base, mostly due to the asset purchase program, didn't pull up the price of silver. In previous years, however, the price of silver sharply rose along with the U.S money base. The concerns over the devaluation of the U.S dollar and the potential rise in inflation may have contributed to the rally of silver as a safe haven investment. But the U.S dollar remained strong against several leading currencies and the inflation low. Thus, the last asset purchase program seem to have had little positive effect on silver as more investors got out of precious metals to other investment alternatives such as the stock markets. This also implies that the drop in the asset purchase program shouldn't have a strong adverse effect on the price of silver (considering it didn't pull silver price up to begin with). So even if the FOMC continues to reduce QE3 in the following months, it might not have a long term adverse effect on silver.

Besides the demand for silver as investment, its demand in Asia is also likely to play a secondary role in the progress of silver price.

Demand for silver in India

The demand for silver in India has grown very rapidly in the past several months. The decision of the government to raise import taxes on gold has reduced its demand. In exchange, the demand for silver, a partial substitute for gold, sharply increased in the past year. During the first ten months of 2013 the country imported 4,652 tonnes and is expected to import around 5,200-5.400 tonnes during the year - this could top India's former record of 5,048 tonnes back in 2008. The strong physical demand for silver in India didn't seem to help pull up the price of silver. One of the reasons is its strong correlation with gold.

Gold and silver

It's no surprise that the prices of gold and silver are strongly correlated. The chart below shows the linear correlation of the daily changes of gold and silver prices in each month of the past year.

As you can see, although the relation between the two metals has moved during the year, it remained very strong and robust. Considering gold has a bigger market than silver has, it stands to reason that silver was mostly affected by the direction of gold price. Since gold's demand (both as investment and the physical metal) diminished in the past year, the sharp fall of gold has also dragged down along with it the price of silver.

Final note

Based on the recent developments, I think silver isn't going anywhere in the near future. It could slightly bounce back from the over-reaction to last month's FOMC mini-tapering decision. Moreover, if the FOMC reveals in the minutes of the last meeting plans to introduce other monetary measures, this could even pull up the price of silver. Nonetheless, as long as the FOMC keeps its interest rates low and the physical demand for silver continues to rise, the price of silver is likely to remain at its current level.

For further reading see: Gold and Silver Outlook for January.

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.