Silver Prices Will Remain Rangebound

Includes: SLV
by: Alpha World


After the sharp decline last year, silver prices were expected to regain some lost ground.

Silver prices have staged a rally twice so far this year, however, each time they have seen a pullback.

As the Federal Reserve continues with its tapering, silver’s inflation-hedge appeal has taken a hit.

Silver bulls expected that a rebound in industrial demand will boost silver prices.

Silver prices plunged last year, falling around 35%. Like gold, silver struggled as its inflation-hedge appeal was dented after the Federal Reserve hinted at the tapering of its multi-billion dollar asset purchase program by the end of 2013. However, there were expectations this year that silver prices would recover some of the lost ground. The optimism was based on the fact that silver has already bottomed-out and will benefit from a better global macroeconomic outlook, given that it has industrial uses unlike gold. Silver bulls were expecting that stronger industrial demand would offset the lack of investment demand and in fact boost silver prices. That happened momentarily.

Silver prices bounced back in June by gaining 12%. However, the white metal is flat, year-to-date. The iShares Silver Trust ETF (NYSEARCA:SLV), which rallied on two different occasions this year, is nearly flat this year. Every time silver has broken through there has been a pullback and prices have traded in a tight range. Surprisingly, gold has managed to post 8% gain so far this year.

Fading Investment Appeal

One reason why silver prices have remained rangebound right through the year has been the metal's fading investment appeal. Indeed, net long positions at the Comex market have been consistently dropping right from the beginning of the year.

Bloomberg, citing data from the Commodities Futures Trading Commission, noted in a report in May that hedge funds lowered their bets on silver by 90% during March and April at the Comex market. While a five-year average of net-long positions held by money managers stood at 20,510 contracts, net-long positions actually fell to 2,620 contracts in the third week of April, according to Bloomberg.

The trend has continued in August. Forbes, citing Jonathan Butler, precious metals strategist at Mitsubishi Corporation, notes that speculators have winded-up net long futures of about 42 million ounces or 14% in the first week of August, a steepest weekly drop since February 2013. In the same period, speculators increased short-positions by some 33 million ounces or 25%.

What's driving down investment demand?

The main reason behind investors' declining interest in silver is the fact that the Fed is now winding down its bond purchases. The Fed, which started tapering its latest multi-billion dollar asset purchase program called QE3, is also expected to hike the benchmark interest rates in 2015. This has made the U.S. dollar sturdier vis-a-vis other global currencies thus making dollar-priced commodities more costly. Already, the U.S. dollar index has gained about 1.40%, year-to-date.

Lack of inflationary pressure is also weighing on the metal's inflation-hedge appeal. Indeed, the U.S. Consumer Price Index has been consistently below 2% until April since the start of the year. The inflation rate stood marginally above 2% both in June and July but still remains well under the Federal Reserve's target of 2%. Elsewhere in Europe, fear of deflation is threatening to stall the euro area's economic recovery.

However, investment demand is just part of the silver story. The precious metal also has industrial uses and with the U.S. economy recovering and global economy stabilizing, industrial demand was expected to pick-up this year.

The Industrial Demand

Industrial demand accounts for about 50% of the silver's total demand. As expected, there has been a significant improvement in the industrial demand for silver after a very insipid 2013, which saw a near-flat demand.

According to the Thomson Reuters GFMS, industrial demand for silver has been robust in the first half of the year from wide-ranging industries. The report, which was released in July said that the demand from sectors such as ethylene oxide producers and photovoltaic industry has been particularly strong during the first six months of the year. Moreover, the report expects these two sectors to show a sturdy double-digit growth in the second half of the year.

The big question is why silver prices have remained rangebound despite the strong industrial demand.

Miners Ramp Up Production

While industrial demand has been strong, silver miners have also been ramping up the production.

Indeed, First Majestic Silver Corp. (NYSE:AG) recorded an increase of 18% on a year-over-year basis in its output for the second quarter of 2014. Hecla Mining Company's (NYSE:HL) second-quarter production rose by 14% while Fortuna Silver Mines Inc. (NYSE:FSM) posted a 52% jump in the silver equivalent output in the same period.

Given this scenario, prices will remain rangebound.

Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.