Silver ETF Rally Continues, But for How Long?

Apr.22.11 | About: iShares Silver (SLV)

iShares Silver Trust (NYSEARCA:SLV)

Yes - we missed the silver bullion boat (though we do hold some silver mining stocks). Now we watch from afar as the band keeps playing and everyone keeps dancing. Our only comfort? We won't be there when the boat sinks.

In two years, the price of silver has nearly quadrupled, to about US$44 from about $12. Even after adjusting for a weaker US$, the increase is a stunning 320%.

Is it demand? Perhaps those silver-coated nano-tubes are not so nano? Or is it supply? Have we hit peak silver already? As far as we can tell, it's neither.

Silver demand has been flat for the last decade. It was 874 million ounces (moz) in 2001 and 879moz in 2010. Nor have the users changed. In 2001, industrial and photographic demand for silver was about 563 moz or about 65% of total demand. In 2010 it was 560 moz and 64% of demand. And whereas industrial demand has grown, it is completely offset by declines in photographic. "Ornamental" demand - jewelry, silverware and coins - has also been steady at around 318 moz in 2010 or about 36% of the total.

Nor is there a shortage on the supply side. Total mine production was 736 moz in 2010, up 21% from 2001 production. On top of that, add 215 moz of recycled silver and 45 moz of silver inventory sold into the open market (mainly by Russia) and the total silver available in 2010 was 996 moz, or 116 moz more than total fundamental demand. In other words, there is more than enough silver to meet genuine demand.

And while industrial silver consumption may be relatively stable, the ornamental demand is completely elastic and price sensitive. I've noticed my local Indian sweetshop has cut back on putting silver leaf on its desserts. (Yes - it's edible.)

The force behind this current rally is speculation on an order not seen in silver since the 1970's. In the last decade, silver held as an investment rarely exceeded 50 moz. In 2008, investment silver demand totaled 18 moz. By 2010, it grew ten-fold to 178 moz. Today, the iShares Silver ETF, the largest by assets, currently holds 360 moz of physical silver bullion, equal to all the excess supply over the last five years.

The growth in investment demand started after the 2008 crisis and the launch of the US fiscal stimulus program. Investors fearing the US$ would collapse under inflation began buying silver. Now, they are buying on the expectation that silver will keep going up, even as the silver insiders - the producers - are hedging by selling their production forward.

Back in the late 1970's, the billionaire Hunt brothers started buying up as much silver as they could on fears the US$ would be devalued by high inflation. Their purchases drove the price from the low teens to $50 in a matter of months. Eventually, the US Federal Reserve stepped in and the Hunt's were forced to sell their holdings. Silver dropped back to $12 within eight weeks. The band was fired. The dancing ended. No word on the boat.

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Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.