Time for Silver to Shine?

Includes: GLD, SLV
by: The Sovereign Society

Universally regarded as a “poor man’s gold,” silver is at the cusp of a major secular rally that will outpace gold prices as the next leg of the bull market takes hold in 2010-2011.

Adjusted for inflation since 1980, silver prices should be trading at roughly $128 an ounce. But massive manipulation from four major short-sellers, including J.P. Morgan (NYSE:JPM), has placed enormous pressure on silver over the last several months even as investment demand soars – mainly from booming coin sales and ETFs, or exchange-traded funds.

With global silver production projected to barely grow in 2010, the odds favor a major recovery off the March 2008 high of $20.78 an ounce. That price is still way below the all-time high of $49.45 per ounce in 1980 as the Hunt brothers tried to corner the market.

Gold, on the other hand, hit a nominal all-time high in early December at $1,217 an ounce.

Silver, despite bullish supply and demand fundamentals since 2000, has trailed gold in the last decade.

Over that time, spot silver prices have rallied a cumulative 219% compared to 295% for gold. But over the last 12 months – marked by a wicked recovery in most risk-based assets – silver has gained 37% versus 25% for gold.

A period of out-performance by silver might have indeed begun and if demand continues to grow, courtesy of exchange-traded funds and silver coins, prices can easily surpass their March 2008 highs this year.

The supply-side story for silver remains bullish. According to CPM, a consultancy firm, 12 billion ounces of silver existed back in 1900; that figure has plunged to only 680.9 million ounces in 2008, according to the Silver Institute (latest figures available). So over the last 110 years we’ve seen a massive 94% drop in above-ground supply. That’s a staggering figure.

In 2008, global silver mine production grew by 2.5%, representing the 6th year of consecutive output growth and 77% of total supply for that calendar year. Peru once again ranked as the largest silver-producing nation in 2008 followed by Mexico, China, Australia and Chile, according to the Silver Institute. Peru produced a total of 118.3 million ounces of silver in 2008, or 17.4% of total world production.

Another bullish trend that should underpin my forecast of $21 silver over the next 12 months is the accelerated decline of government sales.

The net supply of silver from aboveground stocks fell by 14% in 2008 to 151.7 million ounces and was mainly due to lower net government sales and a drop in scrap supply. Russia, China and India reduced their disposals resulting in a 27% fall in government sales in 2008 to 30.9 million ounces.

JP Morgan…Conspiracy Theories…and Silver Prices…

The major obstacle to higher prices over the near term remains the big banks, including J.P. Morgan. Some sort of financial conspiracy to suppress the silver price is now circulating across investment circles whereby silver-bugs assert that J.P. Morgan is aggressively shorting silver.

The largest U.S. bank, which acts as custodian for SLV, or the iShares Silver Trust on the NYSE, is rumored to hold a massive silver short position of 200 million ounces. That statistic alone, more than any other variable and worth more than the entire production of Peruvian silver in 2008, is casting a shadow on major resistance at $20 an ounce – at least for now.

But I suspect that over the next 6-12 months the forces of supply and demand will return to overwhelm the short-sellers because above ground supplies will decline in 2010. Production costs are now rising again for silver. And, since I expect only a gradual tightening phase by the Federal Reserve starting later this year – and only if U.S. unemployment declines, silver is bound to rise further and eventually break $20.78 an ounce.

If gold dominated the first ten years of the precious metals bull market then silver will probably assume leadership over the next 36-60 months.

In this time, a lethal combination of a sovereign debt crisis and a massive currency crash could unleash the forces of demand for both metals in an environment of steadily rising inflation. The odds favor another major advance for the precious metals because central banks will not successfully unwind the post-2008 stimulus without triggering some sort of renewed liquidity crisis, currency meltdown or a crash in global financial markets.

We are still living in uncertain economic times. Hard money rules.

Disclosure: None