Silver: The Economic Conditions Are Not Ideal For A Sustained Rally (Part 1)

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Includes: SLV
by: Prudent Finances

Summary

Industrial demand consumed 60% of total silver supply last year.

Many important markets in the world are not growing economically, but China and India are still growing rapidly.

Fears of an economic slowdown are hurting the silver price.

By Ivan Y

Although I am long iShares Silver (NYSEARCA:SLV), I feel that it's necessary to test the assumptions I have for being long. While there are at least several reasons to be bullish on silver right now, as I outlined in a previous article, it must be admitted that the economic conditions are not entirely favorable for silver right now.

A Metal With A Dual Role - An Industrial Metal

Since silver is both a precious metal like gold and an industrial metal like copper, an ideal economic condition for silver would be strong global economic growth happening at the same time as high inflation. Strong economic growth would increase industrial demand coming from, for example, electronics and the solar industry. According to Casey Research, a cell phone contains 200 to 300 milligrams of silver and a laptop contains 750 milligrams to 1.25 grams. One solar panel contains 2/3 ounce of silver. Silver is also used in countless other applications like batteries, as a biocide in water purification systems and medical equipment, and as a catalyst in the petrochemical industry. According to The Silver Institute, Industrial demand for silver in 2013 was 587 million ounces. Total supply was 978 million ounces. Industrial usage consumed 60% of silver's total supply last year.

Economic Growth

Looking at the economic conditions around the world, it's easy to see that economic growth is not happening right now in many important markets. Economic growth in Japan and Europe is non-existent. Japan's economy contracted by an annualized rate of 6.8% in Q2. Out of desperation, the BoJ last week expanded their QE program. In Europe, the growth rate hovers around 0%. The German economy grew a measly 0.8% in Q2. France came in at less than 0.5%. The U.K. and Spain hovered around 1% and Italy was negative. (Q3 economic growth in Europe is expected to be announced later this month)

The situation is better in the U.S., where annualized GDP growth was 3.5% in the third quarter. That's a very respectable number, even though it is still down from the 4.6% achieved in the second quarter. The 3.5% rate is higher than the growth in any year since the 2008-2009 economic crisis:

  • negative 2.8% (2009)
  • 2.5% (2010)
  • 1.8% (2011)
  • 2.8% (2012)
  • 1.9% (2013)

In China, the economy is still growing at a rate of 7.5%, but that is lower than it has been in previous years and many people question how truthful these numbers from the Chinese government really are. Taken at face value, China's still strong economy is a plus for silver's industrial demand. India is also growing at a healthy rate of between 5.5% and 6.5%. That's pretty good, but keep in mind that India was growing around 10% pre-2011. While China and India are still doing well, things are not so good in other emerging markets. In Brazil, economic growth this year is expected to be less than 0.5%. Russia is expected to do even worse than Brazil at 0.2%.

Summary

It seems like economic growth is a mixed bag right now. China, India, and most of Asia are doing very well, the U.S. is doing okay, and Japan, Europe, Russia, & Brazil are not growing at all.

Looking at these numbers, I think the perception of slow global economic growth is exaggerated. One needs to only look at China and India. However, sometimes perception is greater than reality. This negative perception combined with fears of global deflation is putting a damper to some degree on silver prices. We saw in 2008 what happens to silver when fears of deflation rule the markets. Silver was driven all the way down to below $9. A liquidity crunch also was a major contributor that led to that sub $9 price. In today's world, there is no liquidity crunch, and hence no need to sell silver or any other asset in order to raise cash, but deflation fears are present to some degree. In order for silver to see a sustained rise higher, those deflation fears need to be changed into inflation fears, and that will be Part 2.

Disclosure: The author is long SLV.

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.