Silver has soared in response to the Federal Reserves announcement of unlimited quantitative easing, benefiting from its role as a commodity that combines two different investment plays: a hedge against inflation and a bet on global economic growth.
By the late U.S. afternoon, the price of the front-month contract on Comex was up 4 percent on the days opening price, at $34.60 an ounce. Silvers recent rise from $26 in June marks the latest twist in the fortunes of the highly capricious metal. Silver rose from only $17 an ounce in summer 2010 to almost $50 in April 2011, spurred by the prospect of higher demand for raw materials from emerging economies and by the rally in gold whose price action often influences the silver market. This was followed by a rapid tumble as a darkening economic picture left speculators afraid that the price was in bubble territory, unsupported by market fundamentals.
The recent upturn, which gathered pace last month in anticipation of the Fed action, has left silver skeptics unconvinced that it faithfully fulfills either of its two vaunted investment roles.
A conceptual problem with silvers position as an inflation hedge is its extreme volatility. This arises from its much higher liquidity compared with gold, which can mean that a change in sentiment by just one or two important market players can send the price soaring or plunging. As a result, some investors believe silvers price behavior is not reliable enough to make it a safe-haven asset and its mercurial behavior over the past year has increased their doubts.
When it comes to silvers role as a play on economic growth, the commodity is at an awkward stage. All things being equal, the wide range of industrial uses for silver should create a positive correlation between demand and gross domestic product. However, silver faces a structural problem: Demand for the metal in photography is declining. Growing use in other areas could compensate, but one of the most important of these, the solar energy industry, is suffering from cutbacks in subsidies by governments eager to rein in spending because of their huge debt burdens.
At the same time as it faces problems on the demand side, silver supply is continuing to rise. HSBC estimates that production from silver mines will continue growing at a healthy pace for at least the next two years, largely because of higher output in Latin America. It estimates global oversupply, relative to demand, of 155 million ounces this year, rising to 175 million ounces in 2013.
Silver bulls hope, however, that the news of another attempt by the Fed to stimulate the worlds largest economy will increase industrial demand for silver particularly if higher U.S. economic growth has a strong positive indirect effect on China.
Some analysts are skeptical about future economic growth, and therefore about silvers prospects. Silver prices have benefited from the improved risk appetite in financial markets, said Georgette Boele, head of foreign exchange and commodity strategy at ABN Amro in Amsterdam. However, the rally in silver prices is likely to fade in the absence of a sharp improvement in the global growth outlook, which we do not expect.
However, HSBC thinks the price of silver could benefit from a relatively doom-laden scenario: Mounting debt levels may tempt governments to engineer negative real interest rates as a way of reducing the debt burden. Investor fears that this may happen are supportive of silver, as well as gold and other hard assets.
This leaves investors who believe this narrative with a dilemma: whether to buy gold or silver. Metal analysts often use the long-run average gold-to-silver ratio to ascertain which one provides better value at any given moment. Historically, an ounce of gold has bought about 50 ounces of silver. In early August, this rule of thumb suggested that silver was better value, but its recent rise has abruptly compressed the ratio to 51. With silvers erstwhile ratio advantage fast fading, golds lower volatility may, therefore, give the yellow metal an edge in the competition to win investor interest.