Silver's Price May Retreat in 2006

August 17, 2005

Silver's Price May Retreat in 2006

The past three years were positive for silver – prices on the New York Mercantile Exchange rose 5% in 2002, 11% in 2003 and 14% in 2004, according to The average price last year was just over $6.60 an ounce, its highest since 1987. So far this year the NYMEX price is up 3% to the $7 an ounce level.

Yet some analysts are calling for prices to retreat over the next year-and-a-half. In an April 26, 2005, report, analysts at Canaccord Capital predicted an average price of $7.25 an ounce in 2005, $7.15 in 2006, $7.00 in 2007 and a long-term $6.75. Anindya Mohinta at J.P. Morgan forecast in a July 22 report an average of $7.10 an ounce this year and just $6.70 in 2006.

Two factors are behind this bearish outlook: increased supply, resulting from higher prices for other metals, and falling demand, partly due to higher U.S. short-term interest rates. According to The Silver Institute, overall mine production increased 4% in 2004 to 634.4 million ounces. Including recycled scrap and net government sales, total supply was 879.2 million ounces.

Most silver is mined as a byproduct of lead/zinc (32%), copper (26%) and gold (12%) production; primary silver production accounts for only 30% of overall mine production. The increase in prices for lead, zinc, copper and gold over the past few years will bring more production on stream, resulting in an increase in silver by-product production.

Demand for silver is varied, with jewelry claiming the largest slice, followed by industrial uses, photography and coins. Traditional industrial uses, such as batteries and electronics, accounted for over 40% of silver demand in 2004. JP Morganšs Mohinta is forecasting a 0.5% increase in industrial demand in 2005 to 369 million ounces, down from 2.3% in 2005 as economic growth slows in the developed world.

Silver use in photographic film is declining as digital photography gains popularity. Canaccord estimated photographic demand of 184 million ounces this year, falling to 181 million ounces in 2006. Mohinta thinks photography will account for only 169 million ounces of silver use in 2006, compared with 177 million ounces this year, and sees use falling by up to 5% annually going forward.

One potential positive on the demand side is silver's growing use in power generation and water purification applications, as well as biocides such as wood preservatives. Canaccord estimated in their report a potential 150 million ounces in new demand for biocides and 50 million ounces in superconducting applications in 2007.

Overall, Mohinta sees supply growing by 5.1% in 2006, lagging consumption by 16 million ounces. To put this in perspective, silver has been in a continuous primary deficit since at least 1996 according to Canaccord, with the deficits made up mostly by net government sales. The Canadian brokerage believes that if the new applications for silver become popular, the annual deficit could widen to as much 250 million ounces.

Yet the overriding factor for silver prices over the near-term will likely result from its role as a precious metal, specifically investor demand as a hedge against weakness in the U.S. dollar. The trend is fairly obvious – silver, like gold, has generally benefited from weakness in the U.S. dollar.

J.P. Morgan's Mohinta feels that rising U.S. interest rates will cause the dollar to rise, curbing investor demand for silver and other dollar-denominated commodities. Notably though, silver has remained positive even as the dollar index has increased this year. It's still early to tell if the trend will hold, says Resource Investor.

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