Will mushrooming supply crush gold and silver prices in the years to come?

One of the most common arguments bears levy against gold and silver is the fact that record prices mean more gold and silver mines. With those mines, they argue, comes a glut of supply.

One of the most common arguments bears levy against gold and silver is the fact that record prices mean more gold and silver mines. With those mines, they argue, comes a glut of supply that could crush the precious metals markets.

One of the leading voices in this debate is Dr. Paul Walker of precious metals consultancy GFMS Thomson Reuters. At a conference last week in Dubai, Dr. Walker pointed out that it takes some $120-$150 billion of investment demand every year just to keep gold prices flat – not to mention see prices climb higher (per Resource Investor).

That a lot of cash to maintain a baseline, and I would argue that bodes well for silver prices.

“The amount of silver that’s available for investment each year is 450 million ounces and the amount of gold that’s available for purchase is about 70 million ounces, which means you have a ratio of about six-and-a-half to one is amount of silver you can buy versus gold,” Eric Sprott said in a recent interview (per ETFDailyNews).

At current prices, that means investment demand needs to grow by $13.5 billion to keep silver prices where they are. That’s far less than the $120 billion gold prices will need to stay afloat.

Still, silver prices tend to follow gold prices as both metals act as stores of value during periods of inflation. The main indicator for whether or not gold and silver prices can keep up with supply then is the expectation of inflation, and expectations are a fickle thing.

As Dr. Walker pointed out last week, it’s probably not supply that gold and silver investors should be concerned about, but rather the possibility that the Federal Reserve might raise interest rates in an attempt to begin strengthening the dollar. That, he argues, could be the true “Black Swan” event we’ve all been worried about.

We’re not there yet, though. In fact, we just might see all-time record high gold and silver prices again before we ever see the interest rates rise. Check out our posts Silver prices setting up for 30-year high? and Why Eric Sprott believes silver prices will triple to $100 an ounce in 2012 for more.

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Expect volatility on the path to higher silver prices in 2012

After the 30 percent plunge in silver prices last week, where do analysts expect prices for the white metal to go by the end of the year?

You know things are going bad in the silver market when the U.S. Mint suspends sales of silver coins. The Mint announced on Monday that it was halting incoming orders for uncirculated American Silver Eagles sets so it can re-price the collector coins (per MineWeb). The move came on the heels of a 30 percent plunge in silver prices last week.

It was a perfect storm for precious metals last week. The CME Group announced new margin requirements for gold and silver on Friday, fears of a Greek debt default and a rally in the dollar all converged to push silver down from $40 to $28 an ounce in the span of five days.

It’s safe to say investors panicked, and – in their panic – showed yet again a preference for sitting on the sidelines in cash. That’s telling, as much of the investment demand for silver has been driven by fears of inflation and a debased dollar.

But what happens when every currency in the world is getting debased and commodities are falling, too? Investors don’t have much of a choice but to sell and wait for sunnier days. And some think it could be a while before we see sunnier days.

Even Eric Sprott – a billionaire hedge fund manager and founder of the Sprott Physical Silver Trust (NYSE:PSLV) and the Sprott Physical Gold Trust (NYSE:PHYS) – sounds nervous. In a recent interview with the Financial Post, he cited the fact that consumers just don’t have any cash to spend.

His evidence? Comments from Wal-Mart’s CEO Mike Duke who claims Wal-Mart shoppers are “running out of money” faster than they were a year ago. Duke cites Wal-Mart sales numbers that show customers are shopping at the first of the month (right when they get paid). After the first, sales drop precipitously.

“People’s incomes haven’t been going up, but their costs have,” Sprott told the Post. “It’s palpable what’s happening, and it’s not good.”

That’s not to say that Sprott’s advocating investors turn away from silver.

“Gold was the investment of the [past] decade, and I think silver will be the investment of this decade, so we’re trying to position ourselves to take advantage of that,” Sprott said in an interview with the Globe and Mail on Sept. 13.

He also argues that a Greek debt default would ultimately be a boon for gold and silver prices as it would lead to yet more currency debasement in Europe.

Where does that leave us in the short-term then? One of the few analysts who has went on record in recent days with an actual short-term price target for silver is Chris Thompson from Haywood Securities.

Thompson expects the gold-to-silver ratio to tighten this year, and he believes that will push silver prices up to $38 per ounce by the end of the year.

“Nonetheless, we caution that more sharp declines in silver prices, similar to that recently experienced, should not be ruled out, considering the volatile nature of silver prices and the relative ease with which ETF investors can exit the market,” Thompson says (per MineWeb).

As I said earlier in the week (see my post Silver prices setting up for “trade of a lifetime”?), I went long on the ProShares Ultra Silver ETF (NYSE:AGQ) on Monday. The paper-based silver ETF seeks to produce 200 percent of the daily returns for the price of silver.

Yes, there could be extreme volatility in the months to come, but the ultimate driver for the price of silver (currency debasement) hasn’t changed. And that means my outlook for silver prices hasn’t either.

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3 reasons to move from silver into gold

Precious metals investors are re-assessing their holdings, and here are three reasons why gold will likely out-perform silver in the months to come.

The manic rise and fall in silver prices over the past few months has a lot of precious metals investors re-assessing their holdings. In the near-term, it looks like gold bugs have the upper hand. Here are three reasons why the yellow metal will likely out-perform silver in the months to come:

1) Slow and steady wins the race. The fundamental case for gold and silver hasn’t changed, but investor perception has. Whatever the cause of silver’s violent 30 percent plunge, the aftershocks of that move will likely continue for several months. Meanwhile, gold’s proven that its support won’t be knocked out so easily. Over the past month, the iShares Silver Trust ETF (NYSE:SLV) has shed nearly 18 percent of its value. The SPDR Gold Trust ETF (NYSE:GLD) has actually appreciated 0.4 percent during the same time span. That shows unflappable support for the yellow metal even as panic seemed to set in for commodities across the board. When the muck truly hits the fan, there’s nowhere safer than gold.

2) A ratio gone mad. There’s been a lot of speculation about the gold:silver ratio of late. Silver bulls like Eric Sprott of Sprott Asset Management – which manages the Sprott Physical Silver Trust ETV (NYSE:PSLV) and the Sprott Physical Gold Trust (NYSE:PHYS) – have been calling for titanic shifts in the ratio. Sprott’s actually argued that the gold:silver ratio could fall as low as 10:1 (meaning gold would cost just 10 times as much as silver). If that were the case today and gold stayed at $1,491 an ounce, we’d be looking at silver prices around $150 an ounce. Perhaps such a move will be possible over the course of several years, but don’t expect it over the next few months. Since the 1980s, the gold:silver ratio’s been closer to 60:1, which means $25 silver is just as likely as $150 silver (in fact, it’s probably MORE likely). In the words of Dave Kansas at the Wall Street Journal: “It’s more likely that the ratio will revert to modern-era norms rather than race back to the Napoleonic era.”

3) Silver ETFs push down prices. One of the most powerful drivers of silver prices today comes from physical silver ETFs. These stock market vehicles use the cash they get from issuing new shares to buy physical silver. Conversely, when the price of silver falls, ETFs like the SLV must liquidate their physical silver holdings to buy back shares. When the market’s trending up, the SLV can accelerate the rise in silver prices. During extreme silver sell-offs, SLVs decline floods the silver market with excess supply.

“On May 4th as silver plunged below $40, SLV experienced such heavy differential selling pressure that it was forced to liquidate 4.8% of its holdings in a single trading day!” writes Adam Hamilton and Scott Wright of the Australian investing site, TheBull. “This was 16.8 (million) ounces of physical silver that hit the markets!” That’s an enormous amount of silver. Hamilton and Wright point out that it’s 60 percent of Silver Wheaton Corp.’s (NYSE:SLW) silver output for an entire year, and it hit the market in 6.5 hours!

Gold’s stability in the face of panic selling in the silver market is evidence that gold holders have the stronger hand. More selling in the silver space, though, could be on the slate as the gold:silver ratio moves back toward reasonable levels. The ratio hasn’t fallen as low as it did last month in 30 years, after all. Interpret that how you may, but I see it as evidence of an anomaly that’s in the process of correcting.

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Time to short silver?

A number of noted hedge funds and hedge fund managers have started selling. Does that mean it’s finally time to start shorting silver?

If there’s one rule I’ve learned in investing, it’s that ignoring the old saying “the trend is your friend” can lose you a whole lot of money. Stocks, bonds, currencies and commodities are all cyclical. And while I believe that the long-term trend in silver is up (reference my post yesterday: 3 reasons the rally in gold and silver prices is far from over), it’s clear that support for the white metal is breaking down in the short-term.

In part, we have the CME Group to thank for that. The Comex’s owner announced that it was raising margin requirements for the metal for the third time time in a week. As of the close of business on Monday, new initial margin requirements for silver have climbed from $14,513 to $16,200 per contract, according to BusinessWeek. Margins have risen more than 280 percent from $4,250 over the past 12 months.

The CME Group adjusts margin rates when it fears volatility in the markets could expose the company itself to losses. If metal falls too fast, for example, some traders may be unable to cover their losses – and that’s tantamount to a default that cuts into CME’s profits.

“Silver is often the lead indicator for changes in trends, or at least for corrections,” an analyst at Societe Generale SA wrote in a note to clients (per BusinessWeek). Right now, the lead indicator is pointing down.

And physical silver ETFs probably aren’t helping the situation. Stocks like iShares Silver Trust (NYSE:SLV) and the Sprott Physical Silver Trust (NYSE:PSLV) trade on exchanges just like shares in companies. They take the equity they get from investors, though, and use it to purchase physical bullion. When investors move out of the ETFs, SLV and PSLV sell bullion from their physical stockpiles.

Since ETFs are so easy to move in and out of, many investors fear they’re injected even more volatility into the already-volatile silver market. That steepens both climbs and sell-offs in the metal.

The most damming signal yet that the end may be near for silver, though, comes from a number of noted hedge funds and hedge fund managers that have started moving out of the metal. Among them? George Soros, Passport Capital’s John Burbank, Alan Fournier of Pennant Capital and Eric Sprott of Sprott Asset Management (the company that happens to manage the Sprott Physical Silver Trust).

Inflation may be imminent, but your best bet on making money might be shorting one of the world’s most popular inflationary hedges. We can logically justify why an asset should move in a particular direction, but all we know in the end is the trend. And you shouldn’t have much trouble identifying the trend if you look at silver’s recent charts.

Not sure how shorting works? Check out my post: How to short silver.

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Post-plunge: What’s next for silver prices?

Is this the start of a long and steady decline in silver prices, or is it merely a deep breath before the next aggressive upswing in prices?

On a fateful day in 1980, silver prices collapsed 30 percent. It was a day so bad, it’s got it’s own nickname: Silver Thursday. We fell almost halfway as far on Monday.

Futures prices for the white metal got massacred at the start of Asian trading – tumbling 13 percent in a near vertical decline that can’t help but remind investors of Silver Thursday. Or maybe it should just remind us of 2008. Double-digit price swings in silver were the norm during the height of the banking crisis just three years ago (and silver prices are four times higher today!).

Nonetheless, yesterday’s volatility in the silver market gives one pause. Is this the start of a long and steady decline in silver prices, or is it merely a deep breath before the next aggressive upswing in prices?

The bearish case is compelling, if for no other reason than the fact that the pros themselves seem to be jumping ship. Eric Sprott – one of the biggest silver bulls in the world – offloaded $34 million worth of shares in his company’s Sprott Physical Silver Trust (NYSE:PSLV). That’s after he’s went on record countless times claiming he expects the gold-silver ratio to fall as low as 16:1.

“Every dollar of money that was raised by selling shares of [the Trust]… was reinvested in silver or silver equities,” Sprott reassured the Globe and Mail yesterday.

We can’t know that for certain, but Sprott claims he saw opportunities in the shares of silver miners, which have vastly underperformed the price of spot silver this year. That makes sense. No one’s better positioning to make money off the 50 percent+ gains we’ve seen in silver this year than the companies that actually pull the metal out of the ground.

There are still plenty of physical silver bulls out there, too. Silver prices could fall as low as $40 an ounce, according to David Banister of the Market Trend Forecast.

For Banister, it’s just another consolidation period that should be looked at as a buying opportunity. Indeed, he sees silver spiking to $60 an ounce in the near-term. That would be a gain of 36 percent from today’s price near $44 an ounce.

“Any pullbacks in silver should be bought here and same with the silver stocks post haste,” Banister writes. Perhaps, he’s right. You can’t make money buying when everyone else is buying, too. You’ve got to get in when everyone else is headed for the door.

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Gold silver ratio pointing to higher gold prices?

With an unprecedented plunge in the gold-silver ratio, here are three reasons to consider reallocating your portfolio in favor of gold.

In two short years, the gold:silver ratio has plummeted 62 percent from 80:1 to 30:1. That means it takes a mere 30 ounces of silver to buy one ounce of gold. The dramatic shift of fortunes has a lot of investors and analysts saying silver’s overheating. Is it time to jump ship and swim for the golden shores? Perhaps. Here are three reasons to consider reallocating your portfolio in favor of gold:

1) ‘Mean Reversion.’ The gold:silver ratio is at 30-year lows. “Generally, relative strength relationships ‘revert to normal’ or at least move towards equilibrium over time,” writes Corey Rosenbloom at AfraidToTrade.com. Suffice it to say that a gold:silver ratio of 30 is far from normal. Over the past three decades, the gold:silver ratio has averaged somewhere between 65 and 70. Over the long haul, we’ll probably look back on today as an aberration. When the gold:silver ratio decides to revert to ‘normal,’ which we assume it will eventually, it could happen quickly. And it could happen in two quite different ways: “The mean reversion scenario suggests other outcomes such as a dramatic ‘catch-up’ rally in gold,” Rosenbloom writes, “or a ‘blow-off top’ correction down in silver.” Either way points to gold as a better option.

2) Rife with speculation. The fundamentals for investing in gold and silver are quite similar. Both have historic status as a monetary metals. They even have their own symbols for trading on international currency exchanges. Logically then, both metals should have followed similar trajectories after the Fed announced its quantitative easing program, QE2, in September. Instead, gold futures have climbed 20 percent while silver shot up 150 percent. That leads me to believe the rise in silver prices has been driven by speculators and momentum traders who are attracted to the smaller, more volatile silver market. If that’s the case and the momentum shifts away from silver, prices could collapse quickly.

3) Government Intervention. Over the long haul, I’m convinced there’s still a bullish argument for gold and silver prices. QE2 may be coming to an end in June, but unless the Fed plans to aggressively raise interest rates, inflation will start sinking its teeth into our pocketbooks. In such an environment, there are few places to retreat outside of precious metals. Hedge fund and money market managers know as much, and since they control such vast amounts of capital, entering the silver market in a large way isn’t really an option. The gold market, though, has the depth and stability to absorb enormous inflows of capital. Expect gold to outperform in such an environment.

Of course, for all the pontificating of analysts and writers (myself included), there’s a chance that the gold:silver ratio has been artificially high over the past few decades. Perhaps the market’s shaking loose the shorts? Or maybe the sudden change in silver’s fortunes is due to renewed industrial demand from the solar industry?

Eric Sprott of Sprott Asset Management helps oversee more than $1 billion in assets, and he’s publicly argued that we’re in the midst of a watershed moment in the precious metals market. He’s went on the record calling for a gold:silver ratio as low as 10:1. Such bold predictions by respected investors could, in and of themselves, be pushing silver prices higher much faster than gold. Right now, though, the present looks very different than the past, and that should be enough to give all investors pause.

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Why has the media gotten silver price forecasts so wrong?

Silver’s up more than 40 percent since the start of 2011 and that has me wondering why have the media and financial analysts have gotten their silver price forecasts so wrong?

It’s easy to look back on the past and see investing ideas that should have been no-brainers. I suspect that will be case for investors sitting on the sidelines while silver prices continue to surge. The white metal rose more than 80 percent last year and is already up more than 40 percent since the start of 2011. It begs the question, though: why have the media and financial analysts gotten their silver price forecasts so wrong?

According to GuruFocus.com, silver “experts” came into the year with an average silver price forecast of $29.50 an ounce in 2011. It’s April, and silver prices are already approaching $46 an ounce. Something’s seriously out of whack, and here are a few ideas why silver price predictions have fallen woefully short of the mark:

Metals as the new reserve currency. The tight interrelationships in the global financial system exported the mortgage derivatives crisis around the world. When the U.S. economy tanked in 2008, so too did economies in Europe and Asia. That means bailouts haven’t been limited to the U.S, and the net effect is its not just the dollar that’s declining in value; it’s most of the world’s major currencies. That’s turned finite commodities like oil and precious metals like gold and silver into de facto reserve currencies. When there are questions about the stability of fiat money around the world, precious metals provide one of the few safe havens left. The media and silver analysts may have under-estimated the U.S.’s inflation exportation.

Bond backlash. Standard & Poor’s warning earlier this week that the U.S. government’s AAA debt rating could be lowered in the next two years came as a surprise to no one. What did come as a big surprise is the backlash from financial titans and foreign governments.

Just last week, the world’s largest bond investor Pimco completely exited its position in U.S. treasuries. It’s not just Americans who are becoming disillusioned by U.S. debt, either. China, in particular, has been vocal in the international media in its calls for stronger fiscal policies in the U.S. When no one wants to hold bonds, other asset classes – commodities and precious metals, in particular – are bound to rise. The extremely rapid pace of the rise points to growing uncertainties about how the U.S. government will respond to the mounting debt crisis.

Under-reporting inflation. If you listen to the official line, it seems like there’s not much to worry about when it comes to inflation. The U.S. Bureau of Labor Statistics is reporting that the Consumer Price Index is rising at a mere 2.7 percent a year. In reality, though, that number’s actually higher than 10 percent. Since the year 2000, the Bureau has stripped out energy and food prices from its model in an attempt to more accurately portray inflation (what they term “core CPI”). Shadowstats.com tracks CPI according to the old inflation calculation model, and per that “outdated” scale, we just broke into the double digits again. Heavyweight investors are well aware of that fact, and they’ve sought out gold and silver as a means to protect their assets.

A correction in the gold:silver ratio. With most of the emphasis on gold bullion over the past decade, it appears the pendulum is finally shifting toward silver. Many analysts had been calling for a correction in the gold:silver ratio in the face of rising industrial demand and a desire to invest in precious metals without shelling out for gold. Silver stands in as a great alternative.

According to GuruFocus.com, the gold:silver ratio has stood at a rough average of 13:1 over the past 1,000 years. Its only been in the past 100 years that the ratio has been heavily skewed. At one point in the 1990s, the gold:silver ratio approached 100:1. Today, it’s closer to 35:1, and Eric Sprott at Sprott Asset Management expects it to go as low as 16:1. It’s hard to blame analysts for expecting the ratio to change more gradually than it has over the past 18 months. The question now is, just how low will that ratio go? No one knows the answer, but if they did, their silver price forecasts would certainly be more accurate.

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Sprott silver predictions calling for uncharted gold-silver ratio

Sprott Asset Management’s chief investment officer Eric Sprott believes the silver:gold ratio could tumble as low as 10:1. What would that mean for silver prices in 2012 and beyond?

Sprott Asset Management’s chief investment officer Eric Sprott has been one of the most vocal silver bulls in the media these days. Sprott believes that the silver:gold ratio could tumble to 20:1 or lower; perhaps as low as 10:1, according to Brian Sylvester of The Gold Report. While gold may meet strong resistance at $2,000+ per ounce, Sprott believes silver will keep climbing – and, in the process, substantially lower the silver:gold ratio.

Let’s give that prediction some historical background before looking at what it might mean for the future price of silver:

1980: The silver:gold ratio hit its all-time low driven in part by the Hunt brothers’ efforts to corner the silver market. At its peak, the ratio stood at 17:1.

2003: The current bull market in precious metals starts gaining steam with the silver:gold ratio at 83:1.

2011: The current silver:gold ratio stands at roughly 38:1.

2012+: Sprott predicts the silver:gold ratio could enter uncharted waters sinking as low as 10:1.

Before dismissing Sprott’s predictions off-hand, keep in mind that’s he’s not an end-of-the-world-preaching silver bug who lives in a bunker in the Canadian wilderness. He directs a vast pool of cash that’s made a big bet on the silver metal. According to some estimates, Sprott’s got $1 billion or so of client capital and his own cash invested in silver.

A big chunk of that comes from the Sprott Physical Silver Trust (NYSE:PSLV), which launched in November 2010 and now stores more than 22 million ounces of physical silver.

“When you’ve got guys like Eric Sprott and Frank Holmes [CEO and CIO of U.S. Global Investors]-guys that are really recognized as ‘thought leaders’ in the space – predicting much higher silver prices, that in itself becomes a fundamental driver for the price,” James West, editor of the Midas Letter, tells Sylvester.

Should Sprott’s bullish calls on silver prove out, and the ratio sinks to 10:1, you could expect to see silver prices at $200 an ounce or higher depending on where gold stands. Those predictions would sound foolhardy if the future of the dollar and other global currencies didn’t look so dim. So long as that picture doesn’t change, though, Sprott’s got a backer in me.

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