Tarnished silver will shine again

published 7 November 2007

Has silver lost its shine? On the surface, you might think so, given the precious metal's 15% price collapse this week, shortly after hitting a 25-year peak of $15.17. Since its high, it has been caught up in the global downdraft in equities and commodities and at one point dipped back below $13.

Sudden plunges like this show that these are "highly speculative markets" that have been driven as much by momentum as the fundamentals, says Philip Coggan in Investment Adviser. It's all down to unjustified inflation fears, he says, which have led investors to load up with commodities. Not only that, but it's a symptom of the large pool of liquidity that has caused other asset prices (such as residential property) to soar in recent years. Commodities are merely the "latest bandwagon" to climb aboard.

But the biggest single factor behind the strong rally in silver prices over the last eight months has been the anticipated launch of the Barclays Global Investors silver exchange traded fund (ETF), say Chris Flood and Kevin Morrison in the FT. After the bank made an application last autumn to the SEC for approval of its iShares silver ETF on the American Stock Exchange, investors pushed the silver price up well over 100% to its recent high.

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Why? The fund is designed for investors who want to buy into the silver market, without having to worry about buying the physical metal or silver mining shares. But someone has to buy the underlying asset in order to offer the product and in this case it was Barclays, who recently placed 1.5 million ounces of silver with a custodian to back up its ETF. Gold-backed ETFs have already been proving popular with investors, but analysts are concerned that the silver market is not as large, and therefore is more volatile.

David Shvartsman on Finance Trends Matter notes that the silver required to launch the Barclays ETF was the same as the amount disposed of by Warren Buffett's Berkshire Hathaway fund. There's no way of knowing whether this was in fact its destination, but Buffett noted that he had invested in silver (unusually for him, since he rarely dabbles in commodities) yet had made little on his investment as he had bought and sold "very early". It seemed an "appropriate time" to announce that his foray into the silver market had come to an end.

So are the silver market's fundamentals still on track? Yes, say CPM Group, the New York commodities consultants, who believe there has been a "fundamental shift" in the silver market and forecast that prices could return to the "boom" levels of the 1980s. CPM says investors will be net buyers of silver this year for the first time since 1989 and believe that the launch of Barclay's silver-backed ETF will "boost physical demand".

And there are a number of other valid arguments why silver prices should be rising: supply constraints and rising demand from Asia are backed up by the many day-to-day sources of demand. Silver is used for jewellery and tableware, says Richard Irving in The Times, but its uses don't end there. Silver is also a component in dental alloys, solder and electrical contacts; traditional photography; high capacity batteries; and, being the best reflector of light, it is used to back mirrors.

So the story is not over by a long way, but like any bull market, it is likely to have plenty of sharp retractions along the way.

The best ways into the market

The relatively low price of silver (compared to other precious metals) makes direct physical ownership a viable option. It's easy to buy silver and store it as bullion, or in bags of scrap silver. But in the UK, silver bullion bars and coins are subject to VAT (unlike gold), so few traders stock them, though Chard can get silver bars on a plus-VAT basis. Futures can also be used to trade the metal, through a broker.

Alternatively, you can bet on silver prices using a spread-betting firm. Profits are tax-free, as it is defined as gambling, but losses cannot be set against tax.

An easier option is a fund and the world's first silver tracker fund is the recently launched Barclays iShares Silver Exchange Traded Fund (SLV). It tracks the silver price and lets you invest cheaply without taking physical delivery (see www.ishares.com).

If you want to invest in a silver stock, it might be worth looking at Minco (MIO), a precious and base metals company listed on Aim. The shares have been trading "sideways" for the past year, although commodity prices have been soaring, says Joe Brennan in The Sunday Times. After the recent correction in the silver market, Minco shares are trading at 13.75p, even though some analysts believe that its core Mexican business alone is worth 42p a share. If you believe in the long-term bull market for metals, it is only a matter of time before investors "tap into" this name.