The key to predicting the silver price

It's an older store of wealth than gold, but silver hasn't mirrored the yellow metal's recent gains. That's because the direction of the silver price is a question of fashion, not security.

What a pity silver is so unreliable! Gold's price is reaching heights not seen for years, but will silver follow? Who knows! Sometimes it will, sometimes it won't and at the moment it is lagging. But one thing is sure it is a lot cheaper than gold, and there are a lot of ways to buy it. If it was only easier to track!

No one ever seems to have the whole story on silver. Can anyone be sure how much there is around? No chance too much is secreted away in Indian dowries! And does anyone know how much will be mined? Out of the question. It is price-insensitive and mined as a by-product of copper or other metals.

Silver is on the up but how high will it go? Given its unpredictability there is a strong temptation to go back for a look at old lore'. Silver's future for centuries was predicted by its relationship to gold. Silver's price, According to the American Geological Institute, was traditionally around a sixteenth of that of gold. The reason? Gold is about 16 times rarer. But is $45 an ounce plausible, when the best near-term industry forecasts are for $15?

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Silver is an older store of wealth than gold, but it has been friendless for years. Silver's problem is that it is useful. So demand/supply balance sums include estimates of how much will be bought by this or that industry. If a major buyer goes, such as the 25% market share taken by photography, there are problems. Indeed, in the last few years digital photography has taken over from the silver-halide film process.

Silver has become uncomfortably volatile, after 200 flat years to the 1970s. Then it started to recover from 25 cents an ounce. So the buccaneering Texan Hunt brothers decided to corner the market. They got the price up to $52.5 in 1980.

Fatal flaw! The brothers forgot the bottomless store of silver jewellery in India. It poured on to the market to chase profits. Pretty rapidly silver was down to a few dollars an ounce.

Warren Buffett also had a go. In the late 90s he bought millions of ounces at $4.40. He reckoned that supply was not catching up with demand. His action alone put 50% on the price. He sold out and has never gone back.

From 1993 to late 2003, silver ranged from $4.00 to $5.50 an ounce.

Amazingly the market was supposed to be in deficit supply from mines and scrap was less than demand for jewellery and industry. Anecdotal evidence suggested it was attracting investors. So, why didn't the price rise?

The Silver Book, a study out this summer from analysts VM Group, came up with the answer. There was more silver around than people realised.

Recycling from photography had been more efficient than thought. As India got richer they upgraded to gold jewellery selling the family silver. And investors were probably not as active as the rumours suggested.

Since late 2003 silver prices have moved up. Last year was brilliant for silver. Its average price increased 58% on 2005 to $11.61 per ounce. Also there was little increase in silver arriving at markets from mines, central banks or recycling. Bullish sentiment kept on going in 2007's first half, in which the price averaged $13.75.

The question is where now? It comes as mining production is forecast to rise 3% this year to record levels.

Fortunately, central banks are not expected to unload more from their vaults. The Reserve Bank of India, for one, is clean out. But it does have a few million ounces confiscated from smugglers to sell.

OK, photography is a declining market, and there is less silver coinage, but there are other new industrial users. Small at the moment, but they are growing. Not widely known is that silver is a biocide good at killing bacteria. It is used in swimming pool treatments, in hospitals and spas.

Other customers are those who want to keep products clean. They include motor companies who use it in the plastic for car interiors.

Silver is also a good heat conductor, and it holds antistatic and other properties. Over 24,000 silver-coated quartz tiles protected NASA's Magellan spacecraft from overheating and radiation as it orbited the earth.

Jewellery fabricating' in the trade is an important end-product for silver. But silver's future lies with fashion. As, consultant analysts GFMS says, designers' edicts be they in New York, Paris, Beijing or Mumbai will be what counts.

The mining analyst believes that the return of Indian buying is critical. Also of importance are the rise of the metrosexual' male as a jewellery consumer and the popularity of expensive fashion brands. A silver Prada bag does demand no harm whatsoever! Silver's taking more and more of the jewellery market.

Many key investors really seem to like silver. Some of gold's safe haven attraction has rubbed off in these financially unstable times. Last year for the first time in ages investors bought more silver than they sold.

Investment choice is widening. More mining companies are highlighting their silver production now the price has gone up. There are exchange traded funds, mutual funds, options, certificates, bars, even broker buying plans.

But we'd rather go for the real thing the jewellery. If the investment runes aren't right at least it's useful.

By Erin Hamilton and Isabel Turner for The Daily Reckoning