Silver Comment 10th Feb 2011

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by Market Moves Staff

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Spot silver traded at $29.765 an ounce on Thursday morning, representing a 2.87% gain from the prior week’s levels.

Silver, the precious metal that’s also consumed by industry, has recovered from a temporary downtrend seen in January, and some profit-taking is beginning to weigh on the commodity again. However, the metal continues to trade in a quasi state of backwardation – a situation where the futures price is lower than the spot price. Hedging could be one reason, but more recently it has been suggested that it could be due to oversupply of silver. The backwardation story is not entirely clear at this juncture, however, and there are many more theories in the media, with some reports suggesting that there is a shortage of physical silver. Perhaps high silver prices in the spot market make it economically viable for mines to reopen and start production, causing future supply to increase and prices to fall. Historically, the performance of silver has been closely correlated with the price of gold, although in certain periods silver tends to outperform its yellow cousin and vice versa. These trends are explained in our Silver as an Investment report.

The gold-to-silver ratio currently stands at 45.6x, which is slightly more than one standard deviation below the 31-year average ratio of 62.73x. The fact that silver is trading more than one standard deviation away from the historical average suggests that silver’s outperformance against gold may be near an end. However, if there truly is a shortage of physical silver with constrained future production or an exogenous shock that causes widespread fear in markets, then silver could trade at two standard deviations away from its historical average, at a gold-to-silver ratio of 34.07x. Gold currently trades at $1,356 an ounce, all else equal, this would mean that silver could reach $39.8 an ounce.

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