Trade with Commodities: Best Of Both Worlds? Copper and Silver

The rising industrial usage of silver as well as a rebound in investment demand portrays a positive scenario in the long term. However, due to its positive correlation with copper price volatility could continue

SINCE mid-2008, silver expereinced a huge dip of –57% while its precious metal counterpart, gold, remained resilient at –26% during the global commodity selling frenzy. The reason: a rising correlation of the white metal with base metals like copper — which declined by 67% during the period — and a rise in the industrial use of silver in the last couple of years. The premise held true for the subsequent run in the price of silver since December 2008. Against a gain of 31% in gold, silver appreciated 58%, almost tracking an over 70% rise in copper. The behaviour ofsilver highlights a pattern of following the price trend in gold, however, with increased price swings due to its correlation with copper. This is clear from the first chart that shows the average monthly price range as a percentage of the previous month's closing price for benchmark silver, gold and copper prices since 1999. The price rangeis the difference between the monthly high and low prices for the metals. A comparison of the price range with the previous close indicates the monthly pace of change in the prices. As is obvious, the price range of silver follows the directive moves of the price range in gold whileits value is closer to that of copper.
    This phenomenon seems supported by a detailed classification of the world silver demand since 2002. As the second chart shows, the contribution of industrial demand to the total demand has seen anaverage rise of 2% during the period. In fact, the pace of decline in the photography industry's contribution to the total demand seems to be stabilising. There were two distinct developments in demand distribution during 2008: on the back of a global recession, the industrial demand declined by nearly 1%, but the investment demand in terms of coins and medals rose by more than 60% from 2007.
    Silver's exceptional electric conductivity makes it ideal for use in electronics products and its unique chemical property makes it useful in preparation of catalysts. The metal's less-known anti-bacterialproperties are also leading to its increasing use in medical as well as water purification industries.
    Other sectors that are expected to see a rise in the use of the metal are food packaging and solar panels. The new-age addition to the industrial demand is expected from the rising use of radio frequency identification, or RFID, a tagging technology used in supply chain management that is expected to replace the bar code identification system in the coming years. While the industrial demand of the metal is expec ed to provide strong support to prices, the supply side could be affected by worldwide cuts in mine production of zinc and lead, of which silver is a by-product. The scrap supply added about 1% in 2005-06, but has declined 3% since 2007. Against a rise of 12% in 2005-06, the official sector sale has seen an average decline of 30% in the last two years. This leads us to the last aspect of the demand-supply equation: the investment demand. The retail demand for coins and medals saw a remarkable jump in 2008 while jewellery demand continues to remain subdued. However, the interest in products like exchange-traded funds (ETF) and silver futures has seen a revival this month.
    At the start of the 2009, the ETF holdings were believed to be nearly 266 million ounces (Moz) and net long positions in Comex — the commodities arm of the NYMEX — were about 240 Moz on June 19. This is a significant increase from the total net positions of 95.7 Moz in October 2008. The analysis of the relative value of silver to gold and its historic behaviour throws up interesting correlation. While silver has traditionally enjoyed the status of a value store, its use in industrial applications has diluted its status of a precious metal.
    The relation between price movements of these two precious metals can be studied by looking at the gold-silver ratio (GSR). It is a ratio of the daily close of benchmark gold price to that of silver and shows the number of silver ounces required to buy an ounce of gold. A high GSR means gold being relatively priced higher than silver while, conversely, a low ratio indicates a relatively high value of silver. So, the GSR maintains a negative correlation with silver prices. Historically, this ratio has averaged at about 58 and any deviation from this average is eventually met by a counter move.
    In the recent past, this ratio hit a high of 84 in October 2008 when silver prices plunged to $9.20 per ounce. However, the upmove in prices since March 2009 is on the back of GSR starting its move towards the historic mean and is currently at 66.
    In the short term, the price swings in silver will depend on the fluctuation in base metal prices and, hence, global equity markets. However, in the medium term, a healthy investment demand and apossible decline in supply could lend an important support. In the long term, a rise in industrial demand could enhance the prospects of the white metal.
    devangi .joshi @timesgroup .com