Turning Lead Into Silver

Less mining helps keep supplies tight.

If you own silver, then you love this chart.

Hi Ho

Silver spot price

Source: Bloomberg

And you really like this chart, too.

Mean Machine

The ratio of gold to silver prices is well above the 10-year mean and has started reverting

Source: Bloomberg

And you probably also think this one is OK.

Ag Grow

Managed money net position in Comex silver contracts

Source: Bloomberg

That last one might be a little disconcerting, though. Momentum is great, obviously. But that choppy pattern of money flowing in and out of silver, especially in the past five years, might leave you feeling a little queasy. You'll notice things were a bit less volatile between 2009 and 2011, which coincides with the great bull run that took silver to almost $50 an ounce.

The recent rally has taken it to around $17, a four-week gain of 14 percent. Looking back to the start of the 2000s, that puts the past four-week period almost in the 95th percentile. Does that provide any clue as to what comes next? Not really. In that period, there have been 101 instances of silver making a four-week gain of 10 percent or more, according to data compiled by Bloomberg. Looking at the four weeks that came after each of those, 51 enjoyed a further gain, while in 50 cases, prices retreated -- the equivalent of a silver coin toss.

And while that other widely followed metric, the gold/silver ratio (shown in the second chart), also looks hopeful, there are two things to remember on that front, too. First, that ratio is a bit like religious faith: It is only meaningful in so far as we choose to give it meaning. So, yes, if it reverts to the 10-year mean of 60 times, at the current gold price it implies silver getting back above $20. But why does that level make sense, really? Take the 30-year mean of 66 times, and it implies silver has only about $1 more of upside.

Plus (and here we get to the second risk) that presupposes gold holds its current level. That metal's rally in the early part of this year appears to have stalled, which, as I wrote here, fits a recent historical trend and also rests to a large degree on sentiment rather than fundamentals.

A better chart for silver could actually be one where it doesn't appear at all:

The Three Stooges

LME 3-month rolling futures prices, indexed

Source: Bloomberg

These decidedly non-precious metals matter here because only about a quarter of silver comes from dedicated silver mines. Almost half is produced as a by-product of mining lead, zinc and copper.

Humble Beginnings

Sources of silver supply

Source: Scotiabank

So when prices of lead, zinc and copper are in retreat, that tends to discourage digging more of those metals out of the ground -- which in turn chokes off new silver supply. Mined copper is forecast by Citigroup to rise by just 1.3 percent this year, versus about 2.5 percent in each of the past two years. Meanwhile, lead and zinc mining are tipping into outright decline, as the likes of Glencore simply down tools at some projects.

When it comes to fundamental support for commodity prices in the current environment, shrinking supply generally trumps any thesis on demand, whether it be copper, oil, or silver. Bulls will point to the popularity of silver jewelry or growing demand for solar cells, which use the metal. The former, however, is price-sensitive, while the latter is a good medium-term growth story but isn't strong enough yet to offset low or negative growth in silver's other industrial uses.

Solar, and Yet So Far

Change in industrial silver fabrication demand in 2015

Source: Silver Institute, GFMS, Thomson Reuters

Note: Forecast as of Nov. 2015.

All of which means silver bulls occupy an odd position: One of the best fundamental arguments for the precious metal rests on a continuing drubbing for their counterparts in industrial metals to keep discouraging miners.

By extension, this is one corner of the commodities market that actually isn't rooting quite as much for China, to which the fortunes of copper, lead and zinc remain very closely tied. The added bonus from a Chinese economic hiccup would be if it prompted further delays in the Federal Reserve raising interest rates, which would tend to support gold.

See? You can find a silver lining in anything.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

    To contact the author of this story:
    Liam Denning in San Francisco at ldenning1@bloomberg.net

    To contact the editor responsible for this story:
    Mark Gongloff at mgongloff1@bloomberg.net

    Before it's here, it's on the Bloomberg Terminal.