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Precious metal?

Investment | Commodities

By Justin Modray, published 03 November 2010.
Helpful? 25

The price of silver has soared about 40% this year. Is precious metal a solid investment opportunity? Or are the price rises an unsustainable bubble that will burst?

When it comes to investing in precious metals, gold is by far the most well known and popular (you can read my recent article re: gold here). But there are other precious metals open to investors - let's take a quick look along with the factors affecting price.


What is it?
A brilliant white soft metal that is largely mined in South America and China and is an excellent electrical conductor. It has always been viewed as a poor relation to gold, because it's far more plentiful in supply

Last year around 22,000 tonnes of silver was mined out of the ground, compared to just 2,500 tonnes of gold. Silver supply was further boosted by 5,160 tonnes of scrap silver being recycled.

In 2009 about 40% of the overall silver supply was used in industry, where its electrical conduction properties make it a popular raw material (e.g. in electrical components and batteries). The next biggest area of demand was jewellery, accounting for around 18% of supply, followed by investment at about 15%. Photographic use accounted for just over 9%, but is on the decline as the use of digital camera technology grows.

At the time of writing silver is trading at just under $25 per oz, compared to $18 at the beginning of the year and $11 at the beginning of 2009. So why the meteoric rise? The simple answer seems to be soaring investment demand.

Industrial demand fell 20% last year and, while recovering, is still below 2008 levels (when the silver price averaged $15), so this clearly doesn't account for the bulk of the price rise. Neither does jewellery or photographic use, where the trend is downwards.

On the other hand investment demand (aided by a weaker US dollar = cheaper for non-US investors) has gone through the roof, rising from 1,500 tonnes in 2008 to over 4,200 in 2009 and reports (as well as the silver price) suggest it continues to rise.

The trouble with investment demand is that its fickle. Whereas industrial demand tends to be reasonably steady, investment demand can sometimes vanish as quickly as it came. The driver behind the growth in investment demand seems to be safe haven investing due to uncertainty over the global economy, much like gold. So if the economic outlook deteriorates further perhaps the silver price will go higher still, but as and when the global outlook stabilises the price of silver could come crashing back down, although growth in industrial demand may soften the blow.

Investing short term is definitely a gamble and I'm not sure there's sufficient fundamental demand to support the price at these levels longer term. Supply is plentiful and gold tends to profit more from growing emerging markets jewellery demand than silver.


What is it?
A grey-white metal that is one of the rarest elements on Earth and very resistant to corrosion and wear.

184 tonnes of platinum was mined in 2009, slightly lower than average and less than one tenth of the gold dug out of the ground. Three quarters of this came from South Africa, while recycled scrap platinum added 44 tonnes to overall supply.

In recent times the greatest demand for platinum had come from the auto industry, as it's used in the manufacture of catalytic converters. However, declining vehicle sales and a greater use of palladium has hurt platinum demand from this sector, falling from 129 tonnes in 2007 to 69 last year.

Meanwhile platinum jewellery demand has been growing, from 66 to 94 tonnes over the same period. And, while still low in absolute terms, investment demand has grown four-fold over the period, from 5 to 20 tonnes.

The price, at the time of writing, is about $1,710 per oz. This compares to $1,500 at the beginning of this year and $900-£$1,000 in early 2008.

The rises appear to primarily be driven by rising jewellery demand (especially from China) and, to a lesser extent, investment - despite falling demand from car makers.

While the investment effect has played its part in rising prices, the fundamentals for platinum look more solid than silver. Supply is very low and is typically a little less than demand. And auto industry demand should increase over time as car sales in emerging markets such as China and India grow (especially if catalytic converters become compulsory in these markets). However, expect greater demand to be partially offset by more and more recycling, as an increasing number of cars with catalytic converters are scrapped in the West.

Jewellery demand should also continue to grow, especially from emerging markets, provided global economic growth doesn't slow down too severely.

In many ways investing in platinum is a bet on emerging markets, hence it's one I like longer term. But I still fear speculative investors will cause some price volatility shorter term.


What is it?
A silvery white metal that is similar to platinum, but lighter (i.e. less dense).

2009 mined supply was 221 tonnes, with Russia being the largest supplier followed by South Africa. Recycled scrap palladium added 45 tonnes to this figure. Mined supply fell by 17% between 2007 and 2009, partly due to falling prices (as less incentive to mine).

Like platinum, palladium is used in the manufacture of vehicle catalytic converters and, at 126 tonnes in 2009 (over half of all palladium demand), this is by far the biggest source of demand. Unlike platinum, auto industry demand only fell slightly during 2009 and appears to be increasing a little this year.

Other sources of demand are varied, but jewellery weighed in at 25 tonnes last year (17% down on 2008) while investment more than doubled to 19.5 tonnes in 2009 versus 2007. Nevertheless, there's still been an excess supply in recent years.

At the time of writing the palladium price is about $640 per oz, versus $420 at the start of this year. It did reach over $500 in 2008 but fell back to just $185 at the start of 2009.

For a metal that has been in excess supply the last few years such price rises seem strange. Higher expected demand from the auto industry (as the industry recovers and substitutes palladium for platinum to save money) might account for some of the recent price rise, but much higher demand from investors this year looks like the main culprit.

While long term auto industry growth bodes well for palladium, I worry that the recent investment-driven price rise will be unsustainable if/when those investors decide to put their money elsewhere. The difference between demand and supply is not as tight as platinum, in fact an excess supply of palladium has been the norm in recent years.

Speculative investors might continue to push up the price shorter term, but I'd hold off investing until the price falls back down to earth then maybe buy if growing demand from car makers appears sustainable longer term.

Quick summary

Precious metals can make a good long term investment (short term too if you're lucky!). But it's vital to understand what drives supply and demand for each metal then take a view on where this might head in future.

There seems little doubt that investment demand has driven up prices this year, possibly to unsustainable levels, so please think very carefully before jumping on the bandwagon. Yes, returns this year look very sexy and might continue if fears over global economies grow, but if investor demand softens there's quite a long way for prices to fall.

Sources: Silver data - The Silver Institute. Platinum & Palladium data - Johnson Matthey

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