For the last three years, the silver market has been stuck in a bearish channel. Aside from the occasional rumblings about the apparent disconnect from supply dynamics and robust demand, this bearish bias has remained firmly in place.
Spot silver rallied substantially on Wednesday, however, adding 3% (+40¢ per ounce) to trade near $14.30/oz. This rapid climb higher in a single trading session was no doubt fueled by short-covering from the bears, who have long dominated the speculative trade of the metal.
This may be an inflection point where the price trend for silver turns the corner, or it may turn out to be a false signal. It seems worth considering whether or not the strong fundamentals for silver will finally emerge as drivers of price in 2016.
Finding a Bottom
One of the crucial preconditions for a strong swing in market sentiment is that prices for the asset in question find a comfortable bottom. Due to the rapid rise of silver prices amid the financial crisis, re-establishing a true lower bound has been difficult. Should the metal be closer to the high water mark above $45/oz or is its pre-crisis level around $10/oz more appropriate? Thus far, the markets have suggested that the latter to be closer to the truth.
On Tuesday of this week, spot silver dipped back near its 2015 low, trading just above the $13.70/oz mark. From a psychological standpoint, this could be the bottom of the barrel that the bulls will aggressively protect. Another indication that this could be the bottom for silver is the gradually tightening range the metal has traded in. This decrease in volatility and the shrinking trading band are usually signs that shorts and large-scale selling have declined, and may be losing momentum.
You can see this narrowing of the trading range in the price chart (dating back more than 2 years) below.
Simple Silver Supply & Demand
The other most glaring reasons to believe a turnaround for silver could happen in 2016 are usually the two most important: supply and demand.
It's worth noting that, for a number of reasons, the prices of the precious metals in day-to-day trading are not (or have not been) reflective of these essential drivers. There is, however, a certain critical mass with these kinds of dynamics: once enough market participants base their trades more closely on the fundamentals (supply and demand), a snowball effect will make these factors impossible to ignore.
On the supply side, the decline in freshly mined silver has continuously pointed toward higher prices. (This alone shows that current prices are disconnected from the fundamentals.) It appears that silver production in Mexico, the world's largest supplier, peaked in 2013 and has been in decline. Even with growth at some of its largest primary silver mines, overall silver production in Mexico has fallen each of the last two years. Moreover, falling prices for copper, zinc, and lead are causing miners to produce less of these metals—and a whopping 58% of world silver output comes as a byproduct from such mining activity.
On the demand side, most experts see the struggling Chinese economy as a reason for silver prices to remain low through the first quarter of the year. (China consumes 30% of the global supply of silver used in industry.) However, if conditions normalize a bit and industrial activity again ramps up in the People's Republic, this would help buoy the white metal significantly. It would also make silver miners, who have aggressively cut costs in order to survive, far more profitable if and when the positive headwinds arrive. Like so much of the interconnected world economy, developments in China are one of the main indicators to keep watching closely.
At the same time that industrial demand should be recovering, investment purchases of silver bars or coins has consistently been rising in the U.S. Canada, Australia, and elsewhere. This has caused a shortfall in global supply for three straight years. Though time will tell if the expectations above will come to fruition, it is only a matter of time before these fundamentals can no longer be suppressed.
The opinions and forecasts herein are provided solely for informational purposes, and should not be used or construed as an offer, solicitation, or recommendation to buy or sell any product.