Silver fundamentals seen as poor which makes price vulnerable

A number of analysts are now predicting falls in the silver price as precious metals seem to be losing their lustre.

LONDON (Reuters) - 

Investment money flooding into silver has overwhelmed poor fundamentals and helped it to outperform gold, but the tide could be turning for precious metals and the probability of large losses is rising.

Silver's price falls in percentage terms are likely to dwarf those seen in gold, which some fund managers say has stronger supply/demand fundamentals.

"History shows that when you get a substantial correction in precious metals, silver falls more than gold ... It's a more volatile market and smaller in value terms," said Stephen Briggs, analyst at Societe Generale.

One big reason behind surging prices has been the tumbling dollar, making commodities priced in dollars cheaper for holders of other currencies. The weak dollar also prompts producers to raise prices to protect profit margins.

Last week the dollar fell to record lows against the euro, to beyond $1.60, an event which has caused many to question whether further losses can be sustained and whether it has bottomed.

"The dollar is not going to keep on depreciating forever," Briggs said. He expects gold prices to average around $900 an ounce next year from $1,025 this year and silver to average $15.50 compared with $19.20.

Financial uncertainty, which has underpinned precious metals since last August is to some extent becoming less important to investors seeking the higher returns stocks and bonds offer.

With a weakened case for holding precious metals, prices have started to slip. Spot gold is now around $893 an ounce compared with a record high of $1,030.80 on March 17 and silver at $17 from a 27-year high of $21.24.

Goldman Sachs recently said it expects to see gold prices at $835 an ounce in 12 months and silver at around $15.50.

RECYCLING

From the end of last year to March 17, silver prices surged by more than 40 percent, while gold was up more than 20 percent. Silver's heftier gains were built on investor flows.

Barclays iShares silver trust, the biggest silver exchange traded fund listed in the United States, now holds more than 5,770 tonnes of silver, a rise of about 10 percent since the end of last year.

Gold holdings by New York-listed StreetTracks Gold Shares, the world's biggest gold ETF, stand at 591 tonnes, down about 5 percent since end-December.

"Silver is probably going to fall more than gold in percentage terms," said Wolfgang Wrzesniok-Rossbach, head of sales at German metals trading group Heraeus.

"From an industrial and jewellery point of view, there has clearly been a decline in demand. There has been a lot of additional material coming to the market in the form of scrap."

More than 20,000 tonnes of silver were produced globally last year compared with around 2,500 tonnes of gold.

The surplus in the physical silver market is expected by some analysts to rise to around 2,500 tonnes from a surplus of around 900 tonnes in 2007. The physical gold market could see a surplus this year of 600 tonnes from 500 tonnes last year.

"Fundamentals come into play when prices are coming down," said John Reade, analyst at UBS. "Silver doesn't have gold's fundamentals."

ONE SOURCE OF DEMAND

Silver is often a byproduct of other metals such as lead, zinc and copper, where miners are trying to ramp up production with some success.

That means more silver on the market and together with scrap recycling, supplies are set to jump this year, while overall demand, including that from ETFs is expected to fall.

"Silver is very dependent on one source of demand -- ETFs. You can't get excited about silver in the same way as gold. Silver doesn't really have the same cachet," Briggs said.

"Demand from the photographic sector has been falling fast ... It's no longer an important source of demand."

For gold, the picture is somewhat different. Mine production is expected to hold steady this year, but analysts expect output in South Africa, a major producer, to fall over coming years because the ore that remains is deep and expensive to access.

Fabrication demand -- jewellery and coins -- is expected to continue unabated as rising incomes in emerging market countries such as China and India allow people to choose gold over silver.

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