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A Long-Term Look at Silver and Its Future Prospects

May 4, 2011 Guest Commentary by Randy Degner

Note from dshort: Randy Degner is a commodities trader for an oil company in Houston, TX. Today he branches out to share his thoughts on Silver. But first he provides a brief refresher on the rationale for his use of a log-scale chart. The chart below shows the long-term price action for silver expressed in percentage terms using a logarithmic vertical axis. Log charts are typically used to evaluate movements across large price ranges. This differs from a conventional chart, in which the price axis is divided into equal increments of absolute value (e.g., one inch = $10/ounce). That type of chart is useful when looking at price changes in a fairly narrow range, but is much less useful when looking at price changes over very long periods of time and/or very wide price ranges. This is obvious when one considers a change in silver price of $1/ounce. That change is much more significant if silver is moving from $4 to $5 (a 25% change) than it is if silver is moving from $40 to $41 (a 2.5% change). In log charts, the price axis is divided into increments of percent change (e.g., one inch = 10% change in price). On a log chart, a price change between $4 and $5 would be shown as equal to a change between $40 and $50. Each represents a 25% change in silver price.

With that backdrop, let’s examine what this chart is telling us.

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First, silver futures are VERY close to the all-time high at 50.36. In fact, spot silver prices actually made a marginal new all-time high on April 28th before selling off over the last few days in response to the COMEX once again hiking the margin requirement for silver futures (more here).

The uptrend is very robust right now, and looks reminiscent of the break-away rally that began in mid-1979 which took silver prices from $9 to $50 in just six months. If silver can continue higher and close decisively above $50 it has a very good chance of duplicating the strength of the rally 32 years ago. The target in that case is just over $128/ounce. That’s right — silver has the potential to rally more than $75 ounce in as little as six months IF it can move above $50 in the near future.

How might that happen? A weakening dollar is the most obvious answer, though likely an incomplete one. The dollar has fallen 17% from its mid-2010 peak while silver is up almost 150% over that same time, so clearly more is at play than just a bet on dollar weakness. Even if the dollar collapses to the most bearish near-term targets it should fall ‘only’ another 7% to 15%. That’s nowhere near enough to push silver another 150% higher on its own. It will take a continuation of the precious metal ‘hoarding’ we’ve seen over the last couple of years to get silver that high.

Such a rally is not unprecedented, however. The chart below shows the ratio of gold price to silver. Currently gold is trading at just 36 times the silver price after having been at 68 times silver price in August of last year and 84 times in mid-2008. By any historical measure, silver has moved from undervalued to overvalued vs. gold over the last nine months. However, it is nowhere near its all-time extreme. Back in late 1979, the gold/silver ratio got as low as 17:1. If gold reaches its own long-term target at $2200/ounce and silver moves to $128/ounce, the gold/silver ratio would fall to . . . you guessed it . . . 17:1.

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It all hinges on whether silver can break-above the $50 level, and that is certainly an open question. One thing is sure, however. A silver rally to $128 implies a great deal of distress in the financial markets. It’s hard to envision $128 silver and $2200 gold with an S&P value of 1350.

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