A stronger-than-expected U.S. jobs report on Friday adds one more to a list of competing factors that are struggling to give some direction to the silver market. The report, which showed that the economy added 236,000 workers last month, provides evidence that the economy is improving and was sufficient to drive the U.S. dollar index higher -- two bearish factors for silver. With the deadline for sequestration cuts more than a week in the rearview mirror and the Federal Reserve still pumping $85 billion a month into the system, the bullish factors are represented as well. Silver, as represented by the iShares Silver Trust (NYSEMKT: SLV ) , exists in the vortex between all of these forces. While short-term volatility is likely to increase, the significant industrial demand for silver will couple with general economic weakness and should drive silver higher.
Is the employment picture really improving?
While the 236,000 number is a significant beat over the 160,000 that was expected, it still falls short of the 250,000 jobs that most economists believe must be consistently added if the employment picture is really to change. The overall unemployment rate fell from 7.9% a month earlier to 7.7%, representing the lowest reading since December 2008; numbers for the past two months were revised lower by 15,000, meaning that the previous two months were even weaker than expected.
The unemployment statistics and the calculated rate of inflation have become the two most criticized figures in economics, having been accused of poor methodology, miscalculation, and outright manipulation. Many, myself included, trust the anecdotal evidence we get by going grocery shopping or putting gas in our cars as evidence that prices are rising. While the CPI or PPI may be stable, if the goods that we're most exposed to on a regular basis are getting more expensive, claiming no inflation is disingenuous to ignorant. Still, because the Fed has made clear that policy will be set based on these stats, knowing them and understanding them is a critical part of trading precious metals.
The Fed, and specifically Chairman Ben Bernanke, has made it clear that as long as the unemployment rate remains above 6.5% and inflation remains in check, the current course of quantitative easing will remain in force. The concern is that by the time inflation begins to show up in some of the statistics being used, there may be so much pent-up supply of capital that inflation will spike beyond what is easily manageable. This is not a certainty, nor is it a conspiracy theory or doomsday prophecy -- just a legitimate concern.
The global influence
The positive surprise from the U.S. jobs number was sufficient to drive the U.S. dollar index higher by 0.9% on the news, as the yen and euro fell. A strong dollar has been an upside constraint for precious metals as dollar strength makes dollar-denominated assets alternative defensive plays to silver and gold. When the dollar is weak, investors looking for safety are driven more quickly into the commodities as a safe haven.
The one significant advantage that silver continues to enjoy over gold is that its industrial applications are vast, particularly against the relative supply of the material. Being applied for uses ranging from health care to high-tech to defense, silver makes a lot of the things we rely on work properly. In a recent HSBC report of silver in which the firm raised its 2013 and 2014 price targets, James Steel, the chief precious-metals analyst cited four reasons: increased industrial demand, increased jewelry demand, increased demand for the physical commodity, and increased investor demand in reaction to Fed policy. Industrial demand is one of the chief reasons I prefer silver to gold at current levels.
Which forces should win?
In the immediate term, especially as Washington continues to dance around the sequestration issue, it's unclear which forces will win the battle. This type of uncertainty usually leads to increased volatility until some direction can be set. Over the longer term, increasing demand and the reality that the economy is not as stable as we'd like to believe should drive prices higher. If you can stomach the roller coaster, maintaining an allocation to silver is a good idea.
How to participate
For most investors, there are three options: an ETF investment, exposure to silver miners such as First Majestic (NYSE: AG ) or Pan American (NASDAQ: PAAS ) , or a silver streaming play. Between the first two options, SLV looks a bit more attractive given the recessionary pressures the market faces. Both First Majestic and Pan American face ballooning costs and increased environmental pressure. SLV is a more direct commodity play that should be less influenced by the vagaries of the company-specific operations.
Silver Wheaton (NYSE: SLW ) , the leading silver streaming company, is a unique play and still my favorite choice. The company buys the production of other producers at predetermined, fixed prices, meaning that upside in silver prices are more directly available to investors. With reserves of roughly 800 million ounces of silver, the company is uniquely positioned and attractive. Silver Wheaton is a solid choice for the medium and longer terms.
If you're looking for a company whose success is determined by the metals market, but without involving itself in the risks of physically mining the metals, then Silver Wheaton provides a unique play on the future of silver. SLW chooses to finance the mining of silver; it has grown sales and net income every year since 2008 and also has increased competitive advantages over its limited peer group. More details about our outlook for Silver Wheaton can be found here in our Motley Fool analyst report.