2 Factors That Could Cap Silver's Gains in 2014

A stronger dollar and supply exceeding demand could put a lid on silver prices in 2014.

Jul 8, 2014 at 11:05AM

Shares of silver miners Pan American Silver (NASDAQ:PAAS), Silver Wheaton (NYSE:SLW), and First Majestic Silver (NYSE:AG) rallied in June as silver prices rose sharply. The rally in June has meant that silver stocks are now sharply higher for the year, outperforming the broader market. However, further gains in silver stocks are not likely, given that silver's gains are expected to be capped.

Silver miners make a comeback
Silver miners made a strong comeback in June. Indeed, silver stocks, which fell sharply in April and May after momentarily peaking in February, bounced back last month, driven by gains in silver prices, which rose 12%. Shares of Pan American Silver rose more than 24% last month, while Silver Wheaton shares rose nearly 28%. First Majestic Silver shares rose more than 28%.

Last month's gains have meant that silver miners are sharply higher for the year. Year-to-date, Pan American Silver has risen nearly 35%, while Silver Wheaton is up more than 33%. First Majestic is up a little over 14%. All three stocks have easily outperformed the S&P 500, which is up more than 7.80% so far this year.

Indeed, it has been a dramatic turnaround for silver miners after a disastrous 2013. Silver mining stocks tumbled last year as silver prices fell sharply. Not surprisingly, they have bounced back this year as silver prices have strengthened.

Last month, silver prices gained as investors scurried for safe-haven bets amid rising tensions in the Middle East and Ukraine. Simmering concerns over possible inflationary pressure in the U.S. have also somewhat supported the demand for inflation-hedge bets. Besides, an improving global macroeconomic environment has also spiked the demand for the industrial metal.

The big question is whether silver miners will continue to rally. That will depend on how silver performs. As I noted in a previous article, silver's gains are likely to be capped.

Will silver continue its upward trajectory?
Silver regained the $21 an ounce level in June. In July, the metal has been hovering just over $21, and market participants are eagerly waiting to see whether it will breach the $22 an ounce level. The sudden spike in silver prices last month has raised hope that the metal may even test the $25 an ounce mark, a level not touched since August 28, 2013.

Those who are bullish on silver are hoping that modest global economic growth, which is expected this, year will improve industrial demand. It is important to note that despite the sharp drop in silver prices, industrial demand was almost flat in 2013 even as the total physical demand climbed 13% to an all-time high of 1.081 billion ounces, thanks mainly to strong buying from the jewelry industry and record coin and bar purchases.

However, the International Monetary Fund (IMF) in its Word Economic outlook released in April expects the global economic growth at 3.6% this year up from 3% in 2013. Indeed, the global economic recovery should boost the industrial demand given that silver has applications in wide-ranging industries.

Still, I would maintain a cautious stance on silver. Even though global economic activity have been gathering speed in the recent past, an oversupplied market and a stronger dollar may keep a lid on silver prices. Like I said before, most analysts expected silver to hover in the range of $19-$21 an ounce in 2014. 

Factors which could cap prices
The U.S. economy is gaining momentum. Indeed, the latest non-farm payrolls data reflects the ongoing recovery. The unemployment has also fallen to multi-year lows. The Federal Reserve has already tapered its bond purchase program to a monthly pace of $35 billion and chances are that it will further narrow these purchases in the coming months and end the bond purchases before the end of this year.

A tighter monetary policy from the Fed will boost the U.S. dollar vis-à-vis other currencies, making dollar-priced commodities more expensive in the international market, which could affect physical-side demand.

As I noted in a previous article on silver, the silver market is still in surplus as the overall inventory level is high enough to cover any shortfall despite last year's jump in physical-side demand. And remember major miners are increasing their output. Therefore, it looks unlikely that prices will gain further, notwithstanding higher industrial demand. Barclays estimates that the total silver supply (mines, scrap-sales and official sales) will outstrip the demand by 6,482 tons in 2014.

Indeed, these two factors mean that silver's gains are likely to be capped notwithstanding last month's rally. As a result, miners will continue to face margin pressure. 

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Varun Chandan Arora has no position in any stocks mentioned. The Motley Fool owns shares of Silver Wheaton. (USA). Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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