the silver lining

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    The silver lining
    Commentary: Silver in early stages of a major bull run

    By Elliott H. Gue, Wall Street Winners
    Last Update: 10:34 AM ET March 24, 2004

    MCLEAN, Va. (WSW) -- Part precious metal and part industrial commodity, silver never seems to get the attention it deserves from investors. But powered by a combination of rising industrial demand from Asia and a weak dollar, silver prices will move a lot higher in coming years.

    By now, most investors are aware that 2003 was the best year for commodity stocks in decades. The reason for that dramatic run-up is simple: Demand from Asia is growing rapidly while production capacity for most commodities, decimated by a decade of low prices and cutbacks, can rise only slowly. Add to that a weaker US dollar and you have a recipe for explosive growth in prices.

    The positive fundamentals for commodities aren't likely to disappear anytime soon, in fact, the supply/demand crunch is only going to get worse. China's manufacturing base is rapidly expanding and the consumer sector remains in its infancy. To build all those factories and supply an ever-richer Chinese consumer, basic materials will remain in high demand through at least the end of the decade.

    Silver enjoys some of the advantages of both precious and base metals. Like gold, it's traditionally been viewed as a store of wealth-a weaker U.S. dollar generally supports higher silver prices. But the metal's biggest market is in industrial applications including electrical connectors and pollution control devices for cars -- these uses sit at the heart of the Asia demand story.

    Supply and demand

    The biggest fundamental negative I hear about silver is that it's used in photographic films and film development. If film is largely replaced by digital photography, surely that'll cause a drop in demand for the metal.

    But that's only one application for silver and it's not even the primary source of demand. According to the D.C.-based Silver Institute, silver's largest market is industrial applications and, in particular, as an electrical connector.

    Silver offers better conductive properties than copper and is already widely used in automobile and airplane manufacturing. And high-tech products like telecom equipment need to be very power efficient and use quantities of silver wiring and connectors.

    Last year, automobile sales in China came in just over 1.9 million, a fraction of the 5.5 million vehicles sold in the U.S. Meanwhile, China's population tips the scale at 1.3 billion, nearly 5 times that of the U.S. The Chinese population is very young and is growing wealthier -- it's easy to see that demand for cars will grow rapidly in coming years, as Chinese youths demand the same sorts of consumer products as their western counterparts.

    And it's not just cars. Already, China has more mobile phone subscribers than the U.S. And, don't forget India. That nation also sports a population of over 1 billion with a rising appetite for cars and consumer electronics. With silver an important part of all of these devices, industrial applications for the metal are bound to keep pulling demand.

    Jewelry remains the second most important use for silver and, once again, Asia is the primary driver. India is by far the world's largest consumer of silver jewelry. Demand for jewelry is directly related to disposable incomes and Indian incomes are rising quickly -- demand for silver jewelry is set to rapidly increase.

    The supply side of the equation is no less supportive to silver prices. Years of low silver prices meant that production capacity has been shuttered to cut costs. And it takes years to ramp up production from newer mines -- the capacity to quickly increase production to meet the rising tide of demand is limited.

    And governments have stopped selling official reserves of silver. Official sales of the metal topped out in 1999 at close to 100,000 ounces annually. By 2003 those sales were closer to 70,000 ounces. The United States no longer has significant stocks of silver and China, a large holder of silver reserves, has decreased its sales in recent years.

    And these aren't just pie-in-the-sky fundamentals; the long-term chart of silver and silver mining stocks supports a bullish view. Silver spot prices recently broke out of a near decade long trading range between $4 and $7 per ounce. And gold and silver stocks represented by the Philadelphia Gold and Silver Index (XAU: news, chart, profile) bottomed in 2001 and recently broke higher out of an important inverted head and shoulders base on the weekly chart. Technically, after a two-decade long bear market, mining stocks are in the early stages of a major bull run.

    How to Play It

    Rising silver prices drop straight to the bottom line of silver mining companies. Most of the miners were unprofitable a few years ago when silver was trading under $4 an ounce because production costs are higher than that. But with silver topping $7 and production costs relatively fixed, margins have scope for further improvement.

    Peruvian miner Compania de Minas Buenaventura (BVN: news, chart, profile) mines for both silver and gold, giving investors a measure of diversification. South America boasts some of the most impressive reserves of both metals and the company is the largest holder of mining rights in Peru.

    In the fourth quarter net income jumped 55 percent for Buenaventura amid a 15 percent jump in average selling prices for silver and 21 percent for gold. That's dramatic leverage to rising prices.

    US-based Coeur D'Alene (CDE: news, chart, profile) is a purer play on silver prices. Once a high cost silver producer, Coeur has been cutting production costs in recent quarters, dramatically adding to profit margins. Last year silver production costs totaled $3.27 per ounce against a sale price closer to $5.20 per ounce.

    Coeur D'Alene is still in the midst of a restructuring. But that's proceeding well and the company's financial position is stronger than ever with $250 million in the bank.

    Elliott H. Gue is editor of Wall Street Winners, which offers trading strategies for both short- and long term investing. Gue is also editor of Trading Floor Pro and associate editor for Personal Finance, where he specializes in global equity and debt markets and options trading.

    Content found in The Guru's Corner is subject to the terms and conditions found in the Disclaimer and does not represent a recommendation of investment advice. Investors should seek the advice of a qualified investment professional prior to making any investment decisions.

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