-- Posted 20 December, 2010 | | Discuss This Article - Comments:

Silver season is coming quickly to a close after one of the best five month rallies in silver history.  From mid-August to early December, silver managed to rise more than 66% from top to bottom, a sign of silver's strength against what is normally a positive, but not nearly as pronounced, rise in silver prices.  In moving forward, there are three main events on which silver investors need to focus.

Chinese Monetary Policy

China represents a growing portion of gold and silver demand, and the country is a popular investment destination for foreign investors.  While Chinese citizens are stocking up on gold and silver as an inflation hedge to negative real interest rates, the Chinese central bank will soon be forced to act in order to keep inflation in check.

Currently, one-year rates on the Chinese mainland are 2.5% while inflation rises toward highs at 5.1%.  With these fundamentals at play, the Chinese can effectively borrow cash to store in gold and silver, pocketing the difference between the cost of borrowing and inflation. 

Investors are calling for an increase in the central bank's target interest rate, which could, at least for a short period of time, stifle domestic physical metal demand.  This is a story that should be followed closely.

Market Performance

Those who purchased silver in the last 15 years are holding gains as large as 700% .  Those who purchased before August have been rewarded with returns of at least 66%.  That kind of impressive performance is the type that tends to attract profit taking interest. 

Should equities begin to lag in 2010, some will turn to their metal profits as an opportunity to even out their losers.  The upside to this phenomenon is that the December effect for silver could be quite strong.  Unless you're holding silver shorts, you've made money this year.  It is likely that in the coming weeks, silver short positions will be closed out for a loss before tax time.  As you're probably well aware, you can only close a short position by purchasing metals, which is good for the markets.

Watch Gold's Lead

Unlike silver, which tends to be more volatile at the start of the year, gold tends to start off with slow advances in the early months before picking up the pace late in the year.  Since silver has already risen to reasonable level within the gold to silver ratio, an appropriate rise in gold may be necessary to bring silver higher in the spring months.

A fast start for gold is unbelievably bullish for silver.   As previously reported, large increases in gold have already prompted many jewelers to start diluting their gold with silver.  Should the price rise even higher, more jewelers will do the same, only helping to further reduce the gold to silver ratio with higher silver prices.

The first few months of the coming new year will really set the pace for the rest of 2011.  If gold and silver are able to stay flat or rise slightly in the first few months of the year, late demand from India in the summer months and the typical explosion through 4Q open up the door for a repeat of 2010's surge in silver prices.  Only time can tell.

Dr. Jeffrey Lewis

www.silver-coin-investor.com