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How Silver Got So Close to $50 an Ounce

It has been quite a story with silver prices lately. The metal entered the year around $30 an ounce having climbed sharply in 2010. After a brief pause in January, it resumed its upward trajectory - then really started to take off following the Fukushima nuclear disaster.

That accident bolstered the case for solar power, which requires a great deal of silver. Add in growing investment demand with governments around the world debasing their currencies and stagnant mine production growth and it's easy to see how silver was able to ramp up to close to $50 before halting.

This past weekend the Chicago Mercantile Exchange hiked its margin requirements on silver futures for the third time in a week, putting the brakes on the rally. But don't think for a second the bull market in silver is over. Far from it.

Last Friday morning, Wyatt Investment Research's small cap analyst Tyler Laundon commented on silver's retreat in a letter to subscribers of the Small Cap Investor PRO service as follows:

"Whoosh. That's the sound of the silver trade unwinding over the past couple of days. The precious metal seems less precious after plummeting from an all time high near $50 to around $34. Not surprisingly, this crowded trade unraveled quickly after silver traded well above its moving averages. Look at this one year chart of silver that shows the violent four day retreat {Editor's note: chart updated after market close on May 9 th }. 5.10.11.PNG

A couple of noteworthy things bear mentioning here. First, silver has fallen from a high of around $50 to $34 - that's a 30 percent correction. This is not too surprising given that the metal had already soared 60 percent in just over 5 months. It was due to pullback to a level where it wasn't so overbought.

Second, the relative strength indicator (RSI) in the chart above is showing that silver is an attractive buy right here. An RSI above 70 generally indicates an overbought condition, while an RSI below 30 is oversold...Some technical analysts will say that silver is likely to test its 200-day moving average, which is around $28, before it will establish a new trend.

I think that level would be a gift for silver investors who have been patient and know that averaging into positions is the best way to generate investment returns over the long-term.

I believe that we'll see silver's volatility mellow out in the coming sessions, and that it will begin to consolidate after a heck of a run. Even if that is around $33, it would still be a 10 percent gain in 2010 - very respectable."

Over the course of Friday and Monday silver did indeed seem to stabilize and closed Monday above $35 an ounce. Many silver stocks rebounded, and one that Tyler rated a buy for 'aggressive investors' rallied over 17 percent between Friday's open and Monday's close. You can find out more about this company here.

***The fact remains that there's no better thermal or electrical conductor than silver. Without it, solar can't compete with other types of electricity generation in a cost-competitive manner. China alone threatens to consume about a fifth of the world's silver production if it is to succeed in its plans to adopt solar power in the next 10 years. And that's just for solar.

The bears will argue that the ratio of gold to silver prices has contracted sharply in recent years and are at its lowest level since the peak in commodities in the early 1980s. But what the bulls are missing is the growing industrial demand for silver for use in solar power.

Based on the amount of silver in the world (refined and yet to be mined alike), the ratio should actually be much lower than it is now, with silver trading much closer to the value of gold. A more appropriate ratio would be around 10-to-1, suggesting silver should be trading closer to $150 an ounce.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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