Silver miners such as Pan American Silver (NASDAQ:PAAS), Silver Wheaton (NYSE:WPM), and First Majestic Silver (NYSE:AG) had a terrible run in 2013 as silver prices were clobbered. Silver prices have been more or less stable this year amid strong industrial demand. While this has improved the outlook for miners somewhat, I remain cautious due to the fact that silver prices have limited upside potential.

Silver prices are stable, but there is a question mark on upside potential

At year-end 2013, most banks had a consensus forecast for silver to trade between $20 and $21 an ounce. Some of the banks had even predicted silver crossing $21. The forecast was based on the fact that silver prices, which nosedived about 35% in 2013, would continue to encourage industrial buyers to stockpile the metal in the backdrop of an improving macroeconomic environment.

Indeed, the U.S. economic recovery augurs well for silver. Earlier this year, silver prices also found strong support from heightening geopolitical tensions between Russia and Ukraine, which encouraged investors to cling on to safe-haven bets. However, that doesn't seem to be the case now. Even though the crisis in Ukraine has escalated in recent weeks, silver prices have failed to take off. Prices have been weighed down as investors' confidence in safe-haven bets has been declining on the backdrop of rising interest rates and better-performing equity markets.

Waning investor demand

Indeed, investor demand for silver is waning, as some of the recent data shows. Earlier this month, a Bloomberg report citing New York-based researcher CPM said that total silver investment demand fell by 42% in 2013 to 105.3 million ounces, the lowest level recorded since 2008. Even hedge funds, which were bullish on the white metal earlier in the year, have turned bearish.

According to the Commodity Futures Trading Commission, money managers slashed their bullish positions on silver by 90% during March and April at the COMEX division of the New York Mercantile Exchange. Data tracked by Bloomberg shows that net long positions held by hedge funds stood at 2,620 contracts for the week ended April 22 compared to the five-year average of 20,510 contracts.

Moreover, Barclays expects that investors will sell 250 metric tons from silver-backed funds.

While robust industrial demand will provide support to silver prices, waning investor demand means that silver has limited upside potential. In fact, waning investor demand is not the only factor that will keep a lid on prices. As I had noted in a previous article, silver prices will also remain range-bound due to excessive supply.

Miners ramping up production

As silver prices fell dramatically last year, physical-side demand shot up, pushing the market into a deficit of 96 million ounces from a surplus of 51 million ounces in the previous year. Even though miners continued to ramp up production last year, lower prices discouraged scrap suppliers. As a result, the total silver supply in 2013 fell 2% to 985.1 million ounces.

In its latest report, metal consultancy firm Thomson Reuters GFMS said it expects that the market will remain under deficit because the level of scrap supplies will be on the lower side. However, it also noted that the level of global inventories is more than enough to cover any shortfall. Therefore silver prices will feel the heat given that major miners are expected to increase their production.

Indeed, Pan American reported in May that it produced 6.61 million ounces of silver during the fiscal first quarter, an increase of 5% over the same period in the previous year. For the full fiscal year, the company maintains its production target of 25.75 million to 26.75 million ounces compared to 26 million ounces reported in fiscal 2013.

Silver Wheaton's silver-equivalent production rose 8% in the first quarter of 2014 to 9 million ounces. First Majestic's silver-equivalent production in the first quarter of 2014 rose to a record 3.63 million ounces.

With miners ramping up production and investor demand waning, silver prices will remain range bound even though industrial demand will provide some support. The key for miners will be to control costs. Most miners expect all-in sustaining costs of between $16 and $18 per ounce in 2014. Given the present price outlook, miners will face significant margin pressure.

