After having being bearish on precious metals prices during 2013 and 2014 (specifically gold), I definitively turned bullish last year in a series of articles here (e.g. my February 20, 2015 article “Why Gold Is Looking Lustrous Once Again,” my May 27, 2015 article “Three Gold Miners To Buy When Gold Bottoms Later This Year,” and my August 14, 2015 article “Why Now Is A Great Time To Buy Gold.”) My then- and ongoing bullishness on the yellow metal centered on three major arguments: 1) annual mine supply to plateau due to miners’ focus on cost-cutting and balance sheet deleveraging in lieu of E&P activity over the last several years, 2) the long-term outlook for global monetary and fiscal policy remains highly expansionary; even in the U.S.—where the Federal Reserve is fully expected to hike by 25 basis points on December 14—policymakers have no choice but to increase spending as Social Security and Medicare/Medicaid spending is expected to drive our federal debt levels by nearly 10 percentage points of U.S. GDP over the next decade, and 3) ongoing increases in Chinese and Indian gold jewelry purchases, driven by the widening middle class and increasing income levels in both countries .
Silver prices have a strong historical correlation to gold prices. However, I have deliberately avoided a (bullish) discussion on silver, as the price of silver marches to the beat of its own drummer. E.g. annual silver mine supply is mostly determined by lead/zinc/copper mining activity, as silver is mainly produced as a byproduct through mining of other metals. In addition, industrial fabrication makes up about 50% of silver demand each year, versus less than 10% for gold demand. This means the supply and demand dynamics for silver versus those for gold could and do vary from year to year.
After making a cyclical peak at $49 an ounce in April 2011, the price of silver declined by over 70% to around $13.50 in January of this year. It subsequently recovered to just over $20 an ounce in the aftermath of the June 23 Brexit vote – with its recent decline back to the $16.50 level, I believe silver today presents a great long-term buying opportunity. Here are three reasons why I like silver for the long run.
- U.S.. and Chinese policies are highly inflationary and will result in speculative flows into silver
The U.S. and China have consistently ranked in the top three of all countries in terms of silver demand (collectively making up 40% of all global demand in 2015) so the countries’ monetary/fiscal policies—along with U.S. and Chinese hedge fund activity—tend to have a significant impact on silver prices.
Within the U.S.—even in the absence of the current Republican-led efforts to cut taxes (which the Tax Policy Center estimates will add $7.2 trillion to the federal debt in the first decade) and implement a proposed $1 trillion infrastructure—U.S. federal debt is still expected to increase from 77% of U.S. GDP at year-end 2016 to 86%, or about $23 trillion, over the next decade, driven by entitlement spending such as Social Security and Medicare/Medicaid. Now that quantitative easing is considered a normal part of the Federal Reserve’s “toolbox,” it is likely that a sizable portion of this debt will be monetized by the Fed when the next recession hits; combined with aging demographics and the structural downtrend in U.S. and global productivity growth, such policies, i.e. U.S. deficit financing that is monetized by the central bank, will be highly inflationary in the long-run.
Similarly, the ongoing fiscal stimuli and a surging housing market has led to significant credit creation in China. On a year-over-year basis, housing prices in Tier-1 cities such as Beijing and Shanghai have surged by over 30%; for Shenzhen, it has risen by over 70%, driven by an astronomical 50% rise in Chinese housing mortgage loans outstanding over the last 18 months. Housing prices in Shenzhen now ranked as the second most expensive in the world, surpassing those of Inner London and Hong Kong, and just behind those of San Jose. The most recent surge in housing prices began in April 2015 as Chinese stock prices were tracing out a peak; a similar peak is being traced out in the Chinese housing market today as regulators institute macroprudential policies to prick the Chinese housing bubble. With pricing growth in the Chinese stock and housing markets no longer a given, Chinese speculators (including Chinese hedge funds) have most recently turned to the commodities market to hedge the depreciation in their Chinese yuan-denominated assets. Over the last four months, zinc prices, for example, have risen by 40%, driven by Chinese buying. Similarly, copper prices are up by nearly 30% over the last six weeks. As commodity pricing power increasingly shifts to China’s commodity markets (silver futures turnover on the Shanghai Futures Exchange has been higher than that on the Chicago Mercantile Exchange for the last three years), I expect Chinese hedge funds and retail investors to next shift their attention to silver. Given the illiquidity and opaqueness of the silver market relative to that of gold (along with a physical market—estimated to be just over $400 billion—that is less than 10% of that of gold, as measured by the value of both precious metals that are in existence today), it will not take much speculative flows to drive silver prices much higher from the current level of $16.50 an ounce.
- Silver mine production to decline over the next several years
Similar to the trajectory of gold mining supply, both primary silver producers—as well as other metals producers with silver as byproducts (e.g. zinc and lead)—are expected to experience declining silver mine production over the next several years. According to GFMS Thomson Reuters, global silver mining production peaked in 2015, with 2016 production projected to total 887.4 million ounces, down by 0.6% relative to last year. This is driven by a projected production decline of 6 million ounces in Mexico, the world’s largest silver-producing country, which itself is driven by the year-to-date silver production decline at Industrias Penoles SAB, one of the world’s largest silver producers and a leading Latin American gold and lead producer.
Except for secondary supply from copper miners (which makes up 22% of annual silver mine supply), silver production is expected to decrease at primary silver producers (30% of annual silver mine supply), gold producers (13%), and lead/zinc producers (34%). This is due to the ongoing move towards cost rationalizations and balance sheet deleveraging in lieu of CAPEX growth and acquisitions in the silver, gold, and lead/zinc mining industries. Finally—another historical set of supplies, i.e. government strategic sales of silver (mainly from Russia, China, and India)—have ceased altogether, versus an annual average of 48.4 million ounces of sales over the 1999-2013 period. Going forward, government sales of silver are expected to be minimal even should prices head higher in the future.
- Global industrial fabrication demand to recover and to remain strong
Industrial demand has historically accounted for about 50% of silver consumption, driven by growth of the electronics industry (42% of industrial demand), brazing alloys and solders (10%), traditional photography (8%), and the photovoltaic, or the PV (13%) industries. Global industrial demand for silver was 588.7 million ounces last year, versus 611.2 million ounces, or a decline of 3.7%. This year, global industrial demand is expected to decline by about 5 million ounces, or a decline of 0.1%, driven by the pervasive weakness in global industrial production growth in both 2015 and 2016.
Going forward, however, industrial demand for silver is expected to recover due to several tailwinds. Firstly, the ongoing growth in the global solar PV industry is expected to continue, especially in China. This should continue to drive silver volume growth in the sector; more importantly, solar PV manufacturers are now hitting the limits of silver “thrifting,” i.e. it has been increasingly difficult for them to reduce the silver content in each solar cell. Secondly, demand for silver in the electronics sector—after having peaked in 2010 at 74.6 million ounces—is expected to recover. This is due to a projected rebound in global computer shipments which peaked in 2010 (U.S. PC shipments have already recently turned around) as well as new sources of demand ranging from sensors to be used in the “Internet of Things” era and OLED lighting. Finally—while not a tailwind per se—the structural demand decline for silver from the traditional photography market is coming to an end. Last year, global photographic demand for silver declined by just 4% to 46.7 million ounces, its slowest rate of decline since 2004. This year, the demand decline from this market is expected to be only 2%. Within the photography market, growth is expected to come from emerging markets where traditional x-ray systems are viewed as more cost effective within their medical and healthcare sectors. As such, I expect global industrial demand for silver to rebound in 2017 and for it to embark on a structural uptrend over the next several years.
Given the above reasons, I now believe silver is a solid, long-term investment. Such a purchase could be made through an ETF, e.g. the iShares Silver Trust (SLV) or physical silver through the purchase of silver American eagles, or the U.S. 40% silver clad Kennedy half-dollars that were minted between 1965 and 1970.
Disclosures: My firm, CB Capital Partners, or I may have material financial interests in SLV and may hold, sell, or trade them depending on market conditions or when fundamentals change.
