Silver steps out from gold’s shadow

June 13, 2016 at 12:00

truthing

A friend of mine collects silver coins. I emailed him on December 29th, “Hey John, I think silver is starting to look a bit interesting. I added to a position yesterday when prices fell near 5-1/2 year lows.”

It turned out to be a good call.

So far gold has had a good run this year and so has silver. As the first week of May closes, both metals are up over 20 percent while copper and equity markets struggle to make single digits for 2016. About time.

After coming within pennies of its 1980 high in 2011, silver steadily plumbed lower levels – Comex futures fell from a $49.52 per ounce peak to a lowly $13.73 by mid-December. Would the white metal descend further to the sub-$9 lows of the financial crisis or was this the bottom of the shaft?

In late-December, several rays of light appeared in the silver mine from faint but persistent sources. Technically, I was ready to bet on a bullish outcome because silver’s relation to gold was long overdue for a correction – this time in silver’s favor. Gold fell far from its 2011 $1,900-plus all-time record too, but not nearly as much as silver. Historically, the price spread between the two precious metals was way out of whack by the end of 2015. Positive outlooks for 2016 also suggested improving conditions for silver from both a supply and demand perspective.

Before sending John’s email, I checked my hunch with gold and silver trader Sumeru Sala. Mr. Sala owns and operates the renowned Nathabhai Silver Jewelry in Mumbai, India and has an uncanny sense for the future direction of precious metals.

He replied, “Happy Holidays Colonel! The silver store is running well as buyers buy confidently at lower rates. Looks like silver below $14.00 is reasonable from a long term view and you must overlook bears predicting $950 gold.”

Recently Comex silver closed at $17.527 and gold at $1,294.0 per troy ounce. Good tidings for the New Year indeed.

Silver City, Silver Peak, The Vegas Silver Slipper, Tonopah’s Silver Queen – historically silver everywhere in the Silver State and not just in name. The earliest prospectors were delighted to find native silver lying above ground in Nevada. Then massive underground deposits of the Comstock Lode were discovered and made public in 1859. This bounty was followed by promising finds in the Reese River district and the enduring 1869 Eureka lead-silver boom. Other significant mining occurred in the Rochester, Pioche and Tonopah districts, with some operations extending well into the 20th century. The Coeur Rochester Mine in Pershing County is the only currently operating primary silver producer in Nevada producing more than 4 million troy ounces in 2015.

After Alaska, Nevada is still the nation’s second largest producer of silver with additional production coming as a byproduct of gold mining. In 2014, the largest by-producers were the Hycroft, Phoenix, Midas and Round Mountain mines. Nevada produced a total of 11 million troy ounces with 6.7 million coming from gold miners.

Globally, silver is a significant byproduct of polymetallic mining too. Approximately 40 percent of production comes from lead-zinc mines and copper mines compared to a much smaller share from gold producers. World 2015 silver production ticked up 2 percent from 2014 as U.S. production fell 7 percent. On the supply side, we find our first ray of light. With mature zinc mines closing and copper producers reducing production worldwide, some analysts predict silver supply will tighten in 2016 – this could potentially favor Nevada gold miners with substantial silver output.

On the demand side, technology may provide the next illumination. From 2014 to 2015, silver use in three traditional USGS categories declined substantially: electrical/electronics (42 to 29 percent), coins and medals (35 to 25 percent) and photography (13 to 8 percent). Jewelry and silverware held steady at 7 percent but the “other uses” bucket exploded tenfold from 3 to 30 percent. A panoply of whiz bang technologies are at the core of this promising growth along with expanded demand in the solar industry and water treatment on a global scale. A few exciting examples are anti-microbial applications in medical devices, high-tech batteries, bio-sensing silver fibers woven directly into fabric, and miniature antennas in identification devices used on casino chips to passports as well as for tracking packages.

In truth, some of this new demand may take years to evolve to significance but the trend is nonetheless bullish for the long term. Supply and demand rebalance is in the early innings.

In 2011, Mr. Sala and I co-authored a commentary on the value of gold relative to other commodities. Our lead example was the ageless gold-to-silver ratio (GSR), an ancient traders’ way of communicating how much silver for so much gold. Today, the GSR is simply the currency-denominated price of gold divided by the price of silver. The resulting ratio removes currency from value comparison. For the case of gold and silver which typically share the same scale, the ratio also removes the unit of weight measurement (e.g. troy ounce or grams). A gold-to-silver ratio of 50-to-1 represents the same relative value to a precious metal trader in the Western world (U.S. dollars per troy ounce) as to a trader in India (Indian rupees per gram).

In the days of the Roman Empire the ratio was set at 12 to 1. The U.S. fixed the ratio at 15 to 1 in 1792 and France soon followed at 15.5 to 1 in 1803. A higher ratio means more ounces of silver for an ounce of gold. Silver slowly lost value to gold over the ages as monetary use and fixes declined. The 20th century average was 47 and the current 10-year average is 62.

As shown in the second chart, this value loss accelerated after the 2011 silver run at $49 per troy ounce. That April the GSR plunged to 31, half the 10-year average. By late-December, the GSR rose to an elevated 76. This caused me to wonder if the widening value spread between the two metals was sustainable.

As I discussed in the Spring 2016 Edition of the Mining Quarterly, this year’s gold rally caught fire after the Bank of Japan announcement of negative rates January 29 – positive interest rates from central banks put the brakes on for gold; negative rates add rocket fuel. Silver dutifully followed gold higher but at a slower pace. The result was a GSR that increased to a peak of 83 in March but then reversed. Silver stepped out of gold’s shadow and gained on the Lustrous One as the GSR plunged. In late-April, it broke a multi-year trend of higher-lows (red dashed line) – a very bullish turn for silver.

Silver is typically expected to race ahead of gold when both rally. Daily gains of 1.5 to 2.0 times gold’s advance are not uncommon for the white metal. Traders call this “beta” where a beta exceeding 1.0 implies greater percentage moves compared to its reference — in this case gold price. For quite some time, silver performance has lagged gold, dipping to a 3-month beta low of 0.5 in February. As I write this column, the 3-month beta has recovered to a more normal 1.9 — another bullish indication.

My big picture remains that gold prices will continue in a trading range for 2016, trapped between a floor of negative central bank interest rates in Europe and Japan and a cap determined by the U.S. interest rate trajectory. Given a slowing domestic economy and wobbly global growth, the willingness of the U.S. Federal Reserve to delay further rate hikes moves this cap higher. Accordingly, it is likely that gold price will keep its head above the $1,200-level but find it difficult to advance beyond $1,350 per ounce. If the GSR finds some equilibrium above the 10-year average, at say 70, silver has more headroom but probably not much beyond $19 per ounce for 2016. The longer term prospects are much brighter with improving supply and demand dynamics. Considering the last five years’ declines, this turnaround deserves a Lone Ranger, “Hi ho Silver away!”