Economic clouds expose a SILVER lining

25 May 2021

Is it worth having exposure to silver; is it after all, the poor man’s gold?

The way governments and central banks treat Fiat currency these days suggests having something tangible like silver to cover at least some fiat and possibly inflation risk. In any case, those of us who believe in diversification are always interested in alternative assets that aren’t well understood and don’t appear overly valued, especially at a time when something intangible such as a digital asset created on a computer and no longer acceptable for buying Teslas can be priced at up to a trillion US dollars or more. 

Of course, there are the usual silver stories circulating such as “silver is being held down”, ”futures warehouses are running out of silver” and “the industrial use of silver is set to explode.” In fact, if you had a dollar for every rumour on silver over the years, you could probably buy your own silver mine. Would you want to?

There is a valid argument that precious metals have been used and survived for centuries as a store of value. While Fiat currencies, those that derive their value by government decree, along with many bonds, have done nothing but deteriorate slowly in value and then eventually fail. This is commonly due to governments eventually becoming tempted to create too much Fiat money stock to buy their popularity.

This eventually leads to the Fiat currency in question losing its value. The chart below shows US Real M2 money stock, suggesting the US could be tempting the gods of sound monetary policy, like so many who came before.  Is there anything new under the sun?

Source FRED

Silver tends to perform in sporadic bursts, as the chart of the silver price demonstrates below. Silver spent most of the period between 2017 and 2020 oscillating between approximately US$14/oz and US$20/oz, before flying above US$25/oz and finding a new range.  It has been outperforming gold in recent months and it appears more constructive technically and with the recent sell-off in digital assets, it appears primed for a potential new leg up in price.

Source FRED

Recently helped by COVID created product scarcity, US Inflation has moved higher, and 3% wage growth for private workers in the first quarter was the strongest since the 1990s.  There is an escalating debate about how long the reflationary burst will last but while it is here and real rates are low, it is potentially another positive driver for silver.

Silver has a tendency to react in a more volatile fashion than gold when the market is faced with rising inflation or fiat currency risk. Just as you buy house insurance, holding some silver as well as gold exposure may have its benefits in the current risky monetary economic environment. Furthermore, silver is not just a precious metal but an industrial metal as well.

Apart from its use filling treasure chests and of course jewellery, other uses for silver include utensils, electronics, medicine, solder and water purification.  More than 36 million ounces of silver are used each year in auto manufacturing, according to The Silver Institute.

Commercial solar panels use about 20 grams of silver per unit.  It is tempting to make a case for silver for use as a “green metal” in solar cells, as these likely have a positive growth future. However, relying on silver as a green climate change play may not be such a good idea. Just as aluminium can be used as a substitute for copper, silver has substitutes in some cases. One of the problems is that the pace of technological change means that metals that are vital today may be less vital tomorrow. Additionally, this pace or search for substitutes will quicken if the price of the metal rises quickly.

Worldwide, the production of solar panels is estimated to use 20% of the globe’s yearly industrial silver consumption. Back in 2019 silver was said to spike on increased demand for solar panels. However, more recently start-ups like Australia’s SunDrive that secured AUD$2.2 million in funding from the Australian Renewable Energy Agency to help scale its low-cost, high-efficiency solar cell manufacturing process is experimenting with using copper in solar panels with other companies looking to also substitute silver out of the solar cell manufacturing process.

The key point of betting on silver’s usefulness in driving the global change to a renewable energy future may not be as simple as it seems long-term because of the risk of technology change and substitution.

Holding precious metals in anticipation of the end of the economic world, as many of the baked beans and ammo set suggest, is also somewhat questionable given the potential difficulty of collecting returns or barter after the world has ended Perhaps the ammo and some chickens and a vegetable garden is more useful!  

Still, as noted, silver does have genuine industrial uses as well as its precious metal benefits.  The current economic environment is a compelling driver for the metal, and the price action is confirmatory and supported by a new gold bull market.  Furthermore, and importantly from our point of view, silver is a diversifying asset. 

Currently we are reaping the benefits of a meaningful allocation to a precious metals strategy in our fund, with more to come in our view as gold and silver appear likely to test some previous highs.  Strangely, however, you won’t find much silver or gold in a typical diversified fund or your standard super fund, as their allocations are likely to be more vanilla and less dynamic in nature. 

Investors who want silver exposure can consider simply buying physical silver or an ETF.   These are the purest plays on a rising silver price.

Alternatively, silver explorers and producers provide potential greater gains in a silver bull market and may enable smaller allocations to be meaningful.  That said, there are relatively few pure play silver stocks, particularly on the ASX.  Silver is more commonly associated with / and produced as a by-product of base metals or gold producers.  Though silver producers are few and far between, explorers and potential mine developers are becoming more common, albeit they are riskier. If buying companies, our preference is towards allocations being made towards carefully chosen companies where there is reasonable confidence in their reserve and reserve growth and management and which should one day be in a position to actually mine the silver they have, with adequate financing and market support likely.  

In essence, we believe silver is a worthwhile asset for consideration today for active portfolios, with good prospects for a break higher in price. Silver may be a little temperamental but this temper can also mean significant upside growth. If properly considered in a detailed way, silver and other precious metal exposures such as gold, can fit very nicely into the mosaic of a diversified portfolio and need not be ignored. 

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