- We are long SLV and repeat our call for a doubling of prices over the next 12 months as outlined previously in “The Coming Stagflation And The Case For Silver”.
- An extreme discount to gold prices, stability in the broad commodity complex, outperformance in silver miners, and large premiums in the physical market are reminiscent of the late-2008 bottom.
- The main differences between now and then are the extent of the economic weakness and the size of the fiscal and monetary response, both of which should be price-supportive.
An extreme ratio of gold to silver prices, stability in the broad commodity complex, early signs of outperformance in silver mining shares, and large premiums in the physical market are all reminiscent of the late-2008 low in silver prices. The main differences between now and then are the extent of the economic growth headwinds and the size of the fiscal and monetary response. We are long the ISHARES SILVER TRUST ETF (SLV) and repeat our call for a doubling of prices over the next 12 months as outlined previously in the article titled “The Coming Stagflation And The Case For Silver”.
Recent stability in the broad commodity complex amid an extreme in the gold-silver ratio is reminiscent of the price action that occurred at the 2008 low. Silver prices tend to track both the general commodity complex, reflecting industrial demand, and gold prices, reflecting investment demand, which in turn is driven by expectations of real interest rates. The following chart shows the spot silver price and the “fair value” price implied by an equal weighting of the continuous commodity index (CCI) and the gold price.
Source: Bloomberg, author’s calculations
The R-squared is a remarkable 0.97 going back to 1997. As gold prices have risen to new multi-year highs over the past few months, the fair value of silver according to this correlation has risen despite the fall in the broad commodity complex. As a result, silver is now trading at a record 35% below our measure of fair value.
If this long-term correlation is to remain intact, and we see no reason for it not to, this suggests a strong likelihood that either gold and the continuous commodity index will fall, silver will rise, or a combination of the two. With the uptrend in gold prices firmly intact and the CCI showing signs of stability following its recent crash, we believe the odds favour silver gains.
Silver Miners Are Leading The Way
A second supportive factor for silver prices is the ongoing rally in silver mining shares. The Global X Silver Miners ETF is closing in on its February highs after doubling from its March lows, which has sent the ratio of silver miners to silver prices back to three-year highs. The historical correlation between SIL and spot silver suggests that the latter should be trading closer to USD20/oz. Again, this price action was evident during the market bottoms of 2008 and 2016, where, after underperforming on the downside, the miners led the recovery.
Silver Miners Vs. Spot Silver
This relates closely to the third supportive factor, which is the recent surge in the price of silver coins. According to the CCEX, the 1 Ounce American Eagle spot price has risen to fresh year-to-date highs, currently trading 35% above spot silver, suggesting robust retail demand for the metal. The last time the premium was this high was around the exact bottom in silver prices back in late 2008.
Source: Bloomberg, CCEX
The above factors would imply a strong risk-reward trade-off in silver even in the absence of a positive fundamental backdrop, yet we see the macroeconomic and policy outlook as increasingly positive for precious metals. As explained previously, the combination of contracting economic output and rising money and government bond supply is an ideal backdrop for rising inflation, while the Fed’s desire to push real yields deeply negative provides little opportunity to cost for precious metal investments.
Source: Bloomberg, author’s calculations
While the spot silver price is up ~80% since the 2008 low, this pales in comparison to the ~120% rise in M2, the ~160% rise in government debt, and the ~280% rise in U.S. stocks seen over this time, suggesting that the opportunity is even greater now than it was back then.