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on Wed Dec 28, 2016 9:09 pm
Two weeks ago we discussed how it’s a good time to start dollar cost averaging precious metals due to ballooning central banks’ balance sheets, the end of a 30-year low inflation period, and the current relative cheapness of precious metals in relation to their 5-year highs. Today, we’ll discuss how silver might be the better option to gold as it’s historically cheap, it has been in a supply deficit for the past three years, and its industrial usage is growing while production is declining.

  • Silver has a big industrial application and could be also used for batteries.
  • The metal has been in a supply deficit for the last three years but prices haven’t yet reacted.
  • The bullish case is very strong. There’s significant downside, but the upside is greater.

The first difference between silver and gold is that silver is used for various purposes and most of it is used for industrial applications.

Demand for silver

Industrial demand for silver didn’t increase in the last few years as global economics became more service driven, photography film isn’t used as broadly anymore, and demand for IT hardware slowed down. Industrial applications demand fell 4% in 2015 mostly due to a 10% decline in electrical and electronics usage. However, silver demand for photovoltaic applications rose 23 percent.

We can’t anticipate that the latest decline in demand is deterministic for the future as silver is an essential metal for where the world is heading due to its versatility. Silver is used everywhere. If you’re reading this on your i-Pad, there’s silver in it, and we could continue with an almost infinite list here from mirrors to pens. Future increases in demand for silver are expected to come from increased solar energy production, medical usage as silver is a great antibacterial agent, water treatment, and perhaps, batteries. For now, the hype lies around lithium batteries, but as lithium prices increase, we could see a shift or higher usage of silver zinc batteries which should be more stable and deliver more energy.

Energy comparison of battery chemistries

As the world develops, there will be more demand for silver. Fortunately for silver investors, this isn’t even all that important as silver is already in a supply deficit.In 2015, there was a deficit of 129 million ounces, or 12.4% of global supply for silver which is relatively high for a deficit.

Global silver supply and demand

Despite the three-year deficit, silver prices have fallen sharply in the last three years following the price of gold due to expected interest rate increases and a Chinese slowdown that didn’t happen.

The Chinese slowdown that didn’t happen pushed silver prices higher from their January 2016 lows, but in general, prices are still near the bottom for silver.

Silver and gold prices from 1997 to 2016

Silver prices are just three times higher than what they were in the 1990s. Knowing that central banks’ balance sheets increased fivefold in the same period, we can consider silver undervalued. In addition for the precious metal, currency silver is also undervalued when compared to gold. At current prices, you need 71.87 ounces of silver to cover for one ounce of gold. This ratio has been seen at such levels previously in history, however, it’s usually much lower.

Number of silver ounces per ounce of gold

On top of the above, silver mine production in 2015 was 886 million ounces while total gold mine production in 2016 was 98.4 million ounces, indicating a 1:9, not a 1:78 ratio.Further, mined silver is expected to decline in the next few years and further increase the supply deficit.

Forecasted silver production.

All of the above indicates that silver prices could spike up in the future. It could be that the supply deficits are finally recognized by the market, that silver gets a fairer valuation in relation to gold, or a simple revaluation in relation to ballooning balance sheets.

Historical inflation adjusted silver prices

A biased but interesting view is First Majestic’s CEO’s statement that we could easily see silver at $100 per ounce in the future due to the facts we described above.

However, we could also easily see silver close to the December 2015 lows of $13.88, or even lower. This would greatly impact silver related investment, but investing in silver is an investment where the downside is limited but the upside is unlimited. At current prices, a good investment would be silver miners as the maximum you can lose is 100% while the upside, if silver reaches $100, could easily be 1,000% or more.

Given that the S&P 500 is historically overvalued, I believe miners in general offer a much better long term risk reward situation than general stocks. Silver miners offer perhaps an even better risk reward ratio given the recent pullback in silver prices and the fact that they are close to decade lows.

There are several ways to invest in silver. The iShares Silver Trust (SLV) replicates the performance of the price of silver. A more leveraged option is to invest in silver miners. As their costs are mostly fixed, potentially higher silver prices have an incredible positive impact on earnings and push their stock prices sky high. For a general approach, a good investment idea is the iShares MSCI Global Silver Miners ETF (SLVP) which gives you a basket of global silver miners.

If you want even more upside, you can directly invest in silver miners. The more they are leveraged and their mining costs per ounce are close to the current price of silver, the more volatile your investment should be.

In all of the above investment vehicles, please be aware that if silver prices dropped below the January 2016 low of $13.73 per ounce, the downside loss could be significant. On the other hand, if some of the above positive catalysts materialize, returns of 1,000% shouldn’t be a surprise.

source: investiv
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