The Potential Win-Win for Silver

By Mike McGlone Special Contributor to Kitco News 

Tuesday May 17, 2016 08:55

(Kitco News) - If the US and global economy recovers, silver demand and prices should be primary beneficiaries. If the US and global economy continues the slowdown trend, shifting Fed tightening expectations back to easing and pressuring the US dollar and stock market, silver should be among the primary beneficiaries.  Silver prices have corrected over 70% from the 2011 high, mining supply is expected to contract in 2016 for the first time in 13 years (GFMS World Silver Survey 2016), demand remains on record pace and the price is historically attractive relative to gold (featured chart). After reaching an extreme gold/silver ratio of 83 at the end of February as stocks swooned, the return on silver has caught up and surpassed gold in 2016 (up 24% Vs. 20% for gold YTD). Silver has since recovered closer to its historic performance beta relative to gold near 1.4 times. Silver has accelerated higher in 2016 along with most commodities as the stock market has recovered and the US dollar has declined. It may suffer when volatility returns to the stock market, but silver appears to be in the initial recovery stages from its inflection point low of this historic correction. In the near term, silver appears on trend to retest good resistance in the $20-21/oz. area. Key support is $15/oz. 

Silver is, at least it was, money. Synonymous with money and currency in many languages, silver is the unique precious metal that is increasingly being used for industrial purposes. Unlike many other commodities that are coming under pressure due to the paradigm shift in technology, notably the energy sector, technology is an increasing demand factor for silver. Industrial demand for silver is currently over 50% of total demand, compared to about 40% a decade ago, and near 30% a decade before that. In 2015, 35% of silver demand was for bars and coins - the highest percentage ever (GFMS World Silver Survey). Very low silver prices have dramatically shifted the supply/demand balance to the 3rd largest deficit on record in 2015. The element with the best reflective and electricity conducting properties is more likely to see increasing demand from advancing technology, rather than increasing production and/or substitution.

The elevated gold/silver ratio is an opportunity and warning. Similar to the flattening yield curve, the elevated gold/silver ratio is a leading indicator of economic weakness. Since the beginning of the century, the gold/silver ratio has averaged about 61. It is currently is near 74.3, having just backed away in February from nearly matching the 2008 crisis peak. The gold/silver ratio has ended only 9% of the weeks since the beginning of the century at a more elevated level than the current – 21% of those weeks have occurred in 2016.  At the current gold price of $1,274/oz., a gold/silver ratio of 61 would equate to a silver price near $21/oz.  But, the gold/silver ratio does not have to decline for the silver price to increase. Silver could also be dragged higher by gold, like it did earlier in the 2016 year. Hopefully, the economic warnings of the elevated gold/silver ratio and flattening yield curve will not come to fruition, but in most scenarios, silver appears quite attractive.