For fixed income investors, currently negative real interest rates that stem from extremely accommodative central bank monetary policies and large pools of international liquidity are a serious concern¹. For equity investors the economic uncertainties arising from the Eurozone crisis and large government deficits in the US and elsewhere are equally unsettling. Generally, investors consider precious metals, commodities including agricultural and energy related investments as capable of providing good long-term inflation hedges and at times such commodities can also provide favourable internal price dynamics. Silver and gold pricing have reported a strong historical positive correlation at +0.94 while correlation of both precious metals to S&P 500 pricing index are relatively low at +0.23 and +0.37 respectively². Some of the investment attributes of silver are highlighted in Tables 1A, 1B and 1C.

In November, 2011 the Toronto CFA held a sold-out seminar on investing in silver. Presentations were made by professional investors in silver and silver mining company executives – David Franklin (CEO Sprott Private Wealth), Bradford Mills (CEO Madalay Resources), Neil Ringdahl (CEO Apogee Silver) and Hemdat Swah (CFO Scorpio Mining).

The Sprott Asset Management Research team reviewed the annual return of silver over the period 1970 through 2010 in relation to the prevailing inflation rate at that time. Their findings indicated that over the study period silver outperformed gold during mild to high inflationary environments when real rates were between +1 and -2 percent while gold delivered the best returns during periods of very high inflation when real returns were between -3 and -5 percent. The currently prevailing mild inflationary environment, with CPI rising at about 3 percent and 3-month Canada T-Bills at just under 1 percent for a negative real return of 2 percent, is one that is consistent with silver outperforming gold.

Silver’s dual appeal: Growing industrial needs as well as jewelry and investment demand

The annual supply of silver is approximately one billion ounces (Table 2) with 70 percent of total supply coming from mine production and 20 percent from scrap recovery. The industrial sector is a major user of silver, constituting 53 percent of total demand with the remaining 47 percent being for retail consumption.

By comparison annual gold supply is about 4,109 tonnes or 132 million oz with 90 percent of demand being for jewelry and investment (Appendix 1). Jewelry demand from India and China accounts for 56 percent of the total world gold jewelry demand (Indian jewelry demand: 36 percent, Chinese jewelry demand: 20 percent).

Silver is a vital part of many products considered essential in modern life – iPhones, flat-panel TVs, solar panels, among numerous other electronic products. Silver usage is also growing substantially in medicine and health-related infection control products. Total industrial demand, which already accounts for more than half of all demand for silver, is expected to increase by 40 percent by 2015. Historically there has usually been enough scrap silver to make up the shortfall between the amount of silver mined, which has grown relatively slowly, and the amount demanded by industry and investors. But this may not be the case in the future as traditional sources of scrap are rapidly depleting and it is much more difficult to reclaim silver from newer products due to the lack of efficient methods and, in the case of solar panels, their relative longevity. Demand for silver is increasing rapidly in China. It is estimated that Chinese investment in silver coins and bars reached about 8.5 million ounces in 2011, a 3 fold increase from the investment made in 2009 of 2.8 million ounces. China was the 2nd largest user of silver in fabrication activities in 2010, just after the U.S.(Chart 3).

The top four silver mining countries are Peru, Mexico, China and United States. Together they accounted for 50 percent of total silver mine production³. By some accounts all the world’s known silver mines’ reserves could be depleted by 2040 at current usage rates.

These fundamental considerations suggest that strong industrial demand as well as investment demand may drive silver prices higher.

The silver-gold price ratio is favourable.

In the inflation-driven precious metals boom of 1979-1980, 17 ounces of silver could have been purchased for the price of one ounce of gold. Today that ratio is 55 for one. Clearly the market-cornering activities of the Hunt Brothers played a significant role in causing the price of silver to spike above US$50 in 1980, but today’s very low silver-to-gold price ratio would still appear to leave a great deal of potential for a rising silver price relative to gold.

Investment product innovations over the past two decades have greatly broadened our access to investments in silver. Such investments can be made in a number of ways, including Canadian Mint silver coins, sector ETFs and silver mining company equities. Market exposure can also be gained through the use of futures, options, swap and forward markets.

References:

¹ ‘Markets at a glance – silver producers a call to action’, Sprott Asset Management, November 2011 www.Sprott.com
² ‘The silver investment market: an update – commissioned by the Silver Institute’, Thomson Reuters GFMS, November 2011