Will Silver Catch Up With Gold?

Source: Thinkstock

Source: Thinkstock

So far this year gold has been outperforming silver. While the price of gold has risen 8 percent for the year, silver hasn’t even risen 1 percent. This is unusual. Often when precious metals are rising, silver outperforms gold. It is a much smaller market, and even a small amount of money going into the silver market can send it soaring.

However nowadays silver is more like an industrial metal, and its monetary role has diminished somewhat. Nearly half of the demand for silver comes from industry. Silver can be found in photovoltaic cells in solar panels, in cellphones, computers, and medical devices. On the other hand gold is still predominantly a monetary commodity — people buy it in order to store wealth. While silver still retains some monetary role, there is a growing disparity in the investment theses for these two metals.

With this in mind, it is easy to write off the underperformance of silver as a weakness in demand for industrial metals. This weakness is reflected in the prices of other industrial metals such as copper and lead (exceptions include metals that are heavily produced in Russia such as nickel and palladium).

Thus investors have a complicated decision to make if they are looking for a safe haven precious metals play. Do they simply buy gold and write off silver as an industrial metal, or do they try to exploit the aforementioned underperformance of silver under the assumption that silver will trade like a monetary metal again in the future? An investor who decided to buy silver on the latter assumption will be rewarded if he or she is correct — silver has a fair amount of catching up to do with gold.

While gold is probably the safer trade in terms of its expected volatility, I think investors should take the added risk and buy silver. Here’s why.

First, while we are assuming that silver’s industrial component is a deterrent for investors looking for a safe haven asset, we should look at the actual fundamentals of the silver market before drawing this conclusion. In fact investment demand for silver has been very strong. One good measure of this is the sale of American Silver Eagles. These are 1 troy ounce silver coin produced by the U. S. Mint, and they are among the most popular vehicles for silver investors. If we look at March demand for this year versus last year we find that silver demand soared. American Silver Eagle sales hit 3.36 million coins (ounces) in March of last year, yet they topped 5.3 million coins in 2014. That’s nearly a 60 percent rise in demand!

Second, silver’s underperformance means that it is less economical to produce. In fact many silver mining companies cannot make a profit mining for silver. While major silver producers such as Pan American Silver (NASDAQ:PAAS) and First Majestic Silver (NYSE:AG) reported fourth quarter operating profits their net profits were negative. Smaller silver miners are in worse shape. For instance Golden Minerals (NYSEMKT:AUMN) had to shut down its Velardenia mine because of low silver prices. Additionally one of the largest undeveloped silver deposits in the world — Silver Standard Resources’ (NASDAQ:SSRI) Pitarrilla mine — isn’t economical with silver trading at $20 per ounce.

Now this hasn’t been reflected in silver supply because most of the world’s silver produced is a by-product of another metal such as zinc, copper, or gold. But now that the prices of these metals are down and this could limit their production, and silver production by extension. Therefore we can see a supply deficit in the silver market, and the right time to buy is now considering the metal’s low price.

Third, smaller investors looking to invest in precious metals are going to gravitate towards silver. You can walk into a coin store and buy $30 worth of silver, but you can’t really do that with gold. There are one gram gold bars and half gram gold bars available on the market, but you have to pay a very high markup to buy them. For instance a ½ gram gold bar costs $31 plus shipping. That’s more than a 50 percent premium to the spot price! With this in mind small investors are going to choose silver over gold. While one small investor can’t move the market a whole bunch of them can, and there are a lot of small investors just entering the middle class in the developing countries in Asia, South America, and Africa.

Given these points I think that not only can silver outperform gold, but silver has not lost its role as a monetary metal. In the near term we could see the silver price continue to underperform. Speculators might view the underperformance of silver as bearish and sell short future contracts. They may also indiscriminately sell short a basket of base metals that includes silver. Finally speculators might decide to put on a long gold/short silver trade in order to bet on gold’s continued outperformance.  But this short term noise will not overwhelm the growing demand for silver from both investors and manufacturers.

Disclosure: Ben Kramer-Miller owns silver and gold coins and shares of First Majestic Silver and of Silver Standard Resources.

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