In our inflation series outlook on 15th December 2020 – we discussed the merits of commodities and crypto currencies. Inflation is now a widely discussed news item and crypto currencies have gone to the moon. Alas, the Crypto trade got away from us and the returns have been astonishing. The question has been “Do you chase or do you wait patiently for the next opportunity?” We have chosen the latter. So what is that opportunity?
There is little risk premium out there with the world awash with government stimulus and retail trading. However, something in the last week has caught our attention that we wrote about in February – Silver. It has been a commodity that has been sideways for the last year but some market technicians are now flagging some important multi year levels that are close to breaking. Watch this space – before Crypto, silver was the commodity that generated a lot of drama. While we believe $50 Silver is justified, a speculative rally could get to $100+ versus $28 currently.
Reminder of the investment case
We have been interested in Silver and recommended an allocation in February based on 4 key principles:
- The first was the supply / demand imbalance. The supply of silver in 2020 has been constrained due to the pandemic impacting mining operations globally. The demand for silver (industrial, jewellery, physical purchases and exchange traded funds) exceeded supply in 2020 by 250 million ounces and in 2021 (forecasted) by 125 million ounces. For reference, we produce around 1bn ounces through mining / recycling each year. So the market is still in deficit before making assumptions of an increase in industrial or investor/ETF demand.
- The investment in exchange traded product has been exploding. Most years around 50 million ounces of net demand comes from exchange traded products (ETF’s) – in 2020, it was 330 million ounces. For every $1 that flows into $SLV ETF, yes, physical silver has to be purchased and placed in a vault. In January/early February we saw a big pick up in ETF allocations but the follow through has remain subdued. How important could this be? A 100mn increase in shares in the ETF ($2.8bn of demand) equates to just under 100mn ounces of silver being purchased which is 10% of global production. In 2020 we saw that level of pick up in $SLV shares in issue.
- Silver has real future orientated industrial needs that are supported by US and Global policies. You need silver for solar panels, electric vehicles, electric charging infrastructure and 5G broadband infrastructure. These are mega trends that governments are subsidising to get to net zero and connectivity. So if you like Tesla, Elon Musk and DOGE coins – you should be paying attention. Industry surveys are saying 50% of global silver production could have to go towards Electric Vehicles by 2035. VW in 2021 will produce 500k electric vehicles versus Tesla trying to product 1mn. The big car manufacturers are gearing up.
- With no risk premia in equities, VIX at its lows and all risk assets bid – we are happy to look at alternatives that are not being discussed widely such as silver. There is enough greed and momentum chasing in other parts of the market.
Why now? What has changed since February?
We first wrote about $GME in October 2020. The real action did not begin until February 2021. We are happy to be early and for those following us – we are not seeking to day trade. Silver we believe, will see a similar dynamic.
What has changed in recent weeks?
- The first is the decline in the US $. See Chart 1 – if this breaks lower the implications for $ and demand for real assets and commodities could accelerate further. So far, the Central Banks seem to be comfortable with inflation spikes being temporary. That means rates are going to remain low and cash needs to find a home. That does not look to be US $ at the moment.
- Second is a number of commentators are pointing to the levels we are getting to in the Silver Futures as being meaningful. If we break higher, through $30, the case is there for Silver to get back to its 2011 high of $50. We would note that Gold has already traded to it’s 2011 high of $1900 per ounce.
How high could Silver trade?
We noted in our original investment thesis that when Silver has rallied it has moved 4 fold (2011 highs) and 7 fold (1980 highs). So speculative rallies in Silver can be significant. Off its lows of $14 in recent years we have only doubled – we are only be getting started. If Silver traded to its 2011 ratio with Gold that would indicate close to $60. That is not fanciful to us.
In a world of DOGE, Reddit, Robinhood, Memes how does Silver look? If Silver traded at its 1 year average ratio to BitCoin of 0.0025 versus 0.0006 currently that is $100. Crazy we know – but Doge Coin was started a joke and has just featured on Saturday Night Live. We live in exceptional times.
The response to that is well BitCoin is overvalued – the argument may be correct but we still believe the asymmetry in Silver is very compelling here and speculative rallies in Silver of 7x (which would indicate a move from $14 to $100) are not without precedent. We remain comfortable versus $28 with upside to $50 and $60 based on fundamental, inflation, industrial demand and the ratio to gold.
Does the modern retail investor care about Silver?
We are in an era of day trading, government cheques, negative interest rates and #WallStreetBets. There was a brief episode in January/February where retail investors did care about Silver. Some people even if wondered if the $GME episode would spill into a short silver squeeze. You can watch here for a history of retail investors and $SLV interest https://www.youtube.com/watch?v=Y9rel-DCHos
Chart 3 shows, using Google Trends data, that during the $GME episode interest in $SLV did increase and people were discussing the ‘short squeeze’. So the dynamic is real, but once again – we don’t need retail speculation to justify the fundamentals of owning silver.
What’s the recommendation?
We would reiterate our investment recommendations from February. We believe the case for owning $SLV (physical Silver ETF) and $SILJ (silver miners ETF) is robust. We believe the upside potential of 100% is supported by fundamentals and historical precedents and relationships with other asset prices.
[Note there are UK/European listed versions of physical silver ETF’s]