Silver just doesn’t draw a crowd like gold. From newlyweds to despots, mythical Greek kings to conspiracy theorists, the yellow metal occupies a revered place in global history, with silver more an afterthought than a precious runner-up. Apparently, you can add investors to the above list. Since 2011, the dollar-denominated gold-silver ratio (how many ounces of silver one ounce of gold will buy you) has more than doubled to 80:1. The last time the multiple was this high Lehman Brothers had just collapsed; a full decade on, market risk only seems to lead to bids for gold.
Yet there are good reasons to believe the grey metal is undervalued in relative and absolute terms. The first is technical. According to bullion merchant Baird & Co, the average gold-silver price ratio for the last 226 years "has been closer to 48:1, with regular troughs below this level". And while the average has been closer to 63:1 over the past quarter-century, moves to 80:1 tend to be followed by a sharp reversion to (and often beyond) the mean.
Such a trend hasn’t gone unnoticed. When the ratio was this wide 21 years ago, none other than Warren Buffett started to amass a 130m ounce (oz) position in the metal.
The Sage of Omaha’s atypical departure from stockpicking started when silver was changing hands for $6 (£4.50) an ounce. It now trades just shy of $16. But the reason Buffett and Berkshire Hathaway vice chairman Charlie Munger gave for their bet – "widely-published reports have shown that bullion inventories have fallen very materially, because of an excess of user-demand over mine production and reclamation" – could equally be applied to the silver market in 2018.
Indeed, the second plank of the bull case is fundamental. Compared to gold, where just 8 per cent of last year’s global demand came from electronics, dentistry and other manufacturers, silver is an industrial commodity. In fact, the use of silver in everything from semiconductors to solar panels and water purification places a draw on around half of all production.
This also means that the metal is much more susceptible to swings in supply and demand than gold. And on the demand side of the equation, the outlook is robust. While the CRU Group expects orders from the solar industry to contract this year, fellow metals consultancy Metals Focus expects overall industrial demand to climb, on the back of a 4 per cent rise in industrial silver fabrication in 2017. A good chunk of this should come from the semiconductor industry, where BMO Capital Markets expects orders to climb by 20m oz – equivalent to 2 per cent of 2017 demand – every year into perpetuity.
It’s not all rosy. Mirroring a pattern in the gold market, demand from coin and bar buyers fell in 2017, while exchange-trade product and metals exchanges saw only minor inventory build-ups.
On the other side of the equation, however, supply is looking decidedly fraught. Global mining output declined 1 per cent in 2016, and contracted a further 2 per cent to 852m oz last year, as grades at some of the world’s most productive orebodies – including the South32 (S32)-owned Cannington development and Fresnillo’s (FRES) eponymous mine – continued to fade. Scrap supplies, which have held the balance in check in cycles past, have nearly halved since 2011. And unsurprisingly – given most silver is mined as a by-product – the enormous cuts to miners’ capital expenditure and project development plans over the past four years look set to further widen the gap. In fact, industry association The Silver Institute calculates that physical and investment demand has outstripped total supply every year for the past decade.
To all of this, the metal’s miners and their shareholders may well ask how prices can remain so depressed. The market has certainly been expecting silver to take off for a while now. When we tipped Peru-focused precious metals producer Hochschild Mining (HOC) at the beginning of this year, we flagged that the average analyst monitored by Bloomberg was predicting silver would rise 5 per cent in a year to $18.31 by the start of 2019. In the event, a rallying dollar and choppy exchange-traded product sentiment has conspired to take 7 per cent off the price to just shy of $16 an ounce. Analysts now don’t expect the grey metal to pass $18 until this time next year.
One might reasonably counter that commodity prices are notoriously difficult, if not impossible, to call. Then again, it is notable that longer-term forecasts are very bullish. By 2021, no analyst surveyed by Bloomberg expects silver to sit below $17 an ounce, while the median estimate is for $19.60. That’s a rise of 23 per cent on the current price, or more than three times the increase expected by the $1,340 median forecast for gold in the same period.
