There Factors Point to Considerable Upside for Silver Prices
Since the summer of 2011, silver prices have fallen by roughly 70%. But since the beginning of October, prices have rebounded. Currently trading near $15.75 an ounce, silver prices have climbed 8.6%.
There are a number of factors that will contribute to the resurgence in silver prices, including China’s addition to the LMBA silver benchmark-setting process, and the slowly improving U.S. economy.
China Helps Boost Silver Prices?
China, the world’s largest producer and consumer of silver, is about to have a little more influence in the precious metals market. China Construction Bank signed a memorandum of understanding with CME Group to join the LMBA silver benchmark-setting process. The agreement means CME can offer offshore Chinese renminbi futures contracts with physical delivery in London and CCB can take part in London silver pricing. (Source: “China Construction Bank to join LBMA silver price-setting mechanism,” Reuters, October 19, 2015.)
China Construction Bank will join HSBC, JPMorgan Chase, Mitsui & Co Precious Metals, Bank of Nova Scotia – ScotiaMocatta, Toronto Dominion Bank, and UBS in taking part in the daily auction process.
By taking part in the daily auction of silver, China is positioning itself as a major player in the international silver and gold trade. With a weak economy and devalued yuan, China is eager to protect and shore up the value of its currency.
And it will do so at any cost. In the first quarter alone, China increased its silver reserves by more than 175% to 345.1 metric tons. While silver prices are up since the beginning of October, they are still low by historical measures. China is going to continue to hoard silver at current prices. (Source: “China Silver Stockpiles Surge as Demand Wanes on Slowing Economy,” Bloomberg, April 16, 2015.)
In addition to being the biggest consumer of silver, China is also the biggest producer/consumer of gold. In September, China added another one percent to its supply of physical gold.
Joining the LMBA silver benchmark is the second step China has taken to increase its influence in the international precious metals market. In June, the Bank of China became the first Chinese bank to join the gold price benchmark process operated by Intercontinental Exchange (ICE).
China is also looking to set gold prices in its own right by the end of 2015 with its yuan-denominated gold benchmark. In 2014, the Shanghai Gold Exchange launched an international platform that allowed foreign investors to trade yuan-denominated gold contracts for the first time.
Can a similar play in silver be that far off?
Gold/Silver Ratio Not Always Reliable
The silver-to-gold ratio is calculated by dividing the price of an ounce of gold by the price of an ounce of silver. This tells you how many ounces of silver it takes to purchase one ounce of gold.
During the 20th century, the gold-to-silver ratio was 47. Since 1970, the gold-to-silver ratio has averaged about 55. In 2011, the ratio was 32:1. And today, the gold-to-silver ratio sits at an eye-watering 74.
Despite all the silver-to-gold ratio talk, there really is no one set fraction investors can look at to deduce how much silver prices need to soar to restore the ratio. It would be great to say silver prices will soar 400% to restore a random historical ratio, but the fact of the matter is, investors are not that rational.
The gold-to-silver isn’t set in stone and it doesn’t level out on a regular basis. It’s an exchange rate. What it tells us is that the ratio is far too high and that silver prices are undervalued. Even on a geological level.
It is widely held that there is one gram of silver for every 12.5 metric tons of earth and there is one gram of gold for every 250 metric tons. By that measure, the gold-to-silver ratio should be pegged at 20-to-1. With gold trading at $1,166.80 per ounce, silver prices should be at $58.30 per ounce; or 272% higher than current levels.
But it will take some sort of catalyst for that kind of rebound to occur.
Industrial Use Will Send Silver Higher
As the poor man’s gold, everyone knows that silver is used as a hedge against economic uncertainty. But that pigeon-holes silver too much. It has much broader use than gold, and why as an industrial metal, silver has a lot more room to run.
In a growing economy, silver demand increases. That’s because silver is an invaluable industrial metal used in medicine, batteries, solar energy, semiconductors, touch screens, water purification, LED chips, nuclear reactors, and many other industrial uses.
While the global economy is hardly on fire, it is expected to experience modest gains over the next couple of years. In 2014, global gross domestic product (GDP) was 3.4% and is forecast at 3.1% this year, and rebounding to 3.6% in 2016. Advanced economies (U.S., eurozone, etc.) are expected to report 2015 GDP growth of two percent and 2.2% in 2016. Specifically, the U.S. economy is projected to climb 2.6% this year and 2.8% next year. (Source: “Uncertainty, Complex Forces Weigh on Global Growth,” imf.org, October 6, 2015.)
That’s what’s so frustrating about silver prices right now. Silver is used as a hedge against economic uncertainty, for jewelry, and for numerous industrial uses. Silver prices are bullish. But even at current levels, they still don’t accurately reflect its versatility.