Silver investors cannot be happy right now. At least not those who purchased silver after its bumpy ride down in early 2013. But if the operative, if not simplified, goal of investing is to buy low and sell high, the window of opportunity for silver is wide open for precious metal investors. That doesn’t mean silver prices will soar 400%+ in the coming weeks. But there are fundamental and technical plays in place that suggest silver prices are poised to experience a significant rebound.
Have Silver Prices Bottomed?
Silver prices have been routed. When you look at the broader market over the last number of years, this may not be a total surprise. Precious metals like silver, gold, and platinum have a negative correlation to the stock market. When times are good, investors shun silver; when the markets are in trouble, investors turn their attention to the grey metal.
Case in point; since bottoming in March 2009, the S&P 500 has advanced roughly 196%; the NYSE is up 140%, while the NASDAQ has climbed a whopping 285%. Silver, on the other hand, is up just 8.2%. But that figure is misleading. Since peaking in April, 2011 at $49.82, silver prices have fallen 71%.
Currently trading at a six-year low near $14.40 per ounce, most analysts expect silver prices to fall even further. If so, 2015 will mark a record fourth consecutive year of declines.
With silver prices still down 8.5% so far this year, and at its lowest levels since the summer of 2009, silver is sitting in a pretty attractive range. That hasn’t stopped most analysts from saying that while silver looks cheap, there are few catalysts to spark a rally.
Though I think most analysts are wrong. Physical silver continues to be a great long-term investment. And I do mean long-term. Silver doesn’t typically make explosive one-day gains. But there have been periods of strong gains over the last 15 years.
Silver as a Hedge Against Economic Uncertainty
Silver Catalyst #1: Investors shouldn’t discount precious metals.
Silver, gold, and platinum are wise investments meant to diversify your portfolio against market volatility. And despite silver’s poor performance over the last four years, it remains a versatile and necessary product.
Where gold is used primarily as an investment tool and jewelry, silver is used as both an industrial metal and a precious metal. As a precious metal, it is used to hedge against economic uncertainty. And there are many reasons why investors should be nervous.
First, there is China. The world’s second-biggest economy is in trouble. Or it is relative to the last 35 years of extraordinary growth. China disappointed the rest of the world when it said its economy would grow at just seven percent annually. Yes, that’s lower than before, but it’s still miles ahead of what the United States, the world’s biggest economy, is doing. And the rest of the free world for that matter.
Regardless, the Chinese economy remains weak and fears are it will hinder global growth. That’s because the rest of the world relied on China to help it stave off a global recession in 2008. And a staling Chinese economy could send global stocks into a tail spin.
I enter as evidence. Data on China’s manufacturing sector, falling to a three-year low in August, points to a struggling economy. The country’s official manufacturing purchasing-managers index fell to 49.7 in August from 50 a month earlier. A reading above 50 suggests expansion where a reading below 50 points to contraction. The government’s nonmanufacturing PMI also fell on a month-over-month basis to 53.4 in August from 53.9 in July. (Source: wsj.com, September 1, 2015.)
China has already cut interest rates five times since last November (to 4.85%) and devalued the yuan to encourage lending and boost growth. Making a currency weak to help boost exports can only work if those on the other end have lots of money to spend.
And that’s why the economic data coming out of China is so scary. The rest of the world has been relying on zero interest rates and Chinese growth to carry the global economy. But what if the latter fails to materialize?
Central Banks have done their part, artificially lowering interest rates to kick-start their local economies. The only problem is; it hasn’t worked. Case in point, since 2008, America’s gross domestic product (GDP) has grown at just over 10%. China’s economy has increased by more than 65%.
Aside from a weakening China and faint economic heartbeat from the U.S., the eurozone continues to underwhelm with economic millstones like France, Italy, and Greece. Japan’s economy shrank in the second quarter. And Canada, the U.S.’s biggest export market (accounting for 19% of all exports compared to China’s seven percent) has slipped into a recession.
None of this bodes well for the U.S. economy. Nor for global stock markets. After all, markets are only as strong as the stocks that support them.
Stock Markets Seriously Overvalued
Silver Catalyst #2: While investors have been happy to support the stock market, they can only do that for so long.
Reality will kick in and investors, as they are wont to do, will run for the exits.
As noted above, the NASDAQ, NYSE, S&P 500, and Dow Jones Industrial Average have all performed exceptionally well over the last number of years. This is in spite of weak economic data. Where investors once rewarded companies for reporting strong earnings and revenue growth, today, they reward them for not losing as much as the companies said they would.
- According to the Case Shiller CAPE PE Ratio, the S&P 500 is overvalued by around 67%. The average CAPE ratio between 1881 and 2015 in the U.S. is 17; today it sits at 25.10. The only other times the ratio has been higher have been in 1929, 2000, and 2007. All three instances were followed by a collapse. (Source: Yale University, last accessed September 15, 2015.)
Where should the markets be according to Shiller? His ratio puts the S&P closer to 1,300. Currently at 1,981, the S&P would have to fall as much as 34%. (Source: nytimes.com, August 27, 2015.)
- The Market Cap to GDP Ratio compares the total price of all publicly traded companies to GDP. Warren Buffett calls it the single best measure of where valuations stand at any given moment. A reading of 100% suggests U.S. stocks are fairly valued. The higher the ratio over 100%, the more overvalued the stock market. It currently sits at 116.4. The Warren Buffett Indicator has only been higher once since 1950. In 1999, it came in at 153.6%. It was only at 108% before the housing bubble burst in 2008.
When the broader stock market experiences a real correction, not a short-term distraction like Black Monday, investors will flock back into precious metals like silver.
Silver Ratio Points to Upside Growth
Silver Catalyst #3: The price of silver is linked with gold.
And gold prices have been declining, like silver, since 2011. At $14.40 per ounce, it takes around 77 ounces of silver to purchase one ounce of gold ($1,107.50 per ounce). In 2011, the ratio was 32:1.
The silver/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. Since 1970, the gold-to-silver ratio has averaged about 55.
To restore the historical average silver/gold ratio, silver prices would have to increase to around $20.00 per ounce—a bullish signal for silver. And investors may not have to wait long for a restoration in the great silver/gold ratio. When the silver/gold ratio tops 70, a correction isn’t too far behind.
The last three times the silver/gold ratio topped that margin were in 1995 when silver prices gained 70%; in 2003 when silver prices climbed 200%, and in 2011 when silver gained 420%.
Correlation is not causation, but the outlook for silver remains bullish.
Dwindling Supply of Silver
Silver Catalyst #4: There is a finite supply of silver out there.
And there are two reasons why the supply of silver has dwindled. Most mining companies do not mine for silver, per se. Silver is most often mined as a by-product of gold, copper, lead, and zinc.
The plunge in gold and copper prices has translated into huge cuts in capital spending by miners—which means lower output. It also means a halt to new mines or expansions. When the global economy does get back onto solid footing, it may be hard for production to keep up with demand.
This could send silver prices considerably higher. That’s because silver is an invaluable industrial metal used in batteries, dentistry, LED chips, medicine, nuclear reactors, solar energy, semiconductors, touch screens, water purification, and many other industrial uses.
But again, the demand for silver as an industrial product will only increase when the global economy recovers. Unfortunately, economic challenges in China, Canada, Japan, Russia, the eurozone, and the United States, to name a few, make it difficult to be outright bullish on silver right now.
While the International Monetary Fund expects the global economy to grow at 3.3% this year, it is expected to approach four percent next year. This bodes well for silver bulls as we head into 2016.