Will Silver Prices Rally Soon?

Is it time to take the plunge and cash in on a rally in silver?

| More on:
The Motley Fool
You’re reading a free article with opinions that may differ from The Motley Fool’s premium investing services. Become a Motley Fool member today to get instant access to our top analyst recommendations, in-depth research, investing resources, and more. Learn more

The price of silver has softened by 2.3% since the start of 2014. Yet the price of gold has rallied, spiking a healthy 5% over the same period. This is contrary to the historical correlation that has existed between the two metals, with silver typically following gold. We have seen a key measure of this correlation, the gold-to-silver ratio, continue to widen. The gold-to-silver ratio represents the number of ounces of silver required to buy one ounce of gold.

There are those who argue the ratio should sit somewhere between nine and 19, representing both where the ratio has sat historically and the natural occurrence of silver compared to gold. But with the ratio having topped out at 100 twice in the last 40 years, once in 1980 and again in 1991, it is a fluid measure of the value of silver in comparison to gold.

What do the indicators say about a silver rally?

The gold-to-silver ratio has widened by five points, from 62 at the start January this year to almost 67. But more astonishingly, over the last two years the ratio has widened by 12 points.

There are other indicators supporting the idea of a silver rally.

Global silver supplies have declined since 2010, dropping 9% to 978 million ounces at the end of 2013, yet demand for silver has continued to grow. From 2010 to 2013, physical demand grew by 5%, and over the last 10 years demand has grown a massive 18% to 1.08 billion ounces annually.

There is also increasing demand for silver from India and China. It’s appreciated not only as a store of value and a hedge against inflation but also as an important component in jewelry and many industrial processes. In 2013 alone Asian industrial demand for silver grew 3%, led by China, where a recovery in the electrical and electronics sector drove increased demand. Both economies are expanding rapidly and their demand for precious metals, including silver, can only continue to grow over the long term.

All of these indicators signal silver is set for a healthy bounce during 2014, and has truly entered oversold territory. But there is no guarantee this will become a sustained long-term rally: Better-than-expected global economic growth, the Fed’s unwinding of quantitative easing, and growing Chinese industrial activity are all applying downward pressure to precious metal prices.

Which company is best positioned to benefit from a bounce in silver prices?

Over the last two years, silver miners have been punished by the market, with silver prices plumbing new lows not seen since 2010. For the year to date, First Majestic Silver’s (TSX: FR)(NYSE: AG) share price has plunged 13%, while precious metal streamer Silver Wheaton’s (TSX: SLW)(NYSE: SLW) share price has remained flat.

But Pan American Silver (TSX: PAA)(NYSE: PAAS) has bucked the trend with its share price jumping a healthy 7% for the same period. This is despite the company’s first quarter 2014 net earnings per share falling by a massive 62%.

First Majestic’s earnings per share for the same period also fell spectacularly, plunging 74%, whereas Silver Wheaton’s dropped by only 35% in comparison.

But it is Silver Wheaton that remains the best option of the three for investors seeking to profit from a rally in silver. This is because it’s a precious metals streaming company, which is not required to make the capital expenditures associated with exploration and mine development in order to ensure sustainable production. It also doesn’t have to incur any of the operational expenses associated with mining, meaning it has far lower overheads than the silver miners.

This means any significant bounce in the silver price will more significantly boost Silver Wheaton’s bottom line than those of Pan American, First Majestic, or other silver miners. It also has another important benefit for investors in that it’s capable of remaining profitable at far lower silver prices than any of the miners. which gives it a competitive advantage.

But it does appear expensive compared to the silver miners, with an enterprise value of 16 times its EBITDA, compared to eight times for Pan American and nine times for First Majestic. This ratio is also more than double the EV-to-EBITDA ratio for its peer group, indicating that the market has factored the company’s competitive advantage into its share price. However, it is a lower-risk investment than the silver miners.

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium service or advisor. We’re Motley! Questioning an investing thesis — even one of our own — helps us all think critically about investing and make decisions that help us become smarter, happier, and richer, so we sometimes publish articles that may not be in line with recommendations, rankings or other content.

Fool contributor Matt Smith does not own shares of any companies mentioned. Silver Wheaton is a recommendation of Stock Advisor Canada.

More on Investing

energy oil gas
Dividend Stocks

2 High-Yield Energy Stocks to Buy as Recession Approaches

Energy stocks such as TC Energy and Canadian Natural Resources allow investors to generate income even in recessionary times.

Read more »

green power renewable energy
Dividend Stocks

3 Top Dividend Stocks to Drive Your Passive Income

These three high-yielding, safe dividend stocks could boost your passive income.

Read more »

Dial moving from 4G to 5G
Tech Stocks

TFSA Investors: 2 Canadian Stocks With Unbelievable Staying Power 

Amid economic uncertainty, investors look for stocks that can thrive in any crisis and grow long term. Here are two…

Read more »

protect, safe, trust
Dividend Stocks

TFSA Wealth: How to Earn $363 in Monthly Passive Income for Life

Canadian investors can harness the power of the TFSA to generate steady tax-free passive income for decades.

Read more »

Canadian Dollars
Dividend Stocks

TFSA Millionaire: How to Turn $40,000 Into $1.2 Million for Retirement

Here's how TFSA investors are using the power of compounding to buy top Canadian dividend stocks to build retirement wealth.

Read more »

potted green plant grows up in arrow shape
Stocks for Beginners

3 Superb Income and Growth Stocks for Every Portfolio

The market is full of superb income and growth stocks, but not all belong in your portfolio. Here are three…

Read more »

stock market
Stocks for Beginners

Worried About Stagflation? 2 Canadian Stocks for All Market Cycles 

Stagflation delays economic recovery. You can keep your portfolio stagflation ready with these Canadian stocks that are suitable for all…

Read more »

exchange traded funds
Stocks for Beginners

Why BMO’s Global Infrastructure ETF Is the Only TSX Stock You Need

BMO Global Infrastructure Index ETF (TSX:ETF) is the only TSX stock you need for passive income, solid cash flow, and…

Read more »