While gold has rallied in recent days to now only be 7% lower than it was a year ago, silver continues to lag with it, now down a whopping 23% for the same period. But despite this poor performance, I expect silver to rebound, offering far greater potential upside for investors than gold.
Let’s take a closer look at three key reasons why I remain bullish on silver.
1.The gold-to-silver ratio continues to widen
There is a close correlation between gold and silver prices, which is represented by the gold-to-silver ratio. This ratio expresses how many ounces of silver are required to buy one ounce of gold and it is considered a key signal highlighting whether silver is under- or overvalued in comparison to gold.
When the ratio is high, silver is undervalued, making it a preferable investment to gold for investors seeking exposure to precious metals. Year to date, the ratio has continued to widen, with it now requiring 72 ounces of silver to purchase one ounce of gold, compared to the 63 ounces at the start of the year.
The ratio is also becoming increasingly disconnected from its historical average. At the height of the bull market in gold, only 43 ounces of silver were required to buy one ounce of gold. Over the last 100 years, the ratio has averaged 47 ounces of silver for one ounce of gold. These indicators highlight just how undervalued silver is in comparison to gold, and I expect the ratio to close, making a rebound in silver imminent.
2. Supply and demand fundamentals are extraordinary
Unlike gold, silver is an industrial commodity with a wide range of uses including being a central component in the manufacture of photo-voltaic cells. With photo-voltaic cell manufacture expected to explode over the next decade as solar power becomes more widely accepted, the demand for silver can only continue to grow.
For 2013, demand for silver outstripped supply and I believe this will continue for at least the short to medium term. This is because of growing industrial demand for silver coupled with diminishing supplies caused by miners slashing expenditures on mine development.
Primary silver miners First Majestic Silver Corp. (TSX: FM)(NYSE: AG), Pan American Silver Corp. (TSX: PAA)(NYSE: PAAS), and Endeavour Silver Corp. (TSX: EDR)(NYSE: EXK) all slashed their capital expenditures on mine development for 2014. For the second quarter alone, compared to the same quarter in 2013, First Majestic’s capex for mine development dropped 56%, while Pan American’s and Endeavour’s were down by 17% and 66%, respectively.
I expect this trend to continue with the price of silver at $17 per ounce, leaving these miners with thin margins, making it uneconomical to mine and develop marginal silver deposits.
3. Institutional investors continue to bet big on silver
Wall Street continues to bet heavily on a rebound in silver. By the end of the second quarter of 2014, institutional investors George Soros and John Hussman had amassed significant stakes in silver streamer Silver Wheaton Corp. (TSX: SLW)(NYSE: SLW) valued at $9.5 million and $7 million, respectively. They have also made a big bet on Pan American Silver with Soros investing $11 million and Hussman $4 million by the end of the same period.
This indicates that Wall Street is expecting a rebound in silver as growing economic and geopolitical uncertainty coupled with supply constraints set to push the silver price higher.
What is the best way to play a rebound in silver?
I believe precious metals streamer Silver Wheaton offers investors the best way to play a rebound in silver prices. As a precious metals streamer, it is a far lower-risk investment than a silver miner because it is able to avoid the considerable costs and risks associated with being a mine operator.
This allows it to generate a superior margin than any of the silver miners and boost its profit even if silver only appreciates marginally in price. Yet it still offers investors the same leveraged exposure to the price of silver, ensuring they get a “bigger bang for their buck” than the returns offered by a silver ETF or bullion.
Motley Fool Canada's market-beating team has just released a brand-new FREE report revealing 5 "dirt cheap" stocks that you can buy today for under $49 a share.
Our team thinks these 5 stocks are critically undervalued, but more importantly, could potentially make Canadian investors who act quickly a fortune.
Don't miss out! Simply click the link below to grab your free copy and discover all 5 of these stocks now.
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 has no position in any stocks mentioned. The Motley Fool owns shares of Silver Wheaton (USA). Silver Wheaton is a recommendation of Stock Advisor Canada.