We have already discussed the importance of gold in the monetary system in our previous article. Platinum, Palladium, Gold and silver forms part of precious metal group. These metals are carefully selected owing to their properties. Most of them are precious because they are rare and serve some important function. Platinum for example is used as an auto catalyst and catalyst in industries besides it is used for making contacts for electronics. Gold has few uses besides jewellery. But silver has thousands of applications as a metal and it is least valued and found in most abundance. These metals form the Precious metals group and they are of interest to many investors around the world. Here is an article that explains the use of gold as money and why precious metals are such an important part of the metal industry.
We have discussed a lot on gold. Hence, we decided to discuss a little bit about silver. Silver too was used as money till last century. The last silver coins in USA were printed in 1964. It has more than 2500 years of history been used as money. Silver has many uses. Besides been a good conductor, it also has found new uses in medical science. Its use as a nano technology particle has opened new applications.
The metal is used mostly as a commodity which is why it gets punished in the market whenever markets face a deflationary wave. However, there are some factors that are looking good in terms of price of silver which an investor should know.
Demand and Supply of Silver
- Production is Declining
Majority of the silver is a by product of mining copper, zinc, gold and nickel. Primary silver mines are few and it is difficult to find such mines. Over the past few years, silver mines have seen their grades falling. In addition, silver reserves have fallen too. This has led to fall in production over the years. It has been difficult to increase silver production year after year. As per silverinstitute.org, global mine production in 2019 was lower by 1.3% over 2018 figures. Primary silver production fell 3.8%. It was also the fourth consecutive year of falling production. Production likely topped in 2015.
- Demand remains constant
Demand for silver has remained constant over the past many years due to new applications in photovoltaics and electrification of vehicles.
Shortage in supply is been met by recycled silver.
Future looks dim for production of silver as new primary mines are few and far between. Besides the world is expected to run out of mineable silver in few years. It is becoming increasingly difficult to produce silver at low prices. The AISC for most silver producers is higher than the market price of silver for past few years. It is therefore difficult to produce silver profitably.
Here is some additional data courtesy of Metal Focus & Nicholas LePan via Visualcapitalist.com, Endeavour Silver, one of the largest silver producer
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Silver and Inflation
Historically, silver has performed better than gold in times of inflationary expectations. Silver been a commodity and a precious metal makes it ideal for protection against monetary inflation. In 2008, when the FED started stimulating the economy through monetary expansion of its balance sheet, silver shot up 440% in a period of 4 years. Currently the FED is involved in a monetary expansion that is unparallel and the balance sheet is expected to balloon from 4.2 trillion dollars at the start of the year to 10 trillion dollars by the end of the year.
Silver in anticipation is already looking to move up. The key point here is to note that silver is considered by many as highly undervalued.
Why inflation is a possibility
The US economy is caught in a bind. With population growth sagging and productivity growth low, there is no real driver of growth. The FED then had to depend on debt for driving growth. The monetary expansion of the past decade has made additional dollar debt less stimulating (due to marginal utility diminishing). Thus every additional dollar results in less growth which means the interest rates have to be kept lower for longer. The FED is already looking to cap yields and precious metals therefore look better in terms of yield producing assets. Some are of the opinion that the US may see negative rates sooner and therefore there is a threat that the dollar may weaken. If the dollar weakens considerably, inflation may increase as people move out of the dollar. Currently global demand for dollar is keeping it stable. It may spike as the dollar trade is reduced and demand for oil is low. However, such a spike can occur in short term and over the medium term dollar is expected to weaken.
With prolonged lockdown, the production capacity has been shrinking. The resulted lockdown has resulted into reduced capacity and productivity of people. People are chasing essential things and 50% of products not available on account of curtailed capacity, there has been rush for chasing those essential items while sacrificing the need for other items. Till the time, things get normalised i.e. normal production of other items returns, the prices of essential commodities will sky rocket. As more dollars chase few goods and services inflation can be expected. If inflation occurs, there is a strong possibility of yields spiking causing more stress in the economy as bonds fall and equities fall too.
The other aspect is to look from a perspective of debt deflation and demography. Debt is a growing problem for the world as total debt keeps hitting new highs every year. The funded and unfunded liabilities keep increasing and there is no way future generations can ever pay the rising debt and other liabilities. In addition, the money velocity has been slowing leading to deflationary environment and money has been moving into financial assets rather than real economy. Therefore, demand for real goods and services keeps falling. It is also the reason why in spite of huge stimulus raising money supply, there has been lack of inflation since 2008 and GDP growth is anaemic.
Source: St Louis FED
The third factor is the demography of the developed countries as more people enter the retirement period therefore leading to increased pressure on social security, pension and healthcare. These three forces are unaffected by stimulus and are constantly pushing the global economy into a cliff. Technological development has meant reduced need for human labour and hence the wages will remain suppressed for quite some time. Under such circumstances, it is evident that there will come a time when the three factors of debt, deflation and demography will push the financial economy into a tailspin leading to increasing defaults, as governments around the world face increasing deficits forcing them to raise taxes thereby reducing demand. The global economic cake is shrinking and countries are trying to get the largest pie for themselves which points to rising conflicts. Should such an event come to fruition, it is evident that there will be supply chain issues and increasing trade wars. We feel that these events will happen over the course of the next few years.
Gold Silver Ratio
The gold silver ratio is also an indicator of inflation deflation signals. Gold prices rise at the sign of first trouble in global economy. As such, it is a barometer of the monetary system. Silver been used as an industrial metal therefore goes down in event of deflation or recession. This leads to spike in gold silver ratio. During 1929 and in 2020, gold silver ratio has crossed 120% indicating high risk of recession. Whether the signal is relevant will only be confirmed in hind sight. However, given the weakness in the economy even before the pandemic, it is expected that a recession is a mere formality. Central banks will then be forced to pump liquidity and resort to additional stimulus measures leading to further easing of monetary conditions which will aid precious metals. Silver been more undervalued should outperform gold.
Data Source: SD Bullion
Therefore, it is essential to seek some protection in precious metals. Gold has been moving higher for quite some time. Silver follows with a lag.
We have been bullish on gold. It’s time for silver too.