Insights

Sprott Silver Report: Silver's Critical Role in Electrification May Fuel its Rise

Authored by Maria Smirnova, Senior Portfolio Manager at Sprott Asset Management LP

Silver is an Attractive Investment Opportunity

At Sprott, we remain bullish on silver’s investment merits. Like gold, silver is a tangible store of value which acts as an effective portfolio hedge. Despite lackluster performance during the past two years, silver fundamentals remain compelling. We believe silver can play a role distinct from gold in a diversified investment portfolio.

By historical standards, both silver bullion and silver equities appear significantly undervalued. From a contrarian point of view, silver represents an attractive investment opportunity. Sprott’s bullish outlook is supported by three key factors which we explore below:

  1. The current 80x gold/silver ratio is elevated compared to an average of 56x over the past 50 years;
  2. Silver’s fundamental supply/demand outlook has never been more supportive of a strong price: while supply is constrained, demand is underpinned by synchronized global economic growth and an uptick in industrial demand (fueled by the trends of electrification and automation); and
  3. Silver short positions have reached near all-time highs.

Silver’s Recent Lackluster Performance

We acknowledge that investing in silver has not provided much bling to portfolios recently. For the past 18 months, the silver price has hovered between $16 and $18/oz.  As shown in the chart below, silver reached a 31-year high near $50/oz in April 2011, on U.S. dollar weakness and fears of inflation (silver’s all-time high was reached on January 18, 1980, at $49.45 per troy ounce). This safety play fizzled and silver fell below $14/oz by January 2015.

Silver Prices (2000 - 2017)
Silver Prices (2000 - 2017)
Source: Thomson Reuters Eikon; GFMS, Thomson Reuters. Data as of 5/31/18.

Although silver climbed nearly 15% in 2016 and gained 6.4% in 2017, it underperformed gold which rose 8.6% in 2016 and 13.1% in 2017. Both metals fell short compared to U.S. equities which climbed 12.0% (2016) and 21.8% (2017) as measured by the S&P 500 Index.

Asset 2016 2017 YTD 2018
(May 25)
Silver $USD 14.9% 6.4% -3.1%
Gold $USD 8.6% 13.1% -0.4%
S&P 500 Index*1 12.0% 21.8% 2.0%

 

1) The Gold/Silver Price Ratio is Steep at 80

As a precious metal, like gold, silver has always attracted investors looking for a store of value, beyond fiat currencies and government control. Silver and gold complement and often move in tandem with each other, where gold historically sells at 56x the price of silver (based on prices from 1970 to 2017). Currently, gold is at about 80x silver’s price, which means that silver is significantly cheaper, relative to gold, than historical averages.

At the end of 2017, the gold/silver ratio was at 77, a high level that perhaps suggests that the market may be expecting another major financial crisis, or at the least that it is time for an equities correction.

On the flip side, to the extent investor anxieties decline — and the gold/silver ratio reverts towards mean — silver inflows and prices will benefit.

The Gold/Silver Ratio Has Averaged 56.5 (1970-2017)
The Gold/Silver Ratio Has Average 56.5X (1970-2017)
Source: Thomson Reuters Eikon. Data as of 12/31/17.

2) The Uptick in Industrial Demand

While silver supply stagnates, we believe demand is underpinned by synchronized global economic growth and an uptick in industrial demand.

Silver benefits from three strong sources for demand: 1) industrial (electronics, batteries, biocides, solar panels, etc.); 2) investment (coins and bars); and 3) consumer (jewelry, silverware and religious objects). Of these industrial demand represents the most significant use.

Silver’s Biggest Use is Industrial
Silver’s Biggest Use is Industrial
Source: CPM Group.

In 2017, coin and bar demand dropped by more than 27%, as investors chased robust equity performance. But this decline was mitigated by increased demand for silver in industrial fabrication, jewelry and silverware (up 4%, 2%, and 12% respectively). At the same time, the world's total silver supply fell by 2% to just under one billion ounces given declines in both mine and scrap supplies.

World Silver Supply and Demand: 2016 vs. 2017

(million oz) 2016 2017 % Change
Silver Supply 1,009.4 991.6 -2%
Physical Demand 1,041.9 1,017.6 -2%
Industrial Fabrication 576.8 599.0 +4%
 Coins & Bars 207.8 151.1 -27%
Jewelry  205.0 209.1 +2%
Silverware  52.3 58.4 +12%

Source: World Silver Survey 2018. Produced for The Silver Institute by the GFSM team at Thomson Reuters.

The Reason for the Industrial Uptick

In part, silver can thank the high-tech auto industry, which both reflects and is driving a global shift toward electrification powered by solar technology. Lithium and cobalt, two key battery metals, are currently in the spotlight but investors should also understand that silver has a critical role to play in the shift to electric vehicles (EVs) and the growing demand for fossil-free forms of energy generation to support electrification. A new report out [last week] from the International Energy Agency, Global EV Outlook 2018 2, estimated that over 3 million EVs were on global roads at the end of 2017, potentially growing to 125 million by 2030. As countries make this transition from internal combustion engines to electric and hybrid vehicles, combined with the desire of many countries to move away from coal-fired and nuclear-generated energy, solar energy will continue to grow in importance. As the technology boom fuels a dramatic shift in the vehicles we drive, the trends could give silver a turbocharge. In fact, last year the auto sector’s demand for silver grew 5%, while silver demand in photovoltaics increased 19%.

A Road Lined in Silver

To understand how countries are adjusting to electric and self-driving vehicles, look to Asia where a new solar-powered road being constructed in Jinan, a city in eastern China. What’s unique about this 1,080-meter-long (3,540 feet) road is that it’s paved with solar panels according to Bloomberg.3 Transparent concrete covers the panels, which will power the highway’s lights and nearby homes.

Solar panels, known as photovoltaics (PV), have become a growing source of demand for silver. These panels use silver paste, which contains about 90% silver powder. As the use of these solar panels increase, the need for more silver should follow. The tonnage of silver paste used within PVs is expected to grow 10% by 2020, according to PV silver paste developer Heraeus Photovoltaics. Looking further out, BMO Capital Markets4 estimates that silver demand for PVs will double by 2025, accounting for 15% of silver consumption and improving industrial demand.

Electric Vehicles Will Become the Norm

The architects of the Jinan road have a grand vision, eventually charging electric vehicles’ (EV) batteries when riding along the stretch of highway, once wireless charging technology becomes practical.

That’s not the only opportunity coming from EVs. While China’s road is unique, other countries are increasing the amount of electric charging ports to keep up with stricter carbon-reducing policies. Volkswagen5 has embraced this trend, announcing in April that it would add EV charging stations to over 100 Walmarts across the U.S. Porsche (a subsidiary of VW) has committed to building 500 such stations as well. Where will the electricity for these ports come from? Solar panels.

Self-Driving Vehicles Add Another Layer of Growth

China estimates that self-driving vehicles will account for about 10% of all cars on the road by 2030. No doubt, the solar-paneled road will provide fine-grained geo-location and traffic data, supplying autonomous vehicles with additional information to cruise without a human driver.

Silver also benefits from this trend, since it’s a key component in technology within vehicles. With more technology, the more silver you’ll see in the cars, particularly in the tools that protect riders. For example, silver is a component in operating collision avoidance systems, like cameras and sensors. If there’s suddenly a mass-market need for these automated features, then automakers will likely require more silver.

3) The Short-Term Short Opportunity

Despite the positive factors impacting the growth of silver demand, silver shorts have reached near all-time highs, according to UBS.6  We blame speculators for this imbalance. ETF investors, on the other hand, have embraced the bull scenario as ETF holdings in silver reached an 8-month high in April. This is where the short-term opportunity lies because when short interests are high, there’s the possibility of short covering – short investors forced by a rising price to buy silver to cover their positions and cut their losses.  And short covering further drives up the price.

Silver Short Positions Have Reached a High
CMX0SNCS Index (CFTC CEI Silver Non-Commercial Short Contract/Combined)
CMX0SNCS Index (CFTC CEI Silver Non-Commercial Short Contract/Combined)
Source: Bloomberg. Data as of 5/30/18.

The Silver Lining

In summary, we are optimistic that based on these three factors — a historically high gold/silver ratio, a favorable supply/demand outlook and near all-time high short-interest levels — silver can return near to its multi-year base of $21, and that some luster will return to the bling.

There are others who are even more optimistic. Incrementum AG, publishers of the industry bible on gold research, wrote this in its latest report: “The technical picture of silver looks particularly exciting from a contrarian position. The “smart money” hedgers currently hold their lowest short exposure as compared to short interest in recorded history....If our basic assumption of turning inflationary tendencies were to prove accurate, silver would probably be one of the best investments to benefit from rising inflation in the coming years. At a gold price of USD2,300 and a gold/silver ratio of 40x (which we regard as absolutely realistic amid rising prices), we expect a silver price of USD57.50.”

 

More Silver Insights from Sprott:

Sprott Silver Report: An Essential Metal for the 21st Century (Maria Smirnova, 11/01/2017)

Sprott Silver Report: The Case for Investing In Silver (Trey Reik, 6/30/2017)

The Silver Institute: World Silver Survey 2018

1 The S&P 500® Index represents 505 stocks issued by 500 large companies with market capitalizations of at least $6.1 billion; it is viewed as a leading indicator of U.S. equities and a reflection of the performance of the large-cap universe.
2 International Energy Agency: Global EV Outlook 2018.
3 Bloomberg: China’s Built a Road So Smart It Will Be Able to Charge Your Car.
4 BMO Markets Report: Every Silver Cloud Has a Photovoltaic Lining.
5 Engadget: VW’s fast EV charging network is headed to Walmart parking lots.
6 UBS Neo: Silver Upside Potential.

Important Disclosure

This content may not be reproduced in any form, or referred to in any other publication, without acknowledgment that it was produced by Sprott Asset Management LP and a reference to www.sprott.com. The opinions, estimates and projections (“information”) contained within this report are solely those of Sprott Asset Management LP (“SAM LP”) and are subject to change without notice. SAM LP makes every effort to ensure that the information has been derived from sources believed to be reliable and accurate. However, SAM LP assumes no responsibility for any losses or damages, whether direct or indirect, which arise out of the use of this information. SAM LP is not under any obligation to update or keep current the information contained herein. The information should not be regarded by recipients as a substitute for the exercise of their own judgment. Please contact your own personal advisor on your particular circumstances. Views expressed regarding a particular company, security, industry or market sector should not be considered an indication of trading intent of any investment funds managed by Sprott Asset Management LP. These views are not to be considered as investment advice nor should they be considered a recommendation to buy or sell. SAM LP and/or its affiliates may collectively beneficially own/control 1% or more of any class of the equity securities of the issuers mentioned in this report. SAM LP and/or its affiliates may hold short position in any class of the equity securities of the issuers mentioned in this report. During the preceding 12 months, SAM LP and/or its affiliates may have received remuneration other than normal course investment advisory or trade execution services from the issuers mentioned in this report.

SAM LP is the investment manager to the Sprott Physical Bullion Trusts (the “Trusts”). Important information about the Trusts, including the investment objectives and strategies, purchase options, applicable management fees, and expenses, is contained in the prospectus. Please read the document carefully before investing. Investment funds are not guaranteed, their values change frequently and past performance may not be repeated. This communication does not constitute an offer to sell or solicitation to purchase securities of the Trusts.

The risks associated with investing in a Trust depend on the securities and assets in which the Trust invests, based upon the Trust’s particular objectives. There is no assurance that any Trust will achieve its investment objective, and its net asset value, yield and investment return will fluctuate from time to time with market conditions. There is no guarantee that the full amount of your original investment in a Trust will be returned to you. The Trusts are not insured by the Canada Deposit Insurance Corporation or any other government deposit insurer. Please read a Trust’s prospectus before investing.

The information contained herein does not constitute an offer or solicitation to anyone in the United States or in any other jurisdiction in which such an offer or solicitation is not authorized or to any person to whom it is unlawful to make such an offer or solicitation. Prospective investors who are not resident in Canada or the United States should contact their financial advisor to determine whether securities of the Funds may be lawfully sold in their jurisdiction.

The information provided is general in nature and is provided with the understanding that it may not be relied upon as, nor considered to be, the rendering or tax, legal, accounting or professional advice. Readers should consult with their own accountants and/or lawyers for advice on the specific circumstances before taking any action.

 

Maria Smirnova
Maria Smirnova
Senior Portfolio Manager
Sprott Asset Management LP

Sprott Asset Management LP is the sub-advisor for Sprott Gold and Precious Minerals Fund and Sprott Silver Equities Class.
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