Silver: Another Decade Of 500% Returns Is Possible

Includes: HL, RIO, SLV
by: Disruptive Investor

Silver prices have corrected meaningfully after peaking out at near USD50 levels. A correction of over 20% is generally considered bearish and can weaken investors' interest in the metal. If investors consider the long-term picture, silver has given returns of 584% in the last ten years.

This article discusses the reasons for believing that silver can produce another decade of over 500% returns. In line with this expectation, investors can consider fresh exposure to the precious metal on every weakness.

Before discussing the industry specific factors which are bullish for silver, I would focus on the current macro-economic scenario and its impact on the precious metal. The global economy (especially the developed markets) is in a phase of prolonged sluggish economic growth. GDP growth has been volatile since 2007, and recession seems very likely for the U.S. without government support. Further, the eurozone is already in a recession. This scenario necessitates continued expansionary monetary policies by Central bankers globally, and is positive for hard assets like gold and silver.

The point I am trying to make is underscored by the fact that the demand for silver coins and medals has increased by 248% during the period 1990 to 2011. At the same time, the silver ETF holdings have surged since 2007 to record highs.

This surge in silver ETF holdings has been largely due to the financial crisis, which continues to plague the developed economies. Going forward, the silver demand will continue to increase as investors and individuals buy silver more as a currency, which is a store of value than for any other purpose.

As the silver demand diagram shows, industrial demand for silver has also surged by 78% during the period 1990-2011. Industrial demand for silver has increased from 274 million oz in 1990 to 487 million oz in 2011. I am of the opinion that Industrial demand will be the second biggest driver for silver prices after the hard asset factor. I can also say with some conviction that industrial demand for silver will grow at a greater pace than witnessed in the last two decades.

There are certain important properties that make silver a favored industrial metal. First, silver has the highest electrical conductivity of all the metals. Silver is 80% more conductive than aluminum, 50% more conductive than gold and 6% more conductive than copper. This makes silver critically important in the miniaturization of circuits as electronic items become increasingly compact. Second, silver has superior thermal conductivity and higher reflectivity (94%) in the visible light. These factors are leading to silver being increasingly used in a wide array of industries globally. The diagram below gives a summary of the industrial application of silver and the potential new areas where silver can be utilized.

I mentioned earlier that I expect the industrial demand for silver to grow at a more robust pace than before. The primary reason for this rationale is the low per capita consumption of silver in emerging markets as compared to developed markets. Even if the per capita demand for silver in China and India (home to over 2.5 billion people) comes anywhere near the per capita consumption of developed markets, the amount of silver that needs to be mined will be very significant.

The huge impending growth in Asia, Africa and emerging Europe coupled with the population factor will be the key demand driver for silver in the long-term. The chart below gives the expected demand for silver excluding investment and ETF demand. With the above discussed industrial drivers, demand is expected to surge over the next two decades.

Coming to the supply side factors, there could be a demand-supply mismatch with growing demand for silver from Asia in 2015. The current silver demand of 1.06 billion oz is expected to rise to 1.18 billion oz by 2015. With no major silver mining project in the pipeline, surge in investment demand coupled with industrial demand has the potential to outpace the expected supply. If this scenario pans out, silver will trend meaningfully higher over the next few years.

Considering all these fundamental factors, it makes sense to consider exposure to silver at current levels and add to the position on any correction. The metal is certainly poised for another decade of the bull market and has the potential to outperform many asset classes. In line with this expectation, I would consider exposure to physical silver as a first choice of investment. Also, investors can consider the following stocks and ETFs for exposure to silver.

iShares Silver Trust ETF (NYSEARCA:SLV) - The Trust holds silver bullion and is designed to provide investors with a simple method to gain exposure to the price of silver. The ETF has a relatively low expense ratio of 0.5%.

Rio Tinto plc (NYSE:RIO) - Rio Tinto is a leading international mining group with a diversified geographical presence and a diverse product offering. Most of Rio's assets are in Australia and North America, but it also operates in Europe, South America, Asia and Africa. Gold and silver are produced primarily as by products of Rio Tinto's copper operations. Investors can consider exposure to this 2.5% dividend yielding stock as it is one of the best commodity plays.

Hecla Mining (NYSE:HL) - Established in 1891 in northern Idaho's Silver Valley, Hecla Mining is the largest and one of the lowest cash cost, primary silver producer in the U.S., with exploration properties and operating mines in four world-class silver mining districts in the U.S. and Mexico. Hecla operates the Greens Creek mine in Alaska and Lucky Friday mine in Idaho, and owns district-sized land packages in the Silver Valley in northern Idaho; San Juan Silver in Creede, Colorado; and San Sebastian in Durango, Mexico. This stock currently trades at USD5.63 and can be considered for medium to long-term. I must mention here that the risk associated with this stock is high. However, I do believe that the company has decent fundamentals to give robust returns over the next few years.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.