Which single asset class are you most bullish (or bearish) about in the coming year? What ETF position would you choose to best capture that?
Overall, in the coming year, most asset classes appear to be rather bearish; however, precious metals appears to be one of the exceptions. More specifically, of the precious metals, I think that silver has positioned itself well, and for this reason am long the iShares Silver Trust (SLV).
How does SLV fit into your overall investment approach?
When investing in an ETF, I tend to watch trend lines, in particularly the 50-day and 200-day exponential moving averages. When an ETF is trading above both of these trend lines and the sector or index it is tracking has fundamental attractiveness, such as favorable supply and demand imbalances, I buy.
In addition to this, I implement an analytically based exit strategy which enables me to monitor risk and limit potential losses.
As for the iShares Silver Trust, it is trading above both its 50-day and 200-day exponential moving averages.
Can you tell us a little more about the fundamentals of the asset class, and what makes it your top pick?
As a whole, both macroeconomic and microeconomic forces are favorable for silver. From a macroeconomic perspective, the increases in money supply over the past few years to support the U.S. economy and boost artificial demand are expected to lead to increased prices, making inflation inevitable. Additionally, the U.S. government is running a budget deficit of more than $1 trillion per year and has been borrowing to fund this spending spree. This monetizing of debt is more likely than not to support inflation, which will further lead to a reduction in the purchasing power of money, or dollars.
Microeconomically speaking, there is likely to be an imbalance in supply and demand of silver in the near term, providing positive price support to the precious metal. Demand for silver is expected to significantly increase, driven by its heavy industrial uses, a hedge against macroeconomic forces like inflation, and its relative valuation when compared to its sister metal, gold.
On the industrial forefront, silver has unique properties including strength, sensitivity to light, malleability and ductility, electrical and thermal conductivity, reflectivity and the ability to endure extreme temperature changes. As a result, it is commonly used in the electronics space and can be found in plasma display panels and printed circuit boards, as well as in the lining of refrigerators, for food storage containers, and for water purification. Additionally, the metal can be used in the medical sector as an antimicrobial to fight bacteria and as an antiseptic to treat fungal infections. As economies in the developing parts of the world continue to expand and the purchasing power of individuals in these nations rise, demand for products that utilize silver will likely follow.
Silver’s industrial uses further span to the solar energy industry, as that silver paste is used in 90% of all crystalline silicon photovoltaic cells, which are the most common type of solar cells. Additionally, silver is used in another way to generate electricity by reflecting and concentrating solar energy onto collectors containing salts which are used to run generators. Furthermore, as nations around the world continue to seek cleaner energy standards the demand for solar energy will likely increase. In fact, the demand for solar energy has grown at nearly 30% per year over the past 15 years and is expected to sustain this growth in the near future.
On the supply side, it appears that a shortage in silver is on the horizon. In fact, the total annual world consumption of silver is greater than mine production, and has been for nearly twenty years. As a result, inventories of the metal held by governments have started to dwindle away. Furthermore, a study conducted by the United States Geological Survey indicates that silver is nearly twice as rare as gold in the long term because it's not recycled at the same rates as gold, and at current consumption rates all of the silver that's in the Earth’s crust will diminish in the next decade.
Further supply woes could potentially form from the fact that roughly 30-35% of global silver is produced through pure silver mines while the rest is produced through electrolytic copper refining, gold, nickel and zinc refining. As a result, a significant amount of silver cannot be produced without disruption to other mining activities leading to the overproduction in other metals, making silver supply from mining relatively inelastic and insensitive to price changes.
The last force that is boosting appeal of silver is its relative value, in historical terms, as compared to gold. Silver is cheap compared to gold. The current gold:silver ratio is about 65:1, significantly higher than the long-term ratio of 16:1, indicating that silver has tremendous upside potential.
As for inflation, historically speaking, gold has been the “go-to” precious metal when it comes to a long-term hedge against rising prices; however, silver provides a similar protection mechanism enabling investors to safeguard their wealth in addition to the flexibility and multiple uses that it carries, making it a top choice.
Are there alternative ETFs that could be used to capture the same theme? What makes SLV your first choice?
Other ETFs that could be used to play silver include the PowerShares DB Silver Fund (DBS), the UBS E-TRACS CMCI Silver Total Return ETN (USV) and the ETFS Silver Trust (SIVR). However, I personally like SLV because it holds physical silver bullion and is the most heavily traded of the four investment vehicles, enhancing liquidity. As for DBS, it is a good choice; however, it utilizes futures contracts in silver to gain access to the metal and is susceptible to the effects of contango and backwardation. USV, on the other hand, is an exchange traded note (ETN) and hence is a debt security which carries an additional risk of default by its provider. SIVR is similar to SLV, in that it too holds physical silver bullion, however, it is not as heavily traded as SLV and hence not as liquid.
As for capturing the influences that macroeconomic factors are likely to have on silver, one could turn to gold, like the SPDR Gold Trust (GLD) or the iShares COMEX Gold Trust (IAU) as that will reap the same benefits; however, gold doesn’t have the same microeconomic imbalances that are likely to provide additional positive price support to silver.
Does your view differ from the consensus sentiment on silver?
With so many opinions and investment positions, it is difficult to pinpoint what is contrary opinion these days, however, it seems to appear that a bullish sentiment in precious metals, in particularly gold, has prevailed.
Many investors are fearful that the U.S. economy is heading for a double-dip recession with stubbornly high unemployment rates, a faltering residential real estate sector and federal government spending plans which are failing to result in a sustainable spark in the overall economy. This is causing many to flee to safe-haven asset classes like precious metals.
Additionally, with the massive borrowing by developed nations in the past few years, in particular the U.S. and nations in Europe, the fear of currency debasement - the decline in the value of a nation’s currency - has some turning to precious metals as a form of currency.
What catalysts, near-term or long-term, could move metals significantly?
A re-emergence of a sovereign debt crisis in Europe could move precious metals rather significantly. Recently, Ireland’s debt was downgraded, the euro lost ground to its counterpart currencies, credit-default swaps on the sovereign obligations of the PIIGS nations [Portugal, Ireland, Italy, Greece, Spain] climbed sharply and yields of bonds issued by the PIIGS have jumped significantly. When trends like these prevail in the market, fear is generally enhanced and investors flock to “safety net” asset classes; in particular precious metals like silver and gold.
On the downside, massive deleveraging and fear could take their toll on silver and other precious metals. In the heart of the global financial crisis many were forced to liquidate positions to cover losses, no matter how attractive their positions were. Furthermore, as these positions are sold, prices start falling, causing many investors to become fearful, jumping on the bandwagon and selling, regardless of whether or not fundamentals of the specific sector remain positive.
Some of our other subjects have said the historical relationship between precious metals and the dollar has broken down, and that metals will appreciate even in deflation. What's your take on that?
To some extent the relationship has been broken, primarily for the reason that some are starting to use precious metals as a type of currency, regardless of deflation or inflation. As for silver, positive price support is likely to be heavily driven by microeconomic forces, therefore will likely appreciate even if deflation prevails.
What could go wrong with your pick?
At the end of the day, the global industrial sector is the main demand driver for silver. The metal has unique characteristics that make it virtually essential; however, if global industrial growth takes a massive hit in the developing world, the demand for silver could potentially follow.
More specifically, the expected increased demand in silver for industrial use is highly dependent on China and its economic growth. If China faces growth headwinds in the near-term future, a negative impact on silver could result.
As for investment demand for silver, as long as fear and volatility in the global markets prevail, demand will remain elevated.
Thanks, Kevin, for sharing your ideas with us.
Disclosure: Long SLV.
If you are a fund manager and interested in doing an interview with us on just one stock or ETF position you'd hold, please email Rebecca Barnett.