SLV: Silver's Fundamentals Continue To Improve

Stuart Allsopp profile picture
Stuart Allsopp
3.45K Followers

Summary

  • After a number of failed recoveries over the past few months, silver is once again at the lower end of its range, and I am adding to my positions.
  • While the metal is still up 95% since its March 2020 low, this is less than the 107% rise seen in the Bloomberg commodity complex.
  • This is particularly noteworthy as silver tends to outperform the broader commodity complex during periods of rising gold prices.
  • Notwithstanding the concerns of many investors regarding the SLV, the ETF has a proven track record of tracking the silver price with minimal tracking error and a reasonable expense ratio.

Silver Ingots in a Row

asbe/iStock via Getty Images

After a number of failed recoveries over the past few months, silver is once again at the lower end of its range, and I am using this weakness to add to my positions. While the metal is still up 95% since its March 2020 low, this is less than the 107% rise seen in the Bloomberg commodity complex. This is particularly noteworthy as silver tends to outperform the broader commodity complex during periods of rising gold prices. I strongly expect silver to outperform the commodity complex over the coming months and years as the bull market resumes, and see the iShares Silver Trust ETF (NYSEARCA:NYSEARCA:SLV) as a reasonable vehicle to benefit from such a trend.

According to the SLV prospectus, the ETF gives investors direct exposure to silver by physically holding the metal in vaults in London. It is by far the largest silver ETF with a net asset value of USD12.2bn and 534 thousand ounces of silver under management. The SLV has tracked the physical silver price with a 12-month median tracking difference of just 0.7% and has a reasonably low expense ratio of 0.5%, which is particularly low when compared to the spreads on physical. That said, I should note that I have received many comments regarding the suitability of the SLV owing to a lack of physical silver under management and this is something for readers to consider.

Chart

SLV ETF Price (Bloomberg)

From a short-term perspective, the SLV does not look particularly inspiring. After a series of failed attempts to form a base around the USD20 area, the recent rise in real bond yields has pressured the ETF back down to the lower end of its range. It must be noted that a break below the December low at USD19.80 risks ushering in another leg of weakness.

Recent Weakness Contrasts With Strong Fundamentals

That said, from a long-term fundamental perspective, the outlook for silver and thus the SLV has rarely been stronger. As I have argued on several occasions over recent years, silver prices tend to track the performance of gold and the broader commodity complex due to the metal's dual role as a monetary and industrial metal. What has been interesting about silver's weakness over the past six months is that it has occurred despite relatively stable gold prices and surging commodity prices.

The best way to see this is in the chart below, which shows the price of silver relative to its fair value implied by the metal's correlation with gold and the Bloomberg commodity complex. Looking at data from 2000 to now, the correlation suggests silver is currently almost 50% below fair value.

Chart

Bloomberg, Author's calculation

Looking at the correlation over a longer timeframe as the next chart shows, silver is the most undervalued it has been since 1993, which turned out to be the secular low for the metal.

Chart

Bloomberg, Author's calculations

Of course, silver's undervaluation relative to gold and commodity complex may well resolve itself through declining gold and commodity prices rather than silver strength. However, as I argued back in September, such periods of undervaluation have turned out to be great buying opportunities in the past (see ‘Silver Selloff: A Bargain Or Coming Commodity Crash? Maybe Both). Indeed, the average 12-month return for silver following periods where the metal has been 20% undervalued or more has been 18.3%, compared to a 6.0% 12-month return in all periods and a 3.5% return during all other periods. The most recent example was the height of the March 2020 Covid crash, which led to a doubling of silver prices over the next 6 months.

The key question then is whether history will repeat or whether there is reason to believe this recent underperformance will continue. In my view, the fundamental case for silver is as bullish as it has ever been for two key reasons. Firstly, there is no sign yet that the surge in money and government bond issuance seen since the start of the pandemic is ending and the greater the amount of government liabilities, the more likely it is that investors gravitate towards hard assets such as silver.

Chart

Silver Adjusted For M2 And Government Debt, Rebased (Bloomberg)

Secondly, silver is a green metal that will almost certainly rise in demand as the world shifts towards cleaner energy development. This article by Forbes does a good job of explaining the importance of silver in the advancement of green technologies.

Summary

Silver's recent weakness contrasts greatly with the metal's improving fundamental outlook. The current price is significantly below the level implied by gold prices and the broader commodity complex and if history is any guide, we should see huge outperformance going forward. Notwithstanding the concerns of many investors regarding the SLV, the ETF has a proven track record of tracking the silver price with minimal tracking error and a reasonable expense ratio.

This article was written by

Stuart Allsopp profile picture
3.45K Followers
I am a full-time investor and owner of Icon Economics - a macro research company focussed on providing contrarian investment ideas across FX, Equities, and Fixed Income based on Austrian economic theory. Formerly Head of Financial Markets at Fitch Solutions, I have 15 years of experience investing and analysing Asian and Global markets.

Disclosure: I/we have a beneficial long position in the shares of XAGUSD:CUR either through stock ownership, options, or other derivatives. 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.

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