Gold has been a top performer throughout 2016 as traders have insulated themselves from various potential market risks. For a while, gold and its associated mining firms were leading the way higher in the precious metals arena. However silver and silver exchange-traded funds like the iShares Silver Trust ETF (NYSEARCA:SLV) has now taken the initiative, powering ahead of gold.
Earlier this week, silver exploded higher, rising as much as 7% to reach as high as $21/oz before falling back to the $20 level. Regardless, it is the first time silver has crossed $20/oz since mid-2014.
Is now the time to buy silver for a further rally, or has the surge just about run its course?
Rising Global Uncertainty: After several pretty quiet years for global financial markets, things are heating up. China’s economic machine has shown severe cracks on various occasions during the past 12 months. Now European problems have surged to the fore; the Brexit’s unexpected success has set off what could well be a domino effect across the continent.
Coming up later in 2016, there will be a controversial referendum in Italy that could set the stage for a populist uprising in a country whose banks are teetering on the brink of failure already. Far right nationalism is on the rise in France, setting up a potential Frexit soon. Austria just decided to revote its divisive election that almost brought a far-right president to power. In the U.S., the potential election of a President Donald Trump could serve to power SLV higher as the election draws near.
Supply Topping Out: Data from Bloomberg suggests that 2016 will be the first year since the peak of the precious metals boom where silver output drops year-over-year. Mining companies overbuilt in recent years as the price of silver and gold shot ever-higher. The lower price of SLV has finally been reflected by mining investment, depletion of existing mines is finally set to overtake new silver mines coming online. This should serve to tighten up the supply/demand picture for SLV and serve as support for the price.
Finally Overtaking Gold: The gold/silver ratio is one metric that precious metals investors tend to watch closely. It compares the price of an ounce of gold to an ounce of silver and is often a barometer of speculative interest. In times of great enthusiasm for precious metals, silver becomes much more valuable in comparison with gold. In 1980, at the top of the great stagflation gold bull, the ratio dipped to 17, meaning an ounce of gold was worth just 17x an ounce of silver. At today’s price of gold, that would make for $80/oz silver.
At the other extreme, in 1990, when gold and silver were decidedly out of fashion, the ratio sprung up to 100, meaning that an ounce of silver was worth just 1% the value of that same ounce of gold. At that ratio, silver would be worth just $13/oz today. The current $20/oz price represents a ratio in the high 60s. This is important because since September of 2014, the gold/silver ratio has been above 70, representing deep pessimism for precious metals. Various rallies in silver were turned back at this threshold. The newfound rise in silver compared with gold indicates this rally may be for real.
Strong Dollar: The U.S. dollar has regained its swagger after a recent bout of weakness. The British pound has fallen to fresh new multidecade lows this week, with the 1.30 level in imminent danger of being breached. The pound was trading up around 1.50 prior to the unexpected Brexit outcome. The Euro has also slid against the dollar since the Brexit vote.
Since we normally think of the price of gold and silver in dollars, a stronger dollar creates a headwind for holders of the SLV ETF. While the price of silver may be a constant in dollars, for people from the U.K., silver now costs a large premium, due to the fall in the value of the pound against the dollar. With more devaluation expected in China thanks to the resurgent dollar, one of gold and silver’s top consumer markets may also be facing a slowdown in demand.
Impact of Bitcoin: Gold and silver have long benefited from being the safe haven of choice during difficult or unpredictable economic times. If things went wrong, you’d generally be happier owning silver or the SLV ETF than stocks. However, now there is concern that precious metals will no longer be a safe haven. This is a particular concern now that gold is not officially money in the official sense anymore. Without the monetary component, gold and silver would be significantly overpriced based simply on their utility for other reasons.
However, there’s been a shortage of alternatives. Other goods that have value — be it corn, petroleum, cattle and so on, — suffer from various defects such as lack of portability, or difficulties with storage or spoilage. Until now gold and silver were almost uniquely useful as non-paper money stores of value. But the rise of digital currencies may change this. Particularly among younger investors, there seems to be a trend toward fintech-inspired alternatives. Bitcoin in particular is a rising threat; its uniquely limited supply and ease with which it facilitates illicit or discouraged transactions makes it a nice potential alternative to gold. Since May, bitcoin has risen almost 40% in value, and much of that move seems to have coincided with the Brexit fear that also stimulated gold and silver buying. In the future, people may buy bitcoins rather than SLV during market panics.
Brexit Not Great for Silver: While the fallout of the Brexit has been bullish for SLV so far, this could quickly change. Historically, silver does best during inflationary panics. Banking crises, on the other hand, are generally nonevents for precious metals. During three of the recent major banking-driven financial panics, gold and silver fared poorly. In 1998, precious metals briefly spiked after the Russian default, but the gains receded within a quarter. In 2008, gold and silver traded lower during much of the financial crisis. In 2012, the SLV ETF was not a particularly good holding if you were plotting to profit from Greek banking troubles.
At its core, silver is a defense against rapid inflation. When prices are flying and the dollar is debased, you want to hold precious metals. By contrast, you don’t really need protection against deflationary busts since 2008 or the current European mess; merely holding paper currency gets the trick done. The dollar has done an admirable job maintaining its purchasing power over the past five years, particularly if you travel abroad. Banking crises generally involve falling asset prices and slowing business cycles. You don’t need SLV for that; where you did need the SLV ETF recently was when fears of inflation surged between 2009 and 2011. We’re not there yet in this economic cycle.
Verdict on SLV
$20/oz, historically, isn’t a particularly expensive price for silver. Adjusted for inflation, it’s at a reasonable price.
And recent action shows silver breaking out against gold, generally a very positive sign. However the rally is built upon a false premise; the Brexit simply isn’t likely to deliver a lasting boost to SLV, and the rising dollar threatens to undo much of precious metals’ gains so far in 2016.
Silver is a fine holding here, but I’d refrain from adding new positions.
Ian Bezek owns physical silver. He holds no position in the SLV ETF. You can reach him on Twitter at @irbezek.