Gold And Silver Companies With The Potential To Move The Needle

The investment interest for silver has been declining since the peak in price during 2011. I view the overall debt level globally, the industrial applications, the declining interest in cryptocurrencies and the high gold-to-silver ratio favorable for silver.

Rising Debt Levels of Governments, Corporations and Households

Up until the global financial crisis (NYSE:GFC) we saw large increases of household debt for many countries. As real estate prices came down we have seen some deleveraging in the countries that were affected by declining real estate prices. The below OECD chart from 1995 to 2017 illustrates this point for countries like the United States, United Kingdom and Denmark. However, there were several countries where the real estate market did not experience the same severe declines. This is illustrated by Canada, Australia and Sweden where households have continued to increase their leverage. The real estate markets in many of those countries have now started to decline.

img src="https://static.seekingalpha.com/uploads/2018/7/8/48701869-1531069727031438.png" width="602" height="317" data-width="640" data-height="337" data-og-image-twitter_small_card="true" data-og-image-twitter_large_card="true" data-og-image-twitter_image_post="true" data-og-image-msn="true" data-og-image-facebook="true" data-og-image-google_news="true" data-og-image-google_plus="true" data-og-image-linkdin="true"">>

Figure 1 – Source: OECD Household Debt to Income

To support failing banks, the general economy and to avoid a prolonged recession; many countries have since the GFC, increased the government debt levels. This can also be illustrated by OECD data for the United States, United Kingdom and Denmark but is true for many other countries as well.

img src="https://static.seekingalpha.com/uploads/2018/7/8/48701869-15310697278464754.png" width="602" height="343" data-width="640" data-height="364" data-og-image-twitter_small_card="true" data-og-image-twitter_large_card="true" data-og-image-twitter_image_post="true" data-og-image-msn="true" data-og-image-facebook="true" data-og-image-google_news="true" data-og-image-google_plus="true" data-og-image-linkdin="true"">>

Figure 2 – Source: OECD Government Debt to GDP

The record low interest rates have also increased corporate debt levels, so we are now have a situation where the overall debt level is at an all-time high.

img src="https://static.seekingalpha.com/uploads/2018/7/8/48701869-15310697287083795.png" width="602" height="428" data-width="640" data-height="543" data-og-image-twitter_small_card="true" data-og-image-twitter_large_card="true" data-og-image-twitter_image_post="true" data-og-image-msn="true" data-og-image-facebook="true" data-og-image-google_news="true" data-og-image-google_plus="true" data-og-image-linkdin="true"">>

Figure 3 – Source: Bloomberg.com

This does not mean we will naturally have another crisis. However, in a rising inflation scenario the overall debt level could put central bankers in a very uncomfortable situation. Due to debts level, governments, corporations and households are more sensitive to interest rate hikes. The big question is whether central banks would focus on combating higher inflation or higher unemployment rates if they could only focus on one? My thesis is that they will at least initially focus on the unemployment and GDP number, and assume that inflation will naturally decrease, which is not a guarantee.

Even if the general inflation numbers are still relatively muted today, we have seen significant inflation in financial assets, health care and education in the U.S. and many other countries. The relevant question is if that will spread to the wider economy and real assets like gold and silver?

The current U.S. Government deficit spending during a time when the economy is doing relatively well is interesting to say the least. For as long as the central banks are raising rates or at least keeping them flat, I expect they can get away with it. However, there are no signs of the deficit decreasing and as with every cycle, we will reach a point when rates need to be lowered. The scenario with high deficit spending and lower interest rates could put significant downward pressure on the U.S. Dollar.

Deficits don’t matter, until they do.

img src="https://static.seekingalpha.com/uploads/2018/7/8/48701869-1531069727024732.png" width="499" height="377" data-width="640" data-height="484" data-og-image-twitter_small_card="true" data-og-image-twitter_large_card="true" data-og-image-twitter_image_post="true" data-og-image-msn="true" data-og-image-facebook="true" data-og-image-google_news="true" data-og-image-google_plus="true" data-og-image-linkdin="true"">>

Figure 4 – Source: Bloomberg

Gold-to-Silver Ratio

The gold-to-silver ratio is correlated to the volume of metals produced. I tend to view it more as relative potential, and use the historical bound as a guide. During March of 2018 the gold/silver ratio reached a 20-year high of 81.38 and it now stands, as of July 2018, at 78.28, which is certainly at the high end regardless of the period one chooses to compare against.

img src="https://static.seekingalpha.com/uploads/2018/7/8/48701869-1531069727800526.png" width="602" height="374" data-width="640" data-height="399" data-og-image-twitter_small_card="true" data-og-image-twitter_large_card="true" data-og-image-twitter_image_post="true" data-og-image-msn="true" data-og-image-facebook="true" data-og-image-google_news="true" data-og-image-google_plus="true" data-og-image-linkdin="true"">>

Figure 5 – Source: macrotrends.net

Since silver is often viewed as a leveraged investment in gold, the ratio can also be used to measure the speculative interest in precious metals. The gold-to-silver ratio has often had peaks during periods when precious metals are relatively unpopular which is where we are at right now. During periods of relatively high interest in precious metals like 2006 and 2011 we saw a lower ratio as the percentage increase of silver is usually higher during periods leading up to that point.

img src="https://static.seekingalpha.com/uploads/2018/7/8/48701869-15310697296280832.png" width="602" height="417" data-width="640" data-height="444" data-og-image-twitter_small_card="true" data-og-image-twitter_large_card="true" data-og-image-twitter_image_post="true" data-og-image-msn="true" data-og-image-facebook="true" data-og-image-google_news="true" data-og-image-google_plus="true" data-og-image-linkdin="true"">>

Figure 6 – Source: tradingview.com

This might sound counter intuitive when one considers silver has a significant portion of demand coming from industrial fabrication. However, silver tends to trade very similar to gold which can be seen in the below graph.

img src="https://static.seekingalpha.com/uploads/2018/7/19/48701869-15319927934202836.png" data-width="640" data-height="379" data-og-image-twitter_small_card="true" data-og-image-twitter_large_card="true" data-og-image-twitter_image_post="true" data-og-image-msn="true" data-og-image-facebook="true" data-og-image-google_news="true" data-og-image-google_plus="true" data-og-image-linkdin="true"">>

Figure 7 - Source: tradingview.com

Declining popularity in Bitcoin

I am not looking to debate the pros and cons about Bitcoin. I personally don't agree with the store of value argument in cryptocurrencies without any asset backing, but there are many other potential use cases. I do think the overall interest in Bitcoin and other cryptocurrencies have taken some of the investor attention from traditional hard assets like gold and silver. Since the peak of Bitcoin in December of 2017, we have seen a significant decline in price but more relevant to this analysis, the overall interest has drastically declined.

img src="https://static.seekingalpha.com/uploads/2018/7/8/48701869-15310697270817554.png" width="602" height="180" data-width="640" data-height="192" data-og-image-twitter_small_card="false" data-og-image-twitter_large_card="false" data-og-image-twitter_image_post="false" data-og-image-msn="false" data-og-image-facebook="false" data-og-image-google_news="false" data-og-image-google_plus="false" data-og-image-linkdin="false"">>

Figure 8 – Source: trends.google.com (Blue is bitcoin and red is overall cryptocurrency)

Whether the decline is temporary or not is hard to say, but as the interest in cryptocurrencies declines, the more speculative money will likely move into gold and silver if hard assets starts to move higher.

Industrial Demand

Silver exhibits the highest electrical conductivity, thermal conductivity and reflectivity of any mental and has wide spread industrial use. The overall industrial demand has been flat or slightly declining over the last decade though. This is primarily due to the declining use in photography.

There are two applications which are of specific interest considering the long-term secular trends; solar and automotive. For automotive the metal is increasingly being used in internal combustion engine vehicles (NYSE:ICE), autonomous vehicles (NYSE:AV) and electric vehicles (NYSE:EV). Silver is a key component in photovoltaic fabrication in solar.

img src="https://static.seekingalpha.com/uploads/2018/7/8/48701869-15310697304699526.png" width="597" height="253" data-width="640" data-height="272" data-og-image-twitter_small_card="true" data-og-image-twitter_large_card="true" data-og-image-twitter_image_post="true" data-og-image-msn="true" data-og-image-facebook="false" data-og-image-google_news="true" data-og-image-google_plus="false" data-og-image-linkdin="true"">>

Figure 9 – Source: silverinstitute.org

Due to the unique characteristic of silver, I would expect the industrial demand to pick up as we continuously rely on more on green energy and digital techniques. One argument which is often made against industrial demand of silver is that usage would significantly decline if the price of silver increased. My main argument against this point is time is that once significant amounts of money is invested in a process, it takes a very long time to make changes.

Physical Coins and Bars

So how do we invest in silver? One option is to buy physical bullion or coins. The benefits of buying and taking delivery of the physical metal have decreased over time as other low-cost alternatives have been made available. There is certain appeal to having the metal close at hand if one considers a complete break of the financial market. The approach also minimizes the risk of government confiscation. The drawbacks of owning physical metals are that you are often paying a higher premium, storage costs or that there is an increased risk of theft. If you take physical delivery in Europe you are also paying VAT around 20%, but that can be avoided by using bullion storage services. The metal can also be stored in countries with relatively low risk of confiscation without taking physical delivery.

I am not saying government confiscation is a likely scenario, but gold and silver is often considered financial insurance, so the risks are worth weighing.

Futures and Silver Trust ETFs

Futures are certainly one option with a very liquid market, but nowadays I would expect Silver Trust ETFs are more prevalent among SeekingAlpha investors. I prefer silver trusts over derivatives, especially due to the relative size (very large) of the derivatives market over the physical market.

The spread of buying silver trusts is relatively low and the same is true for management fees often below 0.5%. When investing in Silver Trusts, my preference is fully allocated physical trusts like ETFS Physical Silver Trust ETF (SIVR) or Sprott Physical Silver Trust (PSLV). The more popular iShares Silver Trust EFT (SLV) also has the vast majority of assets in allocated physical bullion.

Silver Mining Companies

What characterizes any mining company is the leveraged investment to the underlying price of the metal. In an example of a mining company with total costs around $12/oz of silver, an increase from $15/oz to $18/oz would effectively double earnings while the underlying metal only moves 20%.

One specific drawback of silver mining companies to the value conscious investor is that they often trade at a relatively high multiples. So they often experience significant volatility and offer little downside protection. If one views gold to be a desired component in a precious metals portfolio as I do, you can often find companies with production in both gold and silver, trading at significantly lower multiples. This approach provides more downside protection.

Polymetal International

Polymetal International is a Russian precious metals company listed to the London Stock Exchange (OTC:POYYF) but also trade in the U.S. with an ADR (OTCPK:AUCOY). I recently published an article on this company. Due to the recent political uncertainty you can buy the company at a very low multiple. About 23% of revenues from 2017 came from Silver but the company also has Prognoz which is a large long-term silver exploration project.

Tahoe Resources

Tahoe Resources (TAHO) has had its silver mine Escobal in Guatemala closed for about a year now due to a dispute over minority interests. This has been a long drawn out process in courts. There are other challenges with Escobal like a roadblock and the fact that the export license has expired during the process as well. Tahoe historically had about 50% of revenues from silver. There is no guarantee that Escobal will be restarted and if so, when. The company is presently trading well below book value and offers significant upside if the mine is restarted though.

ChartTAHO Price to Book Value data by YCharts

Sprott

Sprott Inc (OTCPK:SPOXF) is not a mining company but is an investment company within the real asset and precious metals industry. Due to the underlying leverage to the price of silver and relatively fixed cost, it offers similar exposures as a precious metals mining company. About 56% of revenues from Q1 came from the ETF segment where about 20% came from silver. 100% of the Sprott Physical Silver Trust and about 1/3 of the Sprott Physical Gold and Silver Trust. The overall revenue exposure to silver is only 11%, but in a scenario with rising silver prices the company will likely benefit from a feedback loop where the silver AUM would increase from higher prices and an increased inflow of money to the trusts.

Sprott is not as cheap as the previously mentioned companies, but the company pays a stable dividend just below 4% with a 2018 P/E around 20.

ChartSII PE Ratio (Forward 1y) data by YCharts

Silver Mining ETF

The above mentioned leveraged investments have a relatively low, or in some cases like Tahoe just potential exposure, to the price of silver. I do value the downside protection and am prepared to forgo some up the upside. If you are looking for a higher leverage, the Global X Silver Miners ETF (SIL) or other pure silver mining companies would be my preference over leveraged ETFs.

Summary

The overall increasing debt level, the potential spread of inflation, a high gold-to-silver ratio and favorable industrial demand makes silver an interesting long-term investment.

There are number of ways to invest in silver and I prefer a combination of the fully allocated physically backed trusts, and combined gold and silver mining companies with more downside protection.

Disclosure: I am/we are long POYYF, TAHO, PSLV, SPOXF.

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.

Additional disclosure: Please follow me if you would like to receive more frequent updates on the investments I write about.

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Gold And Silver Companies With The Potential To Move The Needle

Source:Mining

Gold And Silver Companies With The Potential To Move The Needle

Gold And Silver Companies With The Potential To Move The Needle

Source:Reuters

Gold And Silver Companies With The Potential To Move The Needle