SILVER gains lustre as it outperforms gold

Toronto – Long called ‘the poor man’s gold’, silver is likely to outperform its much pricier counterpart this year – which makes silver-related equities an attractive option for investors looking to diversify their portfolios.

Last year, spot silver prices rose 48 per cent; so far this year, they have already risen well over 40 per cent. Spot gold prices are up more than 25 per cent.

The gold-to-silver ratio, which tracks how many ounces of silver are needed to buy one ounce of gold, has dropped from 64 to below 60 in a month, and the spread is expected to keep narrowing.

That is happy news for silver miners and royalty companies, with share prices in the sector jumping as much as 70 per cent since the beginning of the year.

‘Many of those companies have a very good growth profile. In the next two, three, four years, they’re going to be producing more metal than they are now,’ said Mr Bart Melek, a senior economist at BMO Capital Markets. ‘And there’s value to that.’

When an investor buys shares in a silver producer with a strong growth profile, he is essentially paying a lower price for more metal in the future.

With silver, Mr Melek sees the upside outweighing the risk. He expects spot silver to trade at an average of US$23 next year, up from an estimated average of US$18.91 this year.

‘I think silver will most probably continue to outperform gold,’ he said. ‘Silver benefits from being gold-like, and it benefits from being an industrial metal, which I think is going to tighten up the supply-demand balance down the road.’

Silver production worldwide is expected to weigh in at around 23,000 tonnes this year, with an additional 7,000 tonnes coming from recovered scrap.

About half the demand for the metal comes from the industrial sector, where it is used mainly in electronics. Silver is also used in jewellery and coins, and to back exchange-traded products (ETPs) and exchange-traded funds (ETFs).

A silver-backed ETF trades on the stock market and follows the value of silver. It is more secure than stocks because its value is backed by real silver, but there are higher costs involved for investors because the silver has to be stored.

‘Fundamentally, we see the companies – and that holds for gold and silver producers – as better bets than the ETFs,’ Mr Melek said. ‘The ETF has storage costs and all sorts of other costs associated with it.’

Silver is a unique metal for investors because only about 30 per cent of production comes from actual silver mines.

‘Two-thirds of the world’s silver is mined as a by-product of other metals – mainly gold, copper or zinc,’ said Mr Darren Lekkerkerker, a portfolio manager at Fidelity Management. ‘So if the silver price goes up but the copper price doesn’t go up, they’re not going to mine more.’

What this means is that even though silver is in strong demand right now, most miners are unable to produce more to capitalise on the high prices.

In fact, major producers such as Barrick Gold and Goldcorp do not even process the silver they mine. They simply sell future silver streams to royalty companies for a set price in exchange for cash upfront.

This model has worked out well for industry leader Silver Wheaton. The Vancouver-based royalty company, which has purchase agreements with mines in the Americas and Europe, pays about US$4 per ounce of silver. The current spot price for silver is about five times higher, at US$24.64 an ounce.

‘The benefit of owning a royalty company is that there is no exposure to increases in capital expenditure and operating costs,’ said Mr Lekkerkerker.

Silver Wheaton shares have risen almost 70 per cent since the start of the year, closing at C$28.10 on Thursday on the Toronto Stock Exchange.

Still, royalty companies are not the only investment opportunity available in the silver market.

‘Historically, the silver market has been viewed as a marginal sector – essentially the poor man’s precious metal sector,’ said BMO analyst Andrew Kaip.

In the past, silver miners were small companies that had to plough all their earnings back into operations each year to maintain production.

Now, the companies mining silver are getting bigger, and with the higher selling prices currently, the sector is changing dramatically.

‘An entirely different business model is emerging,’ said Mr Kaip. ‘Now, you’re actually seeing many of these silver companies looking like they will build significant cash positions.’

He points to Pan American Silver as a good long-term bet for shareholder appreciation and to Coeur D’Alene as a promising option during the next few quarters.

For those willing to take more risk, juniors such as Bear Creek Mining, which has risen more than 45 per cent in the past two months, and Tahoe Resources, which has gone up 30 per cent, are considered viable investments.

With the Federal Reserve signalling that the United States economy could need further stimulus measures, and confidence in paper currencies slipping, investors should not worry that they have missed the boat when it comes to silver. In fact, analysts see plenty of room for silver to continue gaining on gold.

‘We’re just starting to see silver equities going the way we thought they would,’ Mr Kaip said. ‘I expect that trend to continue – it’s still a bright future for silver stocks.’

Source: Straits Times (subscribers only)

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