Faceoff: Will silver keep its sheen?

By Kanupriya Vashisht | October 1, 2011 | Last updated on October 1, 2011
7 min read

Two experts discuss whether this precious metal is a sound investment.

Som Seif,

President & CEO, Claymore Investments Inc

bullish on silver

Demand outstripping supply

We’re bullish on silver right now. Investment demand in the silver industry is increasing, and supply just can’t keep pace. This skewed supply and demand is likely to further push silver quite dramatically.

From an investment perspective, silver is trending higher for many of the same reasons as gold. Like gold, silver is one of the few assets not associated with any liabilities, or linked to a promise of payment by a government or company. And unlike paper money, it cannot be multiplied and brought into circulation at will. With the value of paper assets decreasing, nervous investors are once again rushing into precious metals as hedges against inflation.

There’s also a vital difference between gold and silver. With its limited use as a commodity, gold has a fair amount of room to meet investment demand. On the other hand, silver, with its multiple industrial applications, has no real scope to meet demand through current supply sources.

In terms of supply, silver is a very small industry—about 900 million ounces. Compare that to the size of its demand/market value—US$35 billion to US$40 billion annually. With overall structural issues in the global market, this demand size is continually increasing and playing into the meteoric price rise.

Sound investment for unsound times

With the three most important currencies in the world—Greenback, Euro and Yen—in turmoil, investors are faced with currency exposure risks and structural marketplace risks. They want to put their capital where they can hold it. And silver, like gold, is becoming that safe haven of value. Even though gold will retain the main focus, silver is steadily cementing its place in the arena.

Historically, over the last 20 to 30 years, we’ve seen an explosion of new asset class exposures within institutional and retail investor portfolios, with commodities claiming a significant share of portfolio construction.

The current penetration of precious metals and commodities in investor portfolios is very small. But the greater interest in silver and gold as true asset classes is going to further increase demand. The fact that we’ve had very strong historical returns for the last 10 years will drive investors to chase those returns even further.

Stocks won’t stifle silver

It’s a misnomer that depressed stock markets drive gold and silver. As a matter of fact, we’re equally bullish on stocks right now. If interest rates stay low, price-to-earnings ratios tend to increase, and we’re seeing that in the current markets. Companies are actually doing very well in terms of cash flow given that they are able to borrow at low costs.

Precious metals benefit from a somewhat negative economic outlook stemming from a debt and currency perspective, not volatile stocks.

Gold will continue to run in excess of $2,000; it may even touch $3,000. And if you see those kinds of ranges in gold, you’re going to see substantially higher ranges in silver as well. We wouldn’t be surprised to see silver touch $50 in the short term, and substantially higher if we cross $2,000 in gold.

Silver-plate your investments

When clients want to invest in silver, consider silver bullion. There are also silver bullion ETFs, SBR holdings, and currency-hedged and non-hedged variants.

The hedged silver is suitable for Canadian investors who want to share in the price growth of silver without incurring exposure to U.S. currency risks. The unhedged variant, on the other hand, is suitable for those reckoning on the euro depreciating against the dollar to make additional currency gains as a result, since a fall in the value of the euro increases the price of silver.

Unlike gold, there aren’t many pure-play silver equities in the world because silver mining is generally a by-product of the mining of base metals such as copper, lead and zinc. The limitation with that is that you need an understanding of other metals to buy into silver companies.

Portfolio allocation

Commodities in general should represent 5% to 10% of an average overall portfolio, depending on the risk side. Precious metals should probably constitute half of that number. Anywhere from 1% to 2% of silver allocation in a long-term portfolio is not bad exposure, unless an investor has a tilt toward silver.

It won’t be possible to sustain $75 or $100 levels in silver long-term. All precious metals will, sometime in the future, reach a time to sell. But that said, there’s still a long way to go before we get to that level.

If you’re an average, traditional 60/40 type of portfolio investor—moderate risk to high-growth yield—you should definitely have commodities in your portfolios.

Silver is no hedge against inflation

Jason Pereira,

Financial Consultant, Bennett March/IPC Investment Corporation

Inflation has no silver lining

When it comes to precious metals, silver is decidedly different from gold. It has incredible industrial utility. In fact, I’ve heard many traders say the only two metals we can’t live without are copper and silver; everything else is switchable. But when it comes to prices, silver has the same whirlwind of ridiculousness surrounding it.

When treated as a precious metal, silver becomes quite like gold—a shiny metal, and nothing more. There is a heightened perception of worth, but no rational way to measure it.

If it weren’t for precious metal buyers, silver would exist—like iron and copper—at a rational price determined by market forces. Treating silver as a precious metal inflates the number of buyers far beyond those seeking it for its industrial use. This skews demand and drives up the cost of everything silver is used in. Rather than being a hedge against inflation, silver actually ends up feeding inflation. The whole process is rather counter-intuitive.

A friend of mine once argued he’d like to stock up on gold in case society were to crumble. Philosophically, if society were to fall apart, all I’d care for is canned food and a gun. What use would a pile of shiny metal be? Go into a store and you won’t even be able to exchange it for services or goods. You’ll be forced to reconvert it into paper money for it to have any value or utility.

Two hundred years from now, will people start treating the metal we use today for coinage — copper — as a precious metal? Or better still, if tomorrow beans were to become scarce would people start trading in them?

Historically speaking

A true hedge against inflation is something that, over a period of time, increases in value at a rate roughly at par with inflation. Silver hasn’t historically done that. At various points in time it matched inflation levels, and at others it plunged dramatically.

There are numbers to show that silver hasn’t really been a hedge against inflation. Rather, its value has risen during times of inflation. Silver was under $4 in 1976. At the beginning of 1980 it peaked to $50 U.S. In the next two-and-a-half years, the price collapsed by 90% from this all-time high. After two decades of moving mostly sideways, the rediscovery of silver as a financial investment led to quadrupling of prices in 2008.

Traditionally it took about 15 ounces of silver to buy one ounce of gold. That price correlation has been broken from time to time, as it has been right now. That’s why people believe it is a compelling reason for the increase in the price of silver, as it is nowhere near that 15:1 ratio of gold. But the problem is they are arbitrarily tying the price of silver to an investment (gold) that doesn’t make a lot of sense in the first place.

Bubbles burst

Whenever we start fabricating the demand of a product that has no fundamental value or utility, it signifies a mania, a panic, a bubble. And sooner or later bubbles burst.

Just think about what could happen when the frenzied inflation in silver starts impacting manufacturers who use silver? They will inevitably start exploring cheaper alternatives. Just like oil. When oil was trading at $40 a gallon, building solar plants and investing in alternatives didn’t seem wise. But when oil started inching above $100 a gallon, these alternatives started seeming much more viable.

If I’m a manufacturer who uses silver in medical products and the cost of my production goes up five times in five years, you’d better believe I’m shopping for other products that can do the same job. If that happens, utility buyers will start pulling out and suddenly the market will become much leaner. How do you think that would impact people holding silver bullion as a currency hedge?

Cash drag

There really is no logical value to silver as a currency. Investors might actually be better off buying gold and silver ETFs over bullion. When purchasing stocks you can at least look at the companies’ earnings, P/E ratios, payout ratios, etc. There is no way to rationally attach a value to lumps of metal. They just sit there doing nothing.

Unlike stocks and bonds, there is no income from bullion. There are no dividends or interest paid out. Even real estate, regardless of capital appreciation or depreciation, pays you rent. What do gold and silver pay you? Nothing! Worse yet, they’re a cash drag because you need to store them somewhere and pay safekeeping fees. All you’re hoping for is someone will come along and pay more for it than you did.

Kanupriya Vashisht is a Toronto-based financial writer.

Kanupriya Vashisht