Investment | 9 August, 2019

Change of trend in the price of silver

Joaquín González Portfolio Manager

Are gold mining stocks an opportunity?

Historically the performance of gold mining share prices following periods in which the price to earnings paid by the American stock exchange was, statistically speaking, very high, has been excellent and a opportunity as we are going to analyse below.

Although the price of silver may not change its trend, there could at least be an upturn that may drive the price up from the current 16 dollars an ounce to 25 dollars per ounce within a year. We believe that the price of physical silver could have bottomed out, following a period of correction lasting eight years (from 2011 to 2019), in which it has accumulated a loss of 72%.

This theory is based mainly on three factors:

  1. The Federal Reserve’s change in monetary policy
  2. The current global money supply (M2) in dollars compared with the dollar price of silver
  3. Technical analysis

 

1. The Federal Reserve’s change in monetary policy

In 2015 the Fed initiated a process of monetary normalization (increase in official rates). However, given signs of an economic slowdown in the U.S., at the end of this month, it will reverse this process with the first cut in official rates in the last ten years. According to statements made by members of what is the world’s main central bank, the Fed would be prepared to modify its monetary policy over the coming years, by maintaining official rates at levels that would allow inflation (the consumer price index) to remain temporarily higher than its 2% target.

As can be seen in Chart 1 below, the price of silver is closely linked to the real return of 10-year US Treasury bonds (the difference between the IRR of 10-year US Treasury bonds and inflation expectations priced in the market in the same period). So the price of silver is already lagging behind the level marked by the real return offered by the 10-year Treasury Bonds (as happened between 2000-2005), according to which it should be priced at 30 dollars an ounce. If the Fed modifies its monetary policy (lower official rates, combined with higher inflation), this reference price level could even hit 40-50 dollars an ounce.

CHART 1. Silver price vs IRR of 10-year Treasury Bonds, minus estimated 10-year inflation in the U.S. (real return on 10-year US Treasury Bonds)

PLATA.SILVER.CHANGE.BBVA

2. The current global money supply (M2) in dollars compared with the dollar price of silver

Apart from its use for metalwork and in the photographic and chemical industries (among others), as a precious metal silver is also itself considered money (30% of its use).  It should be recalled that the money supply (M2) measures the sum total of money in circulation in an economy.

As can be seen in Chart 2, since the end of 2011 the dollar price of silver and the total volume of money in circulation in the main economies in the world also measured in dollars, has diverged significantly: whereas the price of silver has fallen 72% in this period, money supply has increased by 11%. So if silver were to follow the pattern seen between 1996 and 2011, it could again reach prices of 50 dollars per ounce.

CHART 2. Price of one ounce of silver vs money supply (M2) in dollars in the main economies worldwide

PLATA.SILVER.CHANGE.BBVA

3. Technical analysis

As can be seen in Chart 3, after its 72% correction between 2011 and 2014, and following five years of consolidation, the silver price appears to have bottomed out at around 14 dollars per ounce. In July the price broke through the declining trend line it had maintained since 2013. We consider this very positive, and it could boost its price to 22-25 dollars per ounce as its first level of resistance.

CHART 3. Silver price (ounce)

PLATA.SILVER.CHANGE.BBVA

 

 

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