Silver Miners Have Lost Their Sparkle Lately. That Might Be A Great Reason To Buy.

Silver Miners Have Lost Their Sparkle Lately. That Might Be A Great Reason To Buy.
Stéphane Renevier, CFA

over 2 years ago5 mins

  • Silver miners seem to be in a good position to recover from their poor performance this year: their fundamentals are strong, the macro backdrop is turning supportive, the supply/demand dynamics are positive, and technicals are encouraging.

  • There aren’t that many silver miners around, so you could either try and identify which one is the best, or simply buy a silver-focused ETF, which should give you very efficient exposure to the sector.

  • But be aware of the risks too, from rising rates to lower inflation to a higher US dollar.

Silver miners seem to be in a good position to recover from their poor performance this year: their fundamentals are strong, the macro backdrop is turning supportive, the supply/demand dynamics are positive, and technicals are encouraging.

There aren’t that many silver miners around, so you could either try and identify which one is the best, or simply buy a silver-focused ETF, which should give you very efficient exposure to the sector.

But be aware of the risks too, from rising rates to lower inflation to a higher US dollar.

Silver miners’ stocks have taken a trouncing over the last few months, and outflows from ETFs tracking the “poor man’s gold” have reached a new record. But I’m not sure all this animosity is justified: I think there are a lot of good reasons silver miners are actually a great value play right now.

Why are investors bailing on silver miners?

Silver miners have high fixed costs and variable revenues, so they’re essentially “leveraged bets” on the price of silver. That means their prices tend to be very reactive to the price of silver, and any dip could lead to a significant correction for silver mining stocks.

In other words, if the outlook for silver becomes a bit murkier, investors tend to ditch its miners. So the better question might be why investors are losing faith in the metal itself…

1. Falling industrial demand

Bottlenecks in global supply chains and a slowdown in the Chinese property sector have dented the outlook for industrial demand. And that’s subsequently taken its toll on silver, which derives a lot of its value from its wide use in industry (more on that shortly).

2. The prospect of higher bond yields

When bond yields are low, the opportunity cost of holding silver – which doesn’t pay out any income – is low, meaning its price tends to climb. But if the US Federal Reserve decides to taper its bond-buying and sends yields higher, that opportunity cost will increase and investors are more likely to rotate to higher-yielding assets.

3. A potential drop-off in inflation

The question of whether silver is a good inflation hedge remains hotly debated, but a significant share of investors certainly perceive that to be the case – both against high inflation and the debasement of fiat currencies. But some investors are concerned that the recent spike in inflation will prove temporary and return to its lower long-term trend, and that would send silver prices and miners’ stocks down sharply.

So why are silver miners underappreciated?

1. Silver miners’ fundamentals are strong

Silver miners are cheap, profitable, and they’re generating a record amount of cash from their operations.

For starters, they’ve performed extremely strongly in the second quarter of this year, both operationally and financially. In fact, they’ve been growing their revenues and margins significantly for seven consecutive quarters.

Perhaps more interestingly still, they’ve been generating positive free cash flows for the past few quarters – something they’ve traditionally struggled to do. Those cash flows aren’t just positive either: they’re higher than almost every other sector. That extra cash in hand could help them finance new mines or expand existing ones, or they might just choose to pay it straight to shareholders in the form of dividends.

Gold and silver miners have the highest real free cash flow yield. Source: Crescat Capital, Bloomberg
Gold and silver miners have the highest real free cash flow yield. Source: Crescat Capital, Bloomberg

The cherry on the cake is that silver miners are looking pretty cheap, with about half the stocks in the sector displaying price-to-earnings ratios in the low teens.

2. Silver’s long-term supply/demand dynamics are promising

Silver is different from its close cousin gold in that it has plenty of industrial uses. While it’s mostly used in the production of jewelry, electrical and electronics sectors, it’s increasingly essential to the production of solar panels, electric vehicles, and more. That means the long-term demand for silver should only keep benefiting from the switch to green infrastructure.

On the supply side, the global production of silver has been falling for years. That’s partly because it’s becoming harder to find large economically viable silver mines, and partly because it’s become more economical for miners to mine gold than silver. And while we can expect a short rebound in supply when pandemic-disrupted mines get back up and running, it’s unlikely to be substantial enough a bounceback to meet demand in the long run.

3. The macro backdrop is turning more supportive

The main market narrative is transitioning from a combination of higher growth and higher inflation (i.e. “reflation”) to lower growth and higher inflation (i.e. “stagflation”). And as long as industrial demand stays strong, the latter environment should be supportive for silver, which is perceived as a safe-haven asset and a good hedge against currency debasement.

4. Silver miners’ technicals are encouraging

Silver miners’ stock prices corrected significantly and suffered their highest quarterly outflows ever last quarter. That suggests all the speculators who were for its short-term prospects have abandoned ship, which makes it more likely that, if prices continue to recover, more buyers than sellers will enter the market.

Silver miners suffered the largest quarterly outflow ever. Source: Crescat Capital, Bloomberg
Silver miners suffered the largest quarterly outflow ever. Source: Crescat Capital, Bloomberg

Plus, when you look at the ratio of the price of silver to the price of gold, it seems that silver might be a better value play right now than its shiny cousin.

What’s the opportunity here?

There aren’t actually that many “pure” silver miners available – that is, those that derive a significant share of their revenues from exploring, mining, and transforming silver. Most, after all, have diversified into gold and other metals. So you could go through the relatively short list of miners and try to identify the companies with the highest potential.

Alternative, you could just buy into a silver ETF, which essentially gives you three options. There’s the Global X Silver Miners ETF (ticker: SIL), which is highly liquid and invests in both large and small silver mining stocks. There's the ETFMG Prime Junior Silver Miners ETF (ticker: SILJ), which targets smaller miners. And finally there’s the iShares MSCI Global Silver Miners ETF (ticker: SLVP), which includes a higher proportion of miners based in emerging markets.

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Disclaimer: These articles are provided for information purposes only. Occasionally, an opinion about whether to buy or sell a specific investment may be provided. The content is not intended to be a personal recommendation to buy or sell any financial instrument or product, or to adopt any investment strategy as it is not provided based on an assessment of your investing knowledge and experience, your financial situation or your investment objectives. The value of your investments, and the income derived from them, may go down as well as up. You may not get back all the money that you invest. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment advisor.

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