Precious Metals Review
Never Miss Investing News from Monex
Week of July 10, 2020
Quotes of the Week
“Silver’s role as a valued investment was broadly on display during the first half of 2020, as investors actively accumulated silver in the first six months of the year, leading to a 10 percent gain in investment demand. Paving the way was remarkably strong growth in silver-backed exchange-traded products (ETPs), which have posted successive all-time highs this year, together with solid silver coin and bar investment.
The silver price averaged US$16.65 through to the end of June. Having fallen sharply in mid-March, the silver price has since recovered strongly, rising by 56 percent to reach US$17.84 at end-June; it has since broken through the US$18 barrier. The gold:silver ratio -- the quantity of silver ounces needed to buy an ounce of gold -- fell since its multi-decade high of 127 in March, and at end-June stood at 97.8, which is still very high by historical standards, and may signal that silver is undervalued relative to gold.
Retail and institutional inflows into silver ETPs have been impressive this year. As of June 30, global holdings reached a fresh all-time high of 925 million ounces (Moz), which is roughly 14 months of mine supply. The ETP growth in the first half 2020 of 196 Moz comfortably surpassed the highest annual inflow of 149 Moz set in 2009. North American listed funds accounted for some 90% of the ETP inflows since March.
Retail bullion coin sales jumped by an estimated 60 percent year-on-year. Silver bar and coin sales surged in response to a deteriorating economic outlook linked to the global COVID-19 pandemic, leading to some supply-chain disruptions. This saw dealer stocks for several silver investment products quickly depleted, resulting in extended delivery lead times and higher premiums.
The recovery in professional investor activity in May and June reflected improving sentiment towards silver amongst these investors, particularly as a leveraged play on gold. This trend was clearly reflected on COMEX. Although net managed money longs ended June at 176 Moz, posting a 40 percent decrease compared with end-December 2019 levels, this hides a marked improvement within the first six months, with net longs improving quite sharply between early May and end-June.
Not surprisingly, the COVID-19 crisis negatively impacted silver fabrication demand in the opening half of the year. After a sharp contraction in the March-April period, silver industrial demand has shown signs of improvement from May onwards after many key economies gradually lifted lockdown measures. However, weak consumer confidence and a sharp rise in unemployment weighed on demand in many end-user applications such as automobiles and consumer electronics. Going forward, some of this consumer drag could be mitigated by flow through from various governments’ recently announced infrastructure investment programs, thereby lifting silver industrial demand.
Looking ahead, silver jewelry is expected to weather the storm far better than other precious metals this year. This is due to the relative affordability and greater suitability to online selling of silver jewelry. Metals Focus, the independent precious metals consultancy, forecasts an annual decline for global silver jewelry fabrication of just 7 percent against a projected 25 percent slump for gold. That has certainly been illustrated already by US import statistics, where its imports of silver jewelry (in US$ terms) have improved from -65% y/y in April to -41% in May, whereas gold jewelry imports slumped by 91% in April and have barely recovered to -81% in May.
Investment inflows into silver are likely to continue in the second half of 2020. This is primarily a result of its safe-haven status, a widespread belief among investors that silver is undervalued in absolute terms in comparison to gold, exceptionally low interest rates (reducing the opportunity cost of carrying gold and silver), and unprecedented liquidity injections by central banks. As a result, the silver price is anticipated to surpass the US$21.00 mark in late-2020, with a fall in the gold:silver ratio to below 90.”
“In recent months, Congress and the Federal Reserve have worked in tandem to pump more than $2 trillion into the U.S. economy through the Cares Act and Fed liquidity provisions.
That has some investors starting to worry about a surge of inflation, and wondering. Which investments offer the best protection against rising prices?
The best way to figure that out is to look at the correlation between an asset’s return and the rate of inflation. It’s simple: The more closely an asset’s returns tract the course of inflation, the better the asset serves as a hedge. In concrete terms, the closer an asset’s correlation coefficient with inflation is to 1, the better protection it offers. AT the other end of the spectrum, a coefficient between 0 and minus 1 means the asset’s returns tend to move in the opposite direction of inflation.
Exploring the returns of a variety of assets over the past 50 years and examining their correlation with the inflammation rate over the same period reveals that the assets that correlate best with inflation are metals, real estate and materials--so called hard, or tangible, assets. Gold and oil have the highest correlation coefficient, at 0.35, with silver and real estate next at 0.25.
While these assets have long been acknowledged as inflation hedges, it is interesting to note that the best one can do with such assets over the long term is a 0.35 correlation coefficient. This means that only 35% of the movement in the inflation rate can be captured, or hedged, by gold or oil over many years. The rest of the long-term movement in inflation can’t be protected by these assets.
At the low end of the hedging spectrum are stocks and bonds. Over the past 50 years, the returns of the S&P 500 and intermediate-term bonds had correlations of minus 0.12 and minus 0.14, respectively. This means that when inflation ticks up, the returns to equities and bonds tend to go down. If you are expecting the stock market or the bond market to protect you against inflation, you may be out of luck.
So, exactly how has this played out in the most extreme inflationary periods? I looked at the average returns of various asset classes in the 10 worst years for inflation in the past half-century (1970, ‘73, ‘74, ‘75, ‘77, ‘78, ‘79, ‘80, ‘81, ‘90). The average annual inflation rate in those years was 10%. Oil delivered an average annual return of 28.4%, gold 20.9%, silver 17.5% and real estate 7.7%.
The S&P 500 averaged an annual return of 3.4% in those 10 years, and bonds delivered an average return of 3.1%.
It remains to be seen whether a period of high inflation lies ahead but with more fiscal stimulus on the way and no end in sight to the Fed’s bond-buying program, investors might want to protect themselves against that possibility using securities that offer greater than the near-zero yield offered by Treasury inflation-protected securities (TIPS). For those who do, the lesson of the past 50 years is clear: Hard assets such as oil, real estate and metals seem like far better bets than securities like equities and bonds.”