Silver Equities Are Too Cheap

Maria Smirnova joined Sprott Asset Management in 2005 and currently co-manages the Sprott Silver Equities Class. I asked for her insight into the current market environment for silver and silver companies.

“We must discern which companies could survive the downturn. This is not a market where junior resource companies can raise money unless they have something tangible to offer. For this reason, we are focusing on companies that are already producing metal. They should stand the highest chance of surviving the current weak environment for resource equities.

“If the merits of a junior’s assets are weak, they may go bankrupt and be removed from the market. Companies with solid projects become takeover targets for mid-tier and major mining firms.”

Poor performance of mining equities relative to bullion has created a buyers’ market in these stocks, says Maria. “Mining stocks have underperformed bullion over the past several years. This means that most companies have decreased in price relative to their Net Asset Value (NAV) – which is mostly made up of their gold and silver resources. We expect that taking advantage of these low valuations by buying these companies’ shares now will produce strong returns for the patient investor.”
So what factors could affect silver bullion and equities in the coming months?

“Silver is half commodity, and half hard currency. About half of the silver demand comes from industrial applications and photography. The other half is for jewelry, coins, and bullion. There is a case that silver could move higher if there is a recovery, because of higher industrial usage. New technologies are also using silver, especially in medicine for its accepted antibacterial properties, and for solar panels.”

Maria says that the perception of greater opportunity in the S&P 500 stocks right now hurts precious metals. “Natural resources are unpopular at the moment. There is a big rotation into other stocks, like those on the S&P 500. To mainstream investors, everything seems to be great in the US. Consumption is rising. Housing prices are stabilizing and seem to be improving. Never mind that unemployment remains high. Or that the Fed’s promises of more QE are more impactful on stock prices than economic data or business’ earnings.”

So where are silver and silver equities headed now?

“Many analysts expect macro-economic developments to feed through to a marked rally in the gold price. With silver trading at a historically low price relative to gold, it is easy to see the possibility for gains in the silver price this year. Analysts predict a recovery in industrial demand. Jewelry is price-inelastic - demand is unchanged since 2003. Demand for coins has surged. U.S. Mint sales were up 57% for the period from January to April compared to the previous year. 39 times more silver ounces sold than gold so far in 2013, but there is only 7 times more silver supply. April silver sales were 4.1 million ounces, versus 1.5 million the previous year - a 170% jump. Chinese jewelry demand grew 72% in April 2013 and 26% in March. How much would sales rise if they were not restricted by availability?

“Silver ETFs haven’t sold off as much as gold. Holdings are still up 3% for the year, after declining less than 2% since the end of March – versus a 15.6% decline for gold ETF holdings. Interestingly enough, in 2012, the U.S. Mint’s silver coin sales surpassed the amount of physical silver produced via U.S. domestic mine production. Barring some unknown static silver stockpile, the U.S. Mint is importing foreign silver – not the kind of fundamental flows we would expect given last year’s price action.”

U.S. Probes Gold Pricing

Maria is skeptical that this year’s decline is a natural movement in the market. U.S. regulators are reportedly scrutinizing whether prices are being manipulated in the world’s largest gold market. The Commodity Futures Trading Commission is examining the setting of prices in London, in which a handful of banks meet twice daily and set the spot price for a troy ounce of physical gold.

“You should be suspicious of sudden market moves. Three large banks have already been fined a total of $2.5 billion over manipulation of the London interbank offered rate, or Libor, and many others are still under investigation. The events of the gold and silver smack-down could very possibly be the result of manipulation. The amount traded over 2 days was extreme, and doesn’t usually occur in a normal market. The magnitude of the trade was simply too massive relative to that time period.”