Is Silver Undervalued? 3 Reasons it Could Be

The silver price has dropped drastically over the last five years, but is silver undervalued? Here are three reasons it could be.

silver undervalued

The silver price has dropped significantly over the past five years, falling from around $35 per ounce in 2012 to just over $16 today. But many experts anticipate a rally.

Analysts polled by FocusEconomics expect a minor silver price uptick in the short term — they see silver averaging $17.60 in the fourth quarter of 2017 and $17.80 in 2018. Silver’s rise is expected as part of a larger precious metals rebound caused by geopolitical developments and a weaker US dollar.

Other silver market watchers are even more optimistic. For instance, Keith Neumeyer of First Majestic Silver (TSX:FR,NYSE:AG) has said in the past that if gold hits $10,000 per ounce, silver could reach $1,000. While that’s an extreme prediction, he’s not alone in thinking the silver price is undervalued. Here’s a look at three reasons why it could be.

1. Growing demand

Over half of all silver is consumed for industrial purposes. The white metal is used in a variety of different applications, including technology, jewelry, manufacturing, electronics and even nuclear energy. Demand from the solar power industry is especially high at the moment, and grew by 34 percent in 2016.

Apart from industrial demand, the white metal also benefits from investment demand. It is widely known as a “safe-haven asset,” and increases in value when investors face economic and geopolitical uncertainty. Lower global interest rates also contribute to silver investment demand.

While some believe that silver is undervalued given its diverse uses, others have argued that spikes in silver demand tend not to last long. For example, Shelley Goldberg of Bloomberg notes that while the silver price has benefited recently from increased demand from the solar industry, this demand should drop off as manufacturing processes become more efficient.

Similarly, silver investment demand tends to rise and fall. While it was extremely high in 2015, it fell from those levels in 2016. Overall, worldwide demand for silver fell 11 percent from 2015 to 2016.

2. Supply deficits

The silver market has recorded a small deficit for the past four years, and last year saw its third-largest shortfall on record. In total, the market was in deficit by 147.5 million ounces that year.

While those circumstances pushed the silver price up 9.3 percent year-on-year in 2016, many market watchers are surprised that it did not rise higher. Speaking to the Investing News Network earlier this year, Johann Wiebe of Thomson Reuters GFMS explained, “the answer [why not] is very simple and straightforward: aboveground stock.”

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He continued, noting that unlike base metals, silver “has an investment component [and] is stored in almost the same form as it is refined” — notably bars, coins and the like. “There is an abundance of that material available,” he added. “That is metal that can come back to the market quite quickly in the case that there is demand.” In other words, there’s rarely a chance for silver supply and demand imbalances to get out of hand.

3. The gold-silver ratio

The gold-silver ratio refers to how many ounces of silver are needed to buy one ounce of gold. A high gold-silver ratio typically shows that silver is a good buy since it is considered cheap relative to gold.

Predicting the gold-silver ratio can be difficult. Over the past five years, the ratio has seen a high of 83.46 and a low of 51.13. It currently sits at a relatively high point of 76.49. At the beginning of March, the ratio was 81.64 — a level that hadn’t been seen since the financial crisis of 2008.

The gold-silver ratio might be the best tool to use when determining if silver is undervalued. Keith Neumeyer’s bold claim that the metal could reach $1,000 is partially based on the idea that gold-silver ratio is much too high considering the rates at which both metals are being mined.

For one ounce of gold, we are only mining nine ounces of silver. So that would suggest we should be trading at nine to one, which will put — at $1,200 gold — $130, $140 silver. If you look at what we are mining today, that’s where silver should be trading at. We are trading at 73- or 75-to-one, and I just don’t think that ratio can last,” he has said.

So is silver undervalued?

As is often the case in the resource sector, it depends who you ask. While there are compelling reasons to believe that the answer is “yes,” not everyone shares that opinion. It’s up to investors to do their research and make the choices that are best for them.

This is an updated version of an article originally published by the Investing News Network in 2016. 

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Securities Disclosure: I, Sivansh Padhy, hold no direct investment interest in any company mentioned in this article.

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