Is Silver Undervalued? 3 Reasons it Could Be

The silver price has dropped significantly in the past seven years, falling from around $35 per ounce in 2011 to about $14 today. This major drop has left investors wondering, “is silver undervalued?” Some believe the answer is “yes” — but are they right?

While the white metal has suffered in 2018, pushed down by a strong US dollar and stagnant investor demand, some believe it has incredible upside potential.

One of silver’s strongest advocates is Keith Neumeyer of First Majestic Silver (TSX:FR,NYSE:AG), who has famously said that if gold hits $10,000 per ounce, silver could reach $1,000. More recently, he went on record to say that silver will hit the triple digits. That’s down from his previous prediction, but still bullish.

Most market watchers have tamer ideas about where the silver price could go, but in general the consensus is that its price is not as high as it should be. Here’s a look at three reasons why silver could be undervalued.

1. Strong demand

Silver has diverse uses, and some believe that the metal is undervalued given how many different applications it has. In total, the white metal has four main sources of demand: industrial applications, jewelry, coins and bars and silverware. You read about the various uses for the metal by clicking here.

In 2017, silver demand from industrial applications, jewelry and silverware increased, while demand for coins and bars sank precipitously, dropping from 207.8 million ounces to 151.1 million ounces.

The Silver Institute anticipates a 3-percent fall in global physical demand in 2018, driven by declining bar and coin demand. Demand for jewelry and silverware, as well as for industrial applications, is also seen dropping, although more modestly. That said, the picture looks brighter further into the future — CRU Consulting sees global industrial demand for silver rising through 2030 on “crucial green technologies.”

Even so, it’s worth being aware that there are factors that could hinder the uptake of silver in various technologies. For example, CRU Consulting expects that thrifting will reduce the amount of silver required in solar panels.

In addition, others have argued that spikes in silver demand tend not to last long. As Shelley Goldberg of Bloomberg notes, 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. So while strong demand is an asset, there are nuances to the situation that investors should be aware of.

2. Supply deficits

The silver market has been in deficit for years, and in 2017 the shortage clocked in at 35.2 million ounces, up from 17.14 million ounces the previous year.

Despite the shortfall, the silver price averaged $17.05 that year, representing a decrease of 0.5 percent. Chagrined, many market watchers were surprised that it did not rise, believing that the metal must be undervalued if its price is low despite demand being unable to meet supply.

Speaking to the Investing News Network about this situation, Johann Wiebe of Thomson Reuters GFMS explained, “the answer [why not] is very simple and straightforward: aboveground stock.”

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 and cause a major price increase.

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. In the past year, it has been oscillating between the mid-70s and 80s. These highs are the same as were seen during the financial crisis of 2008.

The gold-silver ratio might be the best tool to use when determining if silver is undervalued. Neumeyer’s bold claim that the metal could reach $1,000 is partially based on the idea that the 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.

Others agree with Neumeyer, but have made less bold predictions in price. Speaking on the topic, Kootenay Silver (TSXV:KTN) CEO James McDonald has noted that if the gold-silver ratio comes back down to between 50 and 60, the silver price should rise to the $20 range.

So is silver undervalued?

As is usually the case in the resource sector, when looking for an answer to the question “is silver undervalued?” it depends on 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.

So let’s turn it over to you: is silver undervalued? And if so, when do you think it’ll catch its big break?

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

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Securities Disclosure: I, Amanda Kay, currently hold no direct investment interest in any company mentioned in this article.