The Gold/Silver Price Ratio is Out of Whack - What’s Next?

Last month, Silver Investing News (SIN) received an enthusiastic response to the question, “do you think silver is headed for a supply shortage?” Of over 1,000 participants, 81 percent said they believe a silver shortfall is in the works, reinforcing the idea that while silver prices are down, they’re likely not out.

Despite that overwhelmingly affirmative response, the article raised a number of good questions amongst readers. To address some of them, SIN got back in touch with Andrew Chanin, co-founder of the PureFunds ISE Junior Silver ETF (ARCA:SILJ), whose comments sparked the original article.

To start off with, Chanin addressed the nature of the shortage — in other words, whether we’re looking at a silver supply shortage in that silver in the ground is actually running low, or in the sense that at current prices miners simply aren’t able to produce enough of it. The simple answer is that though the amount of high-grade deposits around the world is falling, at the moment the latter issue is the bigger concern; however, Chanin gave a much more detailed response, explaining why that’s the case.

For one thing, he said, “about two-thirds of all mined annual silver comes as a by-product, and much of that is from base-metals mining.” That’s a problem because many people are calling for a slowdown in emerging markets, which could keep prices for base metals depressed. If that happens, he said, “it might actually make sense to put such mines on hold temporarily.” Ultimately, that means “a significant area of silver supply … could get taken offline.”

Another factor, Chanin noted, is that low silver prices are hurting producing companies’ exploration efforts. Sure, he said, silver priced at $16 per ounce, or even $10 an ounce is possible, but “it would be extremely, extremely difficult for silver-mining companies to produce silver at those levels, [and] difficult, if not impossible, for them to do it profitably.”

That’s because $20 per ounce — about the price silver has sat at thus far this year — “is a very key level” for many companies that are both producing and exploring. “If silver is below $20, one of the first things that these companies shut down is their exploration. Where will this future supply of silver come from if you have companies shutting down exploration?” Chanin questioned.

Given those issues, he believes “it almost seems wild for people to think that there’s a huge downside left for silver.”

Of course, that statement raises the question of why exactly silver sells for so much less than other precious metals. Responding to that question, Chanin said, “yes, silver is more abundant, it is less rare. There’s more silver in the ground than there is gold, as well as platinum, palladium, rhodium.” However, though gold and silver trade at a 65:1 ratio, in recent years, the annual ratio of ounces of silver mined versus gold has been closer to 8:1. On top of that, most of the gold that gets taken out of the ground “is turned into jewelry or bars and gets worn or put in vaults” — meaning that it can be used for investment purposes — while 40 percent of annual silver supply goes towards industrial purposes.

The lack of silver available for investors to buy is an issue because over the last decade silver has seen an “immense, six-fold increase in investment demand” that does not seem to be letting up. Chanin commented, “I think there’s so much money and capital directed to gold that people are really starting to want to better diversify themselves. Silver could be a really interesting option, especially if there’s scarcity in gold.” It might, he said, even be a good metal for central banks stock up on “because it does have great industrial uses.”

Given those factors, Chanin said he believes “the 65:1 price of gold to silver ratio is out of whack due to the ratio it is being mined.” He continued, stating, “if I had to guess where that ratio might be closer to in the future, I think 20:1 might be a lot more reasonable. We haven’t seen something like that in years. I think there’s just an overall dislocation of the price that I don’t believe really reflects the true scarcity of silver.”

A positive first quarter

Chanin also touched on how silver juniors did in 2014’s first quarter. His response was encouraging.

“Q1 showed a very strong reversal in mining stocks from the trend we saw last year,” when precious metals “were one of the most punished sectors,” said Chanin. More specifically, “when silver popped up over $20 earlier this year … a lot of people looked at that as an opportunity for these companies to see better margins for each ounce they pull out of the ground.” He believes that “if silver prices are able to maintain a higher price and go to where they were this time last year, which was around $28 or so, some of these companies could become very profitable.”

And which companies might those be? Chanin identified some familiar qualities that contribute to success, including management with “a proven track record” as well as “a good vision for the project that it has, especially [management] that is responsible with its costs.” Management “that has strong relations with the jurisdictions its properties are in” is also a plus, he said.

Chanin also recommended that investors consider the countries a company’s projects are in. “It helps if a company has properties in multiple countries or safe jurisdictions as opposed to one mine in a semi-risky country,” he explained. That, of course, is something his ETF can help with. “The beauty of having a portfolio of a bunch of companies is that you can spread out that risk,” he noted.

But what about prices?

For many investors, the real question is what all this information means for silver prices.

Though Chanin didn’t offer a specific price prediction for silver, his comments about the metal’s price dislocation bring to mind a February interview with Sprott’s John Embry. Like Chanin, Embry notes that the price ratio of gold to silver is currently over 60:1; however, he continues on to state that the ratio “has fallen precipitously in raging bull markets for the metals, going as low as 12:1.” That, he believes, means “the silver price could have an upwards move at four times the rate of any gold price increase.”

Putting that in numerical terms, Embry said, “[m]y colleague Eric Sprott and I think that within a reasonable timeframe silver will probably trade over 100 dollars — a big move from its current price of 20 dollars an ounce.” If he’s correct, silver bugs certainly have a lot to look forward to.

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

Editorial Disclosure: The PureFunds ISE Junior Silver ETF is a client of the Investing News Network. This article is not paid-for content.

The Investing News Network does not guarantee the accuracy or thoroughness of the information reported in the interviews it conducts. The opinions expressed in these interviews do not reflect the opinions of the Investing News Network and do not constitute investment advice. All readers are encouraged to perform their own due diligence.

Related reading:

Survey: Is a Silver Supply Shortage on the Horizon?

PureFunds ISE Junior Silver ETF: Exposure to Silver Explorers and Junior Producers