Silver “huge outperformance” amid Commodities Boom

A number of financial news sites are running the story of the head of Goldman Sach’s commodities division, Jeff Currie, making the explosive comments in a Bloomberg interview earlier this week that “I’ve been doing this 30 years and I’ve never seen markets like this……This is a molecule crisis. We’re out of everything, I don’t care if it’s oil, gas, coal, copper, aluminium, you name it we’re out of it.”

The Bloomberg Commodity Spot Index, which tracks 23 energy, metals and agricultural futures, has hit a record this year. So well might you ask ‘but what about silver?’.  Analyst Stuart Allsopp of Icon Economics penned a great article summarised below on where he sees silver sitting in this commodities complex.

“After a number of failed recoveries over the past few months, silver is once again at the lower end of its range, and I am using this weakness to add to my positions. While the metal is still up 95% since its March 2020 low, this is less than the 107% rise seen in the Bloomberg commodity complex. This is particularly noteworthy as silver tends to outperform the broader commodity complex during periods of rising gold prices. I strongly expect silver to outperform the commodity complex over the coming months and years as the bull market resumes.

 (Bloomberg)

From a short-term perspective, [silver] does not look particularly inspiring. After a series of failed attempts to form a base around the USD20 area, the recent rise in real bond yields has pressured [silver] back down to the lower end of its range. It must be noted that a break below the December low at USD19.80 risks ushering in another leg of weakness.

Recent Weakness Contrasts With Strong Fundamentals

That said, from a long-term fundamental perspective, the outlook for silver has rarely been stronger. As I have argued on several occasions over recent years, silver prices tend to track the performance of gold and the broader commodity complex due to the metal's dual role as a monetary and industrial metal. What has been interesting about silver's weakness over the past six months is that it has occurred despite relatively stable gold prices and surging commodity prices.

The best way to see this is in the chart below, which shows the price of silver relative to its fair value implied by the metal's correlation with gold and the Bloomberg commodity complex. Looking at data from 2000 to now, the correlation suggests silver is currently almost 50% below fair value.

Bloomberg, Author's calculation

Looking at the correlation over a longer timeframe as the next chart shows, silver is the most undervalued it has been since 1993, which turned out to be the secular low for the metal.

Bloomberg, Author's calculations

Of course, silver's undervaluation relative to gold and commodity complex may well resolve itself through declining gold and commodity prices rather than silver strength. However, as I argued back in September, such periods of undervaluation have turned out to be great buying opportunities in the past. Indeed, the average 12-month return for silver following periods where the metal has been 20% undervalued or more has been 18.3%, compared to a 6.0% 12-month return in all periods and a 3.5% return during all other periods. The most recent example was the height of the March 2020 Covid crash, which led to a doubling of silver prices over the next 6 months.

The key question then is whether history will repeat or whether there is reason to believe this recent underperformance will continue. In my view, the fundamental case for silver is as bullish as it has ever been for two key reasons. Firstly, there is no sign yet that the surge in money and government bond issuance seen since the start of the pandemic is ending and the greater the amount of government liabilities, the more likely it is that investors gravitate towards hard assets such as silver.

Silver Adjusted For M2 And Government Debt, Rebased:

 (Bloomberg)

Secondly, silver is a green metal that will almost certainly rise in demand as the world shifts towards cleaner energy development. This article by Forbes does a good job of explaining the importance of silver in the advancement of green technologies.

Summary

Silver's recent weakness contrasts greatly with the metal's improving fundamental outlook. The current price is significantly below the level implied by gold prices and the broader commodity complex and if history is any guide, we should see huge outperformance going forward.”