Digging Silver Miner ETFs During Rallies

November 18, 2022

Precious metal exchange-traded funds may be the popular way to invest in silver. Another way, which may be more profitable, is to go the picks and shovels route. 

Silver mining funds offer an alternative to precious metal ETFs. The companies in the funds invest capital to extract the metal from the Earth’s crust at a lower cost than the market price, providing leverage to the investor. 

Most of the annual silver production comes as a byproduct of copper, lead, gold and other metal production. In 2020, less than 27% of silver output came from primary mining activities.  

 

Source: The Silver Institute 

 

The leverage causes silver mining shares to outperform silver when the price rallies, and underperform when it declines.  

Gold/Silver Ratio 

The gold/silver ratio has a long history. Some say the first Egyptian pharaoh, Menes, established the price relationship in 3200 BCE by declaring that two and a half parts silver equal one part gold.  

Since the 1970s, the metric has gravitated around 60 to 70 ounces of silver value in each ounce of gold. When the ratio trends lower, it tends to be bullish for the precious metals; when it rises, it is a bearish sign.  

On Sept. 1, the price of December COMEX gold futures divided by December COMEX silver futures stood at 96.8 ounces of silver value in each ounce of gold value. Source: CQG 

 

 

The above chart shows the ratio’s decline to the 80:1 level on Nov. 14, a bullish sign for silver and gold.  

Highly Speculative  

A falling ratio is a bullish clue for the leading precious metals. Silver is more speculative for two compelling reasons: 

  • Silver’s lower price than gold encourages market participants to turn to the silver market when precious metals move into a bullish trading pattern. 
  • Volatility in the silver market tends to be higher than in gold. On Nov. 14, weekly historical silver volatility stood at over 39%, while the metric in gold was at the 11.75% level.  

The bottom line is that silver offers trend-following speculators a more significant percentage move when bullish and bearish trends develop.  

Mining Shares and Leverage 

Primary silver mining is highly speculative, as exploration and production involve big capital outlays. Miners extract metals or minerals from the earth’s crust and depend on higher market prices than total production costs. Junior miners carry more leverage than seniors because they explore for the precious metal and mine lower-grade ores. 

Senior mining companies with significant capital tend to provide investors with leveraged returns on a percentage basis during bull markets; they also tend to underperform the metal when the silver price declines.  

Meanwhile, junior miners that explore for silver are even more leveraged, as they mine for lower ore grades. During bull markets, investors often flock to junior mining stocks in a quest for oversized returns. Bear markets that lead to disappointment cause the junior miners to underperform the seniors.  

SIL and SILJ  

The Global X Silver Miners ETF (SIL) holds a portfolio of silver mining shares. At $28.53 per share, SIL had over $950 million in assets under management, traded an average of nearly 345,000 shares daily, and charges a 0.65% management fee.  

The top holdings of the ETFMG Prime Junior Silver Miners ETF (SILJ) include: 

 

Source: Barchart 

 

At $10.72 per share on Nov. 14, SILJ had over $713 million in assets under management and traded an average of over 1.5 million shares daily. SILJ charges a 0.69% expense ratio.  

The last significant rally in silver took the price from $11.73 in March 2020 to $30.16 in February 2021, a nearly threefold rise. Over the same period, SIL more than tripled to $51.35 per share, and SILJ nearly quadrupled to $18.84. SIL provided a leveraged upside return, while SILJ did even better.  

Silver Set to Move? 

December COMEX silver futures’ price was just above the $22 per ounce level on Nov. 14. Four factors point to higher silver prices over the coming months and years: 

  • The trend in the ratio is lower, which suggests the path of least resistance of precious metals prices is higher.  
  • Demand is rising. The Silver Institute forecasts that 2022 demand would be a record 1.112 billion ounces. With a total annual global mine supply of 1.092 billion ounces, the silver market is in a deficit, depending on above-ground inventories to fill the void.  
  • U.S. interest rates are trending higher because of inflation, increasing the cost of carrying the metal and financing production. U.S. 30-year Treasury bond futures recently fell to 117-19, the lowest level since 2011. Silver prices reached almost $50 per ounce in 2011.  
  • Meanwhile, the U.S. dollar—silver’s pricing mechanism—has been rising all of this year. In 2002, silver’s high was $5.15 per ounce, so it has held well despite the rising dollar.  

The all-time high in silver was in 1980 at over $50 per ounce. Inflation, geopolitical uncertainty, industrial silver demand and declining faith in fiat currencies support a higher silver price. SIL will likely outperform the metal on the upside, and SILJ could do even better. At below $11 per share, SILJ could be a bargain, given the fundamental and technical underpinnings in the silver market.  

With silver at around $22 per ounce, investing risks are substantial, but the odds of a new all-time peak in the coming years remain high.  

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