The silver miners’
stocks have surged higher in this young new year, putting the
Trumphoria general-stock rally to shame. Following its
fourth-quarter drubbing, this tiny contrarian sector is embarking on
a major new upleg as traders return. Silver-stock uplegs tend to
grow to massive proportions, and silver-mining fundamentals remain
strong today. So odds are the silver stocks are going to power far
higher in 2017.
Because silver
stocks aren’t widely followed, most investors and speculators are
unaware of this sector’s stellar upside potential. Silver mining is
a challenging business both geologically and economically, so there
aren’t many primary silver miners out there. And their stocks’
collective market capitalization is small, a rounding error compared
to the broader stock markets. That doesn’t leave much room for
funds to buy.
On top of that,
silver itself is essentially a leveraged play on gold. The
overwhelmingly-dominant driver of silver prices is gold-price
action. Silver’s fortunes are inexorably slaved to gold’s own. So
the great majority of contrarian capital flowing into
precious-metals stocks naturally seeks out the far-larger gold
miners. Silver stocks tend to fly under the radars of fund
managers, creating exceptional opportunities.
For decades silver
stocks even lacked a major dedicated index, making their
performances relative to gold stocks difficult to track. Thankfully
that started to change in April 2010 when Global X launched its SIL
Silver Miners ETF. While SIL is tiny with just $361m in net assets
this week, it is still nearly 5x bigger than its next-largest
competitor. SIL has slowly become the definitive way to track
silver stocks as a sector.
This ETF remains
far from perfect, with well-known
composition
problems. SIL’s leading component is a major Mexican mining
conglomerate commanding 1/8th of this ETF’s total weighting. While
it is indeed the world’s largest silver miner, Industrias Penoles’
silver business only generated about a quarter of its total
sales in Q3’16. Its stock doesn’t trade like a primary silver miner
since silver is a minor side business for it.
Nevertheless SIL
is the best silver-stock tracking vehicle we’ve got, reflecting how
this sector as a whole is faring. SIL trends offer great insights
into where silver stocks have been and more importantly where they
are likely heading next. Here this leading silver-stock ETF’s price
is superimposed over silver’s, which it naturally closely tracks.
Silver levels drive silver-mining profits, and thus
ultimately silver-stock prices.
![](http://www.24hgold.com/24hpmdata/articles/img/Adam Hamilton-Silver Stocks New Upleg-2017-01-27-001.gif)
A year ago in
mid-January, SIL was battered to all-time lows in split-adjusted
terms. Silver stocks were so deeply out of favor that Global X
executed a 1-for-3 reverse split in SIL in mid-November
2015. No rationale was given, but I suspect SIL’s managers
extrapolated the bearish trend and figured the silver stocks would
keep spiraling lower indefinitely. They didn’t want SIL’s price to
collapse into the single digits.
Since SIL was only
created in April 2010, an all-time low doesn’t mean that much. At
the same time, the leading gold-stock index was crushed to
fundamentally-absurd 13.5-year secular lows. The
precious-metals miners have rarely been more out of favor than they
were a year ago. But smart contrarians know the best time to buy
low is when everyone else has abandoned a sector, when bearishness
is extreme.
Indeed a new
silver-stock bull was born right then in the depths of despair,
and the silver stocks started surging dramatically. Silver-stock
upside in bull-market uplegs is amazing. Silver-mining profits
greatly leverage silver-price increases, dramatically improving this
sector’s fundamentals. And with the entire silver-stock universe so
small, relatively-minor capital inflows can fuel utterly-massive
stock-price gains.
For the first half
of last year, the silver miners’ stocks first rallied and then
soared with silver. Of course they are strongly correlated with the
metal they mine, since it almost solely determines their
profitability. While silver peaked after gold in early August,
strong momentum carried the miners higher for a couple more weeks.
By that point SIL had skyrocketed an amazing 247.8% higher in
just 6.9 months, fantastic gains!
Silver stocks’
upside leverage to silver in this young new bull’s initial upleg was
huge. Silver just rallied 40.6% over that same span, so the silver
stocks amplified its upside by an incredible 6.1x! If silver
itself is heading higher, there’s no better way to play it than with
the silver miners’ stocks. Any given silver-price rise translates
into far-faster increases in silver-mining profits, leading stock
prices to be bid sharply higher.
Despite silver
stocks’ blistering early-2016 bull run, they weren’t unreasonably
high by mid-August’s peak. That was merely SIL’s best level in 3.5
years on a split-adjusted basis, far from secular extremes. And the
silver miners’ operating fundamentals certainly supported higher
stock prices. In order to make better trading decisions in silver
stocks, each quarter I dig into the latest operating results from
the SIL components.
As of Q2’16, the
quarter before silver stocks peaked, the top 17 SIL stocks were
mining silver at average all-in sustaining costs of just
$10.05 per ounce.
That was this industry’s total cost of producing including
everything necessary to maintain and replenish operations at current
silver-production levels. As silver prices averaged $16.79 in Q2,
the elite silver miners of SIL were earning very impressive 40%
profit margins.
There was no
fundamental reason for a silver-stock correction, although there
were plenty of technical and sentimental ones. Silver stocks
had soared very far very fast, and investors and speculators were
getting quite bullish and greedy. Corrections are perfectly normal
and healthy in ongoing bull markets to bleed off excessive greed and
rebalance sentiment. I warned in early July that
a correction was
likely.
But silver-mining
fundamentals were still rapidly improving while the red-hot silver
stocks sold off in the subsequent months. While silver miners will
soon report on Q4’16, their latest results are still Q3’16’s. The
top 17 SIL silver miners’ average all-in sustaining costs merely
edged up 0.8% quarter-on-quarter to
$10.13 per ounce.
Yet the average silver price powered 16.4% higher QoQ to $19.55 in
Q3, ballooning profits.
The elite silver
miners’ profits really leveraged silver’s gains, surging 39.8%
higher to $9.42 per ounce! This industry’s profit margin at 48% was
enormous, and certainly justified further silver-stock gains. But a
normal correction went off the rails in Q4 due to several anomalous
events. Silver’s primary driver gold suffered no fewer than
three major anomalous selloffs, and each sucked in silver and
therefore silver stocks.
In early October
silver plunged after gold futures suffered
cascading
stop-loss selling as $1300 support started failing. Naturally
that extreme selling quickly burned itself out, so silver and SIL
started grinding higher again into early November. Then Trump’s
surprise election win stoked the incredible
Trumphoria
stock-market rally, leading to
heavy gold
selling. Gold is the anti-stock trade, tending to move
counter to stocks.
Again silver
quickly started to rebound from that second anomaly, so silver-stock
levels stabilized. But a third body blow soon arrived in the form
of more
gold-futures selling right after the Fed hiked rates for the
second time in 10.5 years in mid-December. So silver again followed
gold lower. Silver traders have always looked to gold for their
trading cues, so nothing else is more important for prevailing
silver prices.
So by late
December, what started out as a normal and healthy silver-stock
correction had mushroomed into a gross monstrosity. SIL had plunged
42.5% in just 4.2 months, far beyond the normal range of bull-market
corrections. But impressively that was on a huge 20.1% silver
plunge. So SIL leveraged silver’s extreme downside in Q4 by just
2.1x, which was far less than its enormous 6.1x upside leverage in
early 2016!
Silver stocks’
resiliency in an extreme silver correction illustrates their
asymmetric upside potential. This beaten-down sector has
much-higher odds of soaring higher than collapsing lower. Before
this past year’s young new silver bull, silver stocks were battered
relentlessly in the dark years from 2013 to 2015. That spawned such
epic bearishness that everyone susceptible to being scared into
selling low is long since out.
So even though
silver stocks as represented by SIL were battered back to April
levels in late December, an 8.2-month low, this sector looked
wildly bullish. That setup a month ago felt much like last
January’s brutal secular lows. Everyone was bearish, totally
convinced silver stocks were doomed to keep falling. So near those
lows we aggressively bought and recommended trades in great silver
stocks in our newsletters.
That contrarian
call has since proven wise, just like a year ago. As of earlier
this week, SIL has already powered 24.4% higher out of those
excessive lows! Year-to-date it has already soared 19.5% at best,
trouncing the Trumphoria gains in the major stock indexes. Silver
stocks’ surge over the past month has all the hallmarks of a
major new upleg just starting. It has the potential to
ultimately eclipse early 2016’s monster.
While the silver
miners’ Q4 results haven’t been released yet, there’s no way they
are going to justify SIL’s terrible 27.8% plunge last quarter.
Remember the top 17 SIL-component silver miners averaged all-in
sustaining costs of $10.05 and $10.13 in Q2 and Q3. So it’s
reasonable to assume they will stay around $10 in Q4. They’ll
likely actually fall, as silver miners tend to pull in the horns
when silver weakens.
For all the sound
and fury of Q4, the average silver price was still $17.12. While
down by about 1/8th from Q3’s average, this still likely leaves the
elite silver miners with excellent profit margins around $7 per
ounce. That is right in line with Q2’s which ran $6.74. Silver
stocks soared that quarter on those kinds of operating margins,
blasting 63% higher. There’s no way late-December’s silver-stock
low was righteous!
If a major new
silver upleg is indeed underway, silver stocks are going to enjoy
another fantastic year in 2017. Despite their miserable anomalous
Q4 selloff, SIL still soared 73.5% higher in 2016! I suspect the
silver stocks will see even-bigger gains this year. As of this
week, silver has only climbed 9.1% off its own late-December low in
the wake of that Fed rate hike. That’s nothing for an upleg in a
silver bull.
Remember SIL
rocketed 248% higher in largely the first half of 2016 on a 41%
silver upleg. Despite silver’s gains it still remains really
undervalued relative to its primary driver gold. So silver is
very likely to mean revert much higher in 2017, which will again
drive wildly-disproportional gains in silver-stock prices as their
profits leverage silver’s advance. This is easiest to understand
with the Silver/Gold Ratio.
This SGR simply
divides the daily silver close by the daily gold close. Technically
that results in little decimals that are hard to parse mentally, so
I prefer using a scale-inverted gold/silver ratio which is
the same thing. It yields more meaningful whole numbers like 71,
which is where the SGR stands today. This is way too low relative
to gold based on historical precedent, an unsustainable deviation to
be unwound.
![](http://www.24hgold.com/24hpmdata/articles/img/Adam Hamilton-Silver Stocks New Upleg-2017-01-27-002.gif)
This week it took
almost 71 ounces of silver to equal the value of one ounce of gold.
That’s really high historically, meaning silver prices are really
low relative to gold. The average SGR before 2008’s stock panic
was 54.9, which is why 55 has long been assumed to be “fair value”
for silver relative to gold. That stock panic really whacked
highly-speculative silver disproportionately hard, wildly distorting
this relationship.
But as in all
market extremes, those panic-level silver prices were short-lived.
Silver soon mean reverted dramatically higher, rallying far faster
than gold which is necessary to drive the SGR higher. Like usual
after extremes, that mean reversion didn’t stop at the 55 average.
Instead it overshot proportionally to the opposite extreme,
briefly pushing the SGR as low as 31.7! Silver’s price had to
rocket over $48 to achieve that.
During the normal
post-panic years from 2009 to 2012 before the Fed’s open-ended QE3
levitated stock
markets and crushed precious metals from 2013 to 2015, the SGR
averaged 56.9. So there’s plenty of pre-panic and post-panic
precedent for an SGR near 55 being normal. Silver is undervalued
relative to gold when the SGR is higher, and overvalued relative to
gold when it’s lower. Silver is still too cheap today.
Early last year
soon after gold, silver, and their miners’ stocks were battered to
major secular lows, the SGR was briefly pounded to a panic-level
extreme of 83.2. It took an astounding 83 ounces of silver to equal
the value of a single ounce of gold! Back then I used this same SGR
chart to point out that
silver was a
coiled spring, ready to explode higher. And indeed that soon
came to pass as the SGR started to mean revert.
By mid-July the
SGR had soared as high as 65.9, which was still well below the 55
long-term average. But that trio of gold-driven silver plunges in
Q4 bashed the SGR back down to 73.2 in late November. It has merely
rebounded to 70.8 as of this week. That means silver still has
lots of mean-reversion rallying left to do even with today’s
prevailing gold prices. Let’s assume that post-panic average 57 is
silver’s fair value.
At $1200 gold, a
57 SGR implies a silver price near $21.00. That’s another 24%
higher from this week’s prevailing levels. There’s no doubt that if
silver rallies another quarter or so from here back to those prices,
which are above early-August 2016’s silver peak, the silver stocks
are going to soar again. At similar 6x upside leverage to early
last year, that alone could drive another 150%ish surge in
silver-stock prices!
But that simple
SGR mean reversion isn’t even the bullish part yet. Gold itself is
also likely to continue mean reverting much higher, and the SGR
should overshoot proportionally to the opposite side after last
year’s panic-level extremes. Gold is now set up for massive new
buying from two fronts, American stock investors
buying GLD shares
and American speculators
buying gold
futures. That will catapult gold far higher.
Between 2005 and
2011, gold’s average annual gain as capital flowed in was 20.3%
without a single down year. So let’s conservatively assume gold
enjoys an average bull-market year in 2017 with a 20% gain, putting
it near $1380 by year-end. Plug an average 57 SGR into that, and it
yields a silver-price target near $24.25. That’s another 43% higher
from this week’s levels, a major upleg exceeding early 2016’s.
But assuming the
SGR will merely stop at average after a panic-level extreme is way
too conservative, as mean reversions out of extremes tend to
overshoot proportionally to the opposite extreme. For years
before 2013’s Fed-driven gold plunge, the SGR’s trading range had
meandered between 60 and 45. So a modest SGR overshoot to 45 is
almost certain. At $1380 gold, that would push silver back over
$30.50.
That’s another 81%
higher from this week’s levels on conservative assumptions. So it’s
certainly easy to argue the case that the silver miners’ stocks
still have upside potential in the hundreds of percent! I’ve
been trading silver and silver stocks for decades, and I strongly
suspect that the big gains we saw early last year were just a small
foretaste of the great feast to come. Smart contrarians are
aggressively buying!
So while silver’s
own mean reversion relative to gold can be played with that leading
SLV iShares Silver Trust silver ETF which tracks the metal itself,
the gains in the silver miners will dwarf those in silver due to
their great
inherent profits leverage to the metal they mine. SIL is the
leading ETF for silver-stock exposure, but the gains in elite
individual silver stocks with superior fundamentals will really
outshine SIL’s.
At Zeal we
aggressively bought and recommended great gold stocks and silver
stocks to our newsletter subscribers back in December when everyone
remained hyper-bearish. Our unrealized gains on these young trades
are already running as high as +48% this week! If you too want to
thrive in these markets, it is essential to stay informed all the
time. Wealth is multiplied by first buying low when few others
will.
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The bottom line is
silver stocks are embarking on a major new bull-market upleg. After
getting crushed in the fourth quarter on a series of anomalous gold
selloffs, this sector has rebounded dramatically over the past
month. The silver miners’ great inherent profits leverage to the
metal they mine is kicking in again as silver mean reverts higher.
Investors and speculators alike are returning to chase this earnings
growth.
And silver stocks’
market-leading gains are likely just the vanguard of far-larger ones
coming. As a small sector, it doesn’t take much capital flowing in
to propel silver stocks dramatically higher. Thus their bull-market
uplegs tend to grow huge as they mature. And with silver still way
undervalued relative to even prevailing gold prices let alone where
gold is heading, it has a lot of profit-generating mean reverting
left to do. |