SBNY - Precious Metals: The Recession Play Everyone Should Consider In Their Portfolio

2023-04-25 17:20:32 ET

Summary

• Gold and Silver are excellent ways to diversify yourself and as protection in case of a recession. This article can be seen as a great introduction to precious metals.
• The mining life cycle from an exploration company to a major producer is a difficult one, we explain this concept throughout the article.
• There are many different ways to invest in precious metals, physical bullion, ETFs, individual stocks, derivatives. All of these are discussed in the article.
• Precious metals can be seen as safe-haven assets in times of economic and political uncertainty as we are seeing right now, which is why we believe they are a buy.

Introduction

In the uncertain times we are currently living in, with sky high-inflation, geopolitical tensions, policy mistakes, the housing bubble, and much more, people look for safe-haven assets to park their hard-earned money. In this article, we discuss why an allocation in precious metals could be wise in a potential recession. We will discuss all kinds of investment opportunities in the precious metals sector with a potential investment for each individual investor and his or her personal risk appetite.

We will take a look at the following in this article:

• Key Moments in History
• Key Drivers For A Precious Metals Bull Cycle 2021
• Silver Squeeze and Precious Metals Community
• Which Type of Investment Fits Your Risk Profile?

Key Moments in History

Let's get this out of the way first. Why invest in Gold and Silver? You might ask yourself: "Stock Info, precious metals have been underperforming for such a long time, why will this time be different?"

Well, you are completely right. Yes, PM's have underperformed, but precious metals have also protected investors for centuries and when timed right they can give you a significant return in a relatively short amount of time. For example, Silver rose over 150% from bottom to top in 2020. Some silver junior miners rose over 1000% in the same time frame. Yes, 10x+ in 4 to 5 months. The history of precious metals is crucial to understand the thesis for investing in them.

Now let's get into the key moments in history for precious metals.

Gold Standard Abandonment: Some of you might remember U.S. President Nixon's announcement in 1971 that the U.S. dollar wouldn't be pegged to Gold anymore. This was the end of the Gold Standard , which led to a period of economic uncertainty and high inflation. (Keep in mind that a key mechanism of the gold standard was that the global supply of gold rises relatively slow, which in theory, would keep inflation and money creation in check.) As a result, the gold price rose dramatically during that time. That decade the gold price went up over 2200%, not bad for an underperforming asset, to put that into perspective, the Dow Jones Industrial Average returned less than 10% over that time.

2008 Financial Crisis: The global financial crisis of 2008 was a period of economic uncertainty and increased volatility in the stock market. This caused a flight towards safe haven assets such as gold and silver. While the stock market plummeted, the precious metals flourished and saw a significant increase in price during that time.

Furthermore, the quantitative easing policies implemented by central banks all over the world to stimulate the struggling economies worldwide caused a period of low interest rates and loose monetary policy, which further fueled the rise of precious metals.

The Hunt Brothers Silver Market Manipulation: The gold and silver bugs reading this article will know about this phenomenon, but for others, it might sound less familiar. In the late 70's and early 80's the Hunt Brothers attempted to corner the silver market by buying up large amounts of physical silver.

At one point, the Hunt brothers owned up to 200 million ounces of silver, which was around 30% of the world's supply. This led to a significant increase in silver prices. But, the Commodity Futures Trading Commission also known as the CFTC stepped in and issued regulations that limited the amount of silver futures contract any one investor could hold. Eventually, the Hunt brothers had to sell their holdings to meet margin calls, this day is also known as Silver Thursday , which caused the silver price to plummet and took a significant bite out of their family fortune.

Key Drivers for a Precious Metals Bull Cycle

Safe Haven Asset and Recession Fears: In times of economic uncertainty investors often turn to gold and silver as safe-haven assets. In addition, precious metals have a proven track record in periods of high market volatility and economic uncertainty.

A recession is a time when there is a lot of uncertainty and fear in the markets, for example in the financial crisis of 2008 when banks were crumbling, people flock into safe-haven assets such as precious metals to protect themselves and put away large sums of money into relatively safe assets. In addition, we have seen banks fall as well this year with Silvergate Capital ( SI ) and Signature Bank ( SBNY ).

One concerning thing I would like to mention here is that bank failures most of the time come in large batches. As of now, the 2023 banking crisis had 2 failures, for a total of $319 billion in assets. Meanwhile between 2007 and 2014 over 500 banks collapsed, with an inflation-adjusted $960 billion in assets. Between 1980 and 1995 close to 3000 banks failed with $2.2T in assets.

We can now use the popular meme phrase. "This time it is different," but is it really different this time? Time will tell, let's hope we will defy history this time.

Inflation Concerns: When inflation is on the rise or stays elevated for a while (as we are seeing right now), purchasing power of currencies such as the U.S. dollar or the euro tends to decrease. Similar to the principle of "the flight towards safe-haven assets," investors tend to seek alternative stores of value to protect their purchasing power. When you are reading this article you are already ahead of the curve, as most people have a large number of fiat currencies in the bank and see their purchasing power decrease year after year. The chart below clearly illustrates the loss of purchasing power of the dollar over the years.

Furthermore, historically there has been a strong correlation between precious metals and inflation. The 1970s is the most used period in time when we seek to compare periods of high inflation. In the 1970s both Gold and Silver prices went up significantly as inflation soared in the United States. Today, we see something similar as the gold price is close to an all-time high and in case of a recession, it is likely that the price goes much higher. Silver still has some catching up to do, but we will discuss gold vs silver as an investment more in-depth in another paragraph.

Geopolitical Uncertainty : Geopolitical concerns can be another major driver for precious metals. Again, in uncertain times gold and silver are seen as safe havens as they have a long history of retaining their value during times of crisis. In today's world, there are a lot of geopolitical concerns out there.

We have a very unfortunate situation with the Russia-Ukrainian war, increasing tension between the US and China, the further expansion of BRICS , and the internal problems the West is having. For example, the political tension between Republicans and Democrats is very high at this moment in time, with allegations against Trump and turmoil within the political parties.

On the other hand, we got protests against the government in France due to the decision to increase the pension age. In addition, China has been increasing its gold reserves over the last year.

Furthermore, a lot of silver can be found in South America, which has seen a lot of political unrest over the last decades. This could put pressure on the silver supply in the future if conflicts would happen in these areas.

All in all, polarization in the world is at elevated levels with people unhappy with their governments due to a loss of purchasing power, the overheated housing market , and remaining cultural issues such as racism and rising inequality. While all this polarization and uncertainty is sad and we sincerely hope these problems will be solved soon, it is a significant driver for gold and silver prices.

Investment Demand and Industrial Demand: Gold has limited, very specific industrial demand, with 5% to 6% of gold being used in electrical contacts and electrical components. On the other hand, silver has many different industrial uses, such as solar panels, medical equipment, and in the production of electronics. This means silver demand is not only driven by investment, but also by industrial demand. Silver is a critical component in the transition towards clean energy because it is an essential material in some key components of renewable energy systems.

For example, solar panels use photovoltaic cells to convert sunlight into electricity, and these cells contain silver as a conductor that helps to transmit electrical currents. The usage of Silver in these photovoltaic components is expected fluctuate between 70 to 80M ounces per year between 2024 and 2030, according to the Silver institute . In the chart below, we can see the demand in PV cells in million ounces from 2000 until 2030.

In addition, Silver is not only used in solar panels; but also in clean energy technologies, such as batteries and electric vehicles (EVs). Silver is a key component in the production of lithium-ion batteries, which are used in energy storage systems and EVs. We expect the demand for EVs and renewable energy will continue to grow, as we discussed in this article about the renewable energy sector, which makes it reasonable to assume that the demand for silver will grow alongside it.

Downfall of the U.S. Dollar: Last but not least in this paragraph we will have to discuss the downfall of the U.S. Dollar, as this can be a major driver of precious metal prices. First of all, people would become more concerned about the stability of the global economy as a whole, as the U.S. Dollar is seen as the reserve currency across the globe. A book surrounding the cycles in the global economy I would recommend everyone is Ray Dalio's Principles for Dealing with the Changing World Order.

We have seen multiple different countries choosing to lower their reliance on the U.S. and its currency. For example, Saudi Arabia is officially open to trade oil in other currencies than the USD, this can be seen in this article from Bloomberg about Saudi Arabia's decision to accept Chinese Yuan, strengthening the Saudi-Sino relationship.

In addition, French President Emmanuel Macron openly mentioned that he believes Europe must reduce its dependency on the United States and in addition avoid getting dragged into a confrontation between China and the U.S. over Taiwan. This doesn't only show the weakness of Europe but also shows that Europe isn't that confident about the U.S.' decision-making lately.

2021 Silver Squeeze and Precious Metals Community

You might be asking yourself: "why does the community matter?" Well, the precious metals community is a very knowledgeable community where you can learn from, but there are also grifters who use retail investors to pump illiquid mining stocks or promote small mining companies for a profit. As we will be discussing junior mining in this article as well, it is important to get a short overview of how the community is, and how it can impact a mining stock.

The Silver Squeeze movement has taken the precious metals community by storm. After the short squeezes in both GameStop Corp. ( GME ) and AMC Entertainment Holdings, Inc. ( AMC ), some retail investors banded together on social media platforms, most notably Twitter and Reddit to drive up the price of silver. This caused thousands of new investors to start investing in precious metals and as people always chase the highest returns this causes them to look into illiquid mining companies, which they heard about on the internet.

The roots of this movement can be traced to frustration with the financial system and a desire to stick it to the big banks and hedge funds who have long dominated the silver market. We can't deny that big banks and hedge funds have a history of manipulating commodity prices. For example, JPMorgan Chase ( JPM ) settled for a $920 million fine back in 2020 as they admitted to market manipulation of metals futures.

The movement has most notably tapped into the deep-seated desire among many investors to take control of their financial futures and challenge the status quo. The precious metals community, which are also known as gold bugs or silver bugs are people from all walks of life. This makes it a wonderful community, which often tries to help each other by sharing companies they believe are fraudulent and by sharing their insights on assay results (which are hard to read for people just getting into mining investing).

Unfortunately, there are also grifters as mentioned above, which prey on these retail investors and often use the frustration of retail traders to gain followers and promote bad investments to profit themselves. As in the end, it is important to remember that most junior miners ultimately have the goal to sell their mine rights (or at least part of it) to an intermediate or major miner, such as Barrick Gold ( GOLD ) or First Majestic ( AG ).

One of the most prominent figures that made money on the back of retail investors and the Silver Squeeze movement is Jim Lewis of Wallstreet Silver. This is unfortunate as Wallstreet Silver was one of the accounts that actually fueled this movement. This malpractice is explained very well in this thread by @TheHappyHawaiian on Twitter. I would advise everyone that follows Wallstreet Silver on Twitter to give this a quick read.

We know this might make you cautious before following people, but there are definitely some good accounts to follow regarding precious metals as well. We will name a few who we consider interesting and will shortly discuss why.

First of all, fellow Seeking Alpha contributor Lyn Alden Schwartzer . Lyn is an absolutely brilliant mind, with a great understanding of macro analysis. This makes her an excellent contributor to follow as gold and silver are highly influenced by macroeconomic factors. In addition, Michael Maloney is an interesting on to follow, he is a legend in the precious metals community.

Secondly , Gold Ventures . GV is an interesting account to follow regarding ideas on junior mining companies. Be aware to always do your own DD, and remember to never use articles or tweets as investment advice. Furthermore, we got StigvdA , he is highly focused on commodity investing and owns a very concentrated portfolio of mining companies, which he considers "deep value." As he owns such a concentrated portfolio, he stays updated on everything regarding his positions.

Last but not least, we have Junior Mining Network , a great account to follow to stay up to date on all your favorite junior miners.

Which Type of Investment Fits Your Risk Profile?

Now let's take a look at the different ways you can invest in precious metals.

Physical Bullion

One way to invest in Gold and Silver is by buying physical bars or coins. But, as some of you might be aware, there is a significant premium compared to the paper price for gold and silver coins. For example, let's take a look at one of the typical investment coins, the one-ounce Silver Maple Leaf. This is from jmbullion.com.

At the moment of writing the paper silver price is sitting at $25 per ounce. As you can see in the picture below, these coins are going for $35, which means a premium of $10 per coin, or a premium of 40%. This isn't a rare occurrence, by the way, this price difference can be seen on a lot of different investment coins.

But, for the big investors, it might be better to buy bars or gold coins. Unfortunately, there is still a premium on these as well, although it is quite a bit lower compared to these silver coins. Compared to the large difference between the paper price and the actual price per ounce of silver, physical gold typically trades at a much smaller premium, around 1% or less. Unfortunately, buying bullion can be quite expensive. If you would like to buy 1 kilogram of gold, this would cost you a minimum of $65,000, as can be seen in the picture below.

We understand physical bullion isn't for everyone as it can be quite expensive and necessitates finding a secure way to store it. Some people would store it at home, which is fine, but you would need to buy a safe and even then there is obviously still a risk that it gets stolen.

On the other hand, storing it at a bank or another certified depository will cost you a small fee. Even with the issues that storing gold entails, one has to admit it has something magical to it. So while physical bullion might not be for everyone, we believe it certainly has its place and it is a good way to diversify your wealth across multiple different assets, without having all your investments in brokerage accounts.

ETFs

For people who don't like the hassle of physical bullion, you might be more interested in buying some ETF's. First, we will discuss the most well-known gold ETF, the SPDR Gold Trust ( GLD ). GLD is probably the most well-known precious metals ETF. GLD is probably the safest way (apart from physical bullion) to invest in gold. In comparison to junior miners, this ETF is very liquid, so you won't have any liquidity issues when buying or selling. Furthermore, it is possible to buy derivatives on GLD, which might be interesting for some readers with some more risk appetite.

As can be seen in the chart below, GLD is currently fighting an important resistance zone. The all-time high remains at $194, which was the high of August 2020. Nonetheless, one needs to keep in mind that an investment in gold should be seen as a way of diversification and not necessarily to get the biggest returns. Still, a break above the ATH could give some very bullish price action in the remainder of 2023 and 2024.

When taking a look at Silver, most people think about the iShares Silver Trust ( SLV ), but as many silver investors know, the Sprott Physical Silver Trust ( PSLV ) is actually a better option despite the higher expense. Because the silver market is more easily manipulated by hedge funds or big banks SLV isn't the best investment as they aren't fully backed by unencumbered physical silver. For gold, there is also the Sprott Physical Gold Trust ( PHYS ), which is an interesting opportunity, but less necessary as gold is not as easily manipulated as silver. Nonetheless, you are more certain your gold is actually secured when investing in PHYS.

This is where PSLV comes in, so why PSLV you may ask? PSLV is backed only by unencumbered, fully allocated physical silver. This means that for every PSLV that gets bought, they buy an equal amount of physical silver, which is stored at the Royal Canadian Mint, and has only one claimant: Sprott.

In contrast to PSLV, SLV's custodian is JPMorgan ( JPM ), Unlike PSLV, the custody agreement SLV has with JPM allows for the holding of unallocated silver, which means SLV is way easier to manipulate. In addition, PSLV doesn't have derivatives available, meanwhile, SLV does have derivatives available.

In the chart below, you can see that PSLV still has a lot of room left before reaching its all-time high again. While it has broken out of its 2-year downtrend a couple of weeks ago, we can expect some consolidation in Silver prices right now, before expecting it to move up higher.

In addition to both gold and silver ETFs, we've also got some miner ETFs, which are worth looking at. We have the VanEck Gold Miners ETF ( GDX ). The GDX is a basket of some of the biggest gold miners in the world. In the table below, you can see the 10 biggest holdings of GDX, which include Newmont ( NEM ), Barrick Gold ( GOLD ), and Agnico Eagle Mines ( AEM ), to name a few. This table is with the latest data (18th of April 2023), with the 10 largest positions accounting for 58.54% of the total holdings.

Investing in gold miners is a more aggressive way of investing in gold, as these companies' profits are not only dependent on gold prices but on many other variables inherent to mining, such as energy prices. While GDX rose over 180% from bottom to top in 2020-2021, gold rose around 43%. We could argue that GDX, thus acts as a leveraged gold position so to speak. Nonetheless, it is crucial to keep all the different variables in mind and not only the gold price when investing in GDX.

In addition to the GDX, VanEck also has the VanEck Junior Gold Miners ETF ( GDXJ ). In comparison to the GDX, the GDXJ is invested in smaller miners. These positions include Pan American Silver ( PAAS ), Kinross Gold ( KGC ), and Endeavour Mining plc ( EDVMF ), to name a few.

The table below shows the 10 biggest positions of the GDXJ as of the 13th of April 2023. The top 10 holdings of the GDXJ make up a total of 35.66M of the fund's net assets.

Similar to Gold, Silver also has ETFs for both the largest miners and small miners. First, let us discuss the Global X Silver Miners ETF ( SIL ) by Global X. The 10 biggest positions of the SIL include Wheaton Precious Metals ( WPM ), Pan American Silver ( PAAS ), First Majestic Silver ( AG ), and Polymetal International plc ( POYYF ), to name a few.

As of the 21st of April 2023, these top 10 positions make up close to 75% of the ETF. We could say that this ETF is fairly concentrated towards its 10 biggest holdings.

The ETFMG Prime Junior Silver Miners ETF ( SILJ ) is probably the most leveraged one can go with exposure to precious metals through ETFs. As of the 21st, the top 10 holdings make up a total of 58.10% Some of these top holdings include Mag Silver Corp. ( MAG ), Capstone Copper ( CSCCF ), Hecla Mining ( HL ), and Fortuna Silver Mines ( FSM ), to name a few.

It is important to note that once a company gets added or dropped off the SILJ it can have a huge effect on the underlying. Some smaller mining companies are quite illiquid, which can cause an addition or drop to cause a huge surge or fall in price. These can create huge opportunities for speculators, betting on an addition to the index.

To conclude this part on the different ETFs, it is important to note that in particular these ETFs for smaller miners certainly aren't for everyone, but, we believe it is important to discuss these opportunities as for some investors with some risk appetite these are great opportunities.

Nonetheless, most companies within the SILJ list are of decent quality, these aren't small explorers, which we will discuss below, but bigger producers, such as Hecla ( HL ) or First Majestic.

Mining Stocks

Above we discussed a few different ETFs, but one may also opt to buy individual companies. You could buy a mix of smaller and bigger miners. For example AG, GOLD, and WPM. This would set you up with some big precious metals companies. For the people with some more risk appetite, you could start looking into some really small companies, but first of all, there are a few different classes of junior miners, which is important to understand before investing.

A junior mining story generally starts at the exploration stage, but the road to becoming a major, also known as a production-stage company is quite a long road. If you are able to identify an explorer, which makes it to a major you will have an investment, which will be a 10-bagger or even a 100-bagger. Nonetheless, there are a lot of bumps along the way, which can hinder this journey, or a buy-out along the way happens very often as well.

The 3 stages we will discuss in this paragraph are:

• Exploration Stage
• Development Stage
• Production Stage

Exploration Stage: The exploration stage can be considered to be entirely speculative. The success relies entirely on making a new mineral discovery through drill programs. An excellent drill assay can make a junior's share price soar. Similarly, bad exploration results can cause significant downward pressure.

In addition, exploration-stage miners are often in continuous need of cash, as drilling and buying grounds can be quite expensive, and in the meanwhile, these miners aren't making any revenue. When the company achieves enough results in one array, the company becomes a Tier 3 company.

Development Stage: The development stage can be classified into 2 separate stages. The first category is the "post-discovery". Companies in this stage have made a discovery, but aren't quite sure how large the deposit is. In this stage, the stock price usually goes down, as now one has to wait until the company produces a resource estimate, to see how big the resource is. If they are successful at this, the next step is finding out if the precious metals can be mined economically, because, it is one thing to find a big resource, but if it is only economical at $2000 gold or $30 silver, it makes it a lot harder to become a successful major eventually.

If the resource can be mined economically, the company becomes a "near-term producer" or probably better classified as nearer-term, as a company in this stage still has a lot of hurdles to overcome. When a company is in this stage there are three economic studies the company has to go through, each with an increasing level of confidence regarding the resource estimates and the economics of the project. In the table below, I made a quick overview of each one of the 3 stages.

The PEA examines multiple different mining scenarios and economic parameters. Afterward, the PFS follows. The PFS is more detailed than the PEA and is mostly used to determine whether or not to proceed with an even more detailed feasibility study. This study is somewhat of a reality check for most companies, as it often shows certain flaws and areas which need to be improved.

Last but not least, we have the FS, which is the final decision regarding whether or not to proceed with the project. This provides budget figures, shows a clear AISC (All-in sustaining costs), often shown as the dollar cost per ounce mined.

Companies in this stage obviously have less risk than companies in the exploration stage. Nonetheless, most companies will be stuck in this stage and won't be able to move forward on their own. In this stage, the miner often gets bought out by a major company, as it is very expensive to open a mine, which would include a large raise of capital to do it on their own. Nonetheless, if you are an investor and ride a company from the exploration stage until the buy-out, you will have made an exceptional return.

Unfortunately, a lot of companies will fail in this stage as well, or you get diluted into oblivion as an investor. For example, Aurcana Silver ( AUN:CA ) was one of the most promising companies back in 2020, with great prospects, but unfortunately bad management and continuous dilution caused the company to fail.

Production Stage : Congratulations, your junior made it into production stage. Not many juniors are able to accomplish this. Most of the companies within this stage are companies with operations all over the world and providing steady cash flows (this is debatable though). A major mining company can be valued in a similar way as a large oil company, with profitability metrics, but with a mining twist to them.

To conclude this paragraph, it is important to continuously follow up on your junior mining investments, as one bad assay can change the whole story and leave you with a big loss on your initial investment, which might not recover whatsoever. Furthermore, there is a lot of dilution risk, which one has to take into account as management does not always have the shareholders' best interest in mind.

Conclusion

To conclude this article, I hope you learned something more about gold and silver and junior mining as a whole. We discussed a lot of different ways to invest in gold and silver and hope you found something useful for your own personal style of investing.

We believe gold and in particular silver, have some catching up to do, but are currently a buy. We believe that precious metals are a great way to diversify your portfolio or to even benefit from a potential recession in the next few years.

Editor's Note : This article was submitted as part of Seeking Alpha's Best Investment Idea For A Potential Recession competition, which runs through April 28. This competition is open to all users and contributors; click here to find out more and submit your article today!

For further details see:

Precious Metals: The Recession Play Everyone Should Consider In Their Portfolio