CA - PSLV: Expect Silver Prices To Rise During 2023 In A Recession

2023-04-20 08:11:49 ET

Summary

• The Sprott Physical Silver Trust is a closed-end fund with strong appeal as an efficient and safe vehicle for exposure to silver, trading at a discount to NAV.
• Industrial buyers drive around half of overall silver demand, which is somewhat vulnerable in a recession. Such demand, unlike previous recessions, is likely to hold up better this time around.
• The key differences this time firstly relate to how cheap silver currently is heading into any potential recession.
• Aside from that, there are now structural factors in place that can ensure industrial demand for silver is far more resilient.

Sprott Physical Silver Trust Overview

The Sprott Physical Silver Trust ( PSLV ) is a closed end fund that invests in silver that is fully allocated for and held at The Royal Canadian Mint.

The structure enables an investor to redeem units in exchange for the physical assets, however subject to very high minimum amounts and fees are involved. It is worth mentioning though, as this feature assists in ensuring PSLV does not trade at a material discount to NAV like other closed end funds. Looking at the long-term history of PSLV, you can rely on the discount to NAV not widening out to 10%. Whilst not necessarily my base case, I would not rule out the discount entirely closing in the future or even seeing a small premium.

With these attractive features of this closed end fund, I view the expense ratio as quite reasonable. The MER is 0.58%, and the fund has plenty of scale and liquidity, with assets of approximately $4.2 billion.

I have covered another Sprott closed end fund last month in an article of mine here . At the time I made some relatively brief points on the bull case for silver as well as gold. In fact, I suggested there are good reasons that silver will outperform gold.

In the back of my mind however, I have been cautious about taking on too much silver exposure. It is after all, renowned for its industrial demand being more vulnerable in a recession and the recession risks are rising.

I am of the belief now however that the market is underappreciating how well silver can perform even if we do experience a recession later this year.

What drives demand for silver?

At first glance, potential silver investors may view around half of silver demand coming from industrial buyers as a worry. The odds of an impending recession have been rising.

There are reasons however why silver investors should not be overly concerned about the US and / or major parts of the world possibly heading into recession.

• Whilst the supply outlook for silver may improve in 2023, in recent history it has been disappointing.

• There are structural tailwinds in place now regarding industrial demand. These can mitigate much of any demand shock should we head into recession.

• Jewelry still represents a significant part of silver demand. Within that segment, India is a major player and even in the event of a recession elsewhere, the India growth story is solid. China’s re-opening in 2023 is also positive.

• Generally, in recessions over the last half of a century, silver has been quite a reasonable alternative asset anyway when compared with equities.

Is silver in short supply?

Supply is struggling to keep up with demand for silver since the pandemic hit us in 2020. Unsurprisingly, in 2021 and 2022 mine production was well short of the pre pandemic years. Whilst we may see some improvement in 2023, it is still likely to remain on the low side of average in terms of the last decade.

Back in 2020 it was a challenging year for silver in terms of industrial demand, so the lower-than-expected production recorded was not a major issue. Since then however, demand has surged. This was especially the case last year such that the market balance is in clear deficit.

Even more significantly, is that such a deficit seen in the last couple of years, exceeds the cumulative surpluses of the decade prior.

Is silver cheap?

The above silver market balance chart begins in 2013. Interestingly that year follows the two years prior where the silver price traded in the range of 30 to 40 USD/oz. Today as I write, we are around the 25 USD/oz level. This is despite the demand / supply dynamics of the last decade just explained. It is also with inflation trending worryingly high now, plenty of geopolitical instability, and concerns surrounding the global banking system as recently as last month.

If silver is not a very good investing opportunity, perhaps the market is telling us the trend of strong silver industrial demand is under threat from an impending recession?

Why is silver in high demand?

During the first year of the pandemic in 2020 industrial demand for silver fell as you would expect. This may make some investors cautious of getting too bullish on silver this year, given many economists are now predicting recessions around the world.

Yet despite what a horrible year it was for economic growth in the world in 2020 it was, silver demand has bounced back strongly in the last couple of years.

A big part of the bounce back was in fact industrial demand as we can see on the above chart. Noticeably this segment shows quite a consistent rising trend for virtually over a decade. (If we cut some slack for when the pandemic hit us in 2020).

It looks more like a structural growth trend is in place for industrial silver demand. A large part of this trend is due to the energy transition story.

Prospective silver investors that are worried about a global recession should view the demand risks in the context of the bullish structural story. They should also note despite the drop in demand in 2020, demand has rebounded to way surpass 2019 levels. At the same time the silver price remains some 15% lower than the peak we witnessed in 2020.

These positive structural stories were not so apparent when judging how silver performed in previous recessions in history.

India and China demand to have greater impacts

A key feature in the strong demand for silver last year was also because of jewelry demand. Within this segment India is a major player and the pent-up demand from the pandemic was large. Gold gets more publicity about how Indians have strong demand and especially for wedding season. Yet the growth in demand for silver is now increasingly getting more attention. It has always been more affordable, yet more so given silver’s recent underperformance versus gold.

Whilst we do not see as much demand from China in terms of this segment, it can’t hurt that China’s reopening should also see that pent up demand effect taking place.

Once again when investors look at historical tables of how silver performed in recession a very long time ago, they should keep in mind that sources of demand are evolving. Just in terms of India, just in the last decade they have moved from the 11 ^th largest economy to the 5 ^th . They recently overtook the United Kingdom, and the IMF sees India as the 4th largest economy by 2027 .

Performance of silver in recessions

Compared to past recessions over the last few decades, we may be entering a recession soon where at least there are some bullish factors. Such factors that did not exist prior to previous recessions.

Silver appears fundamentally cheap and the supply is weak. With the demand side, relatively new demand sources continue to emerge for the energy transition story. Also, we have growth from emerging markets as a percentage of global GDP that should further increase.

Investors may still be skeptical of the structural factors described just above. Even so, the historical performance of silver during recessions is already reasonably attractive. I would acknowledge thought that measuring the performance can be somewhat objective. Where do we draw precise lines in terms of recession starting and end points? Or is it more relevant to see how silver performed during the start of equity bear markets that occurred due to recessions?

I still believe it is quite useful to attempt to get some insight into silver’s performance in the significant recessions we have seen since the 1970s. This is the chart I have been seeing a lot lately to examine silver during recessions.

Some conclude that in the above periods, silver has only outperformed three times, i.e., years starting 1973, 1981 and then 2007.

From that some may conclude you are worse off with silver than equities in such negative periods. It is not necessarily however as clear cut as that.

Why silver sometimes underperformed in past recessions

Let’s dive a bit deeper into those instances where silver underperformed above.

The 1980 example seems to me is the one that is the least relevant to try and gain and insight from today. The fall in the silver price mentioned above followed a period from just 1979 to 1980 where the price rose dramatically. Eventually the price was to fall just as dramatically in 1980, all largely from the effects of the Hunt brothers as explained here .

To quote directly from this article “ Between 1979 and 1980, the price for an ounce of silver went from $6.54 to $38.30 - an increase of 485%.” Hardly a good example in my view to compare with today when the silver price is way less than 2011 levels.

In 1990 you did certainly want to own the S&P500 rather than silver throughout the 1990s. That was a more comfortable strategy to adopt though back then when you look back at the CAPE ratio of the US stock market. Things look quite different in that respect right now.

In 2001 well there is a miniscule underperformance of silver versus stocks shown. If one looks at the chart from 2002 it does not take long to see that silver did much better for many years after that.

The 2020 underperformance shown in the table above from silver is not too dissimilar from the 2001 example. If you look out further from 2020, then silver was the better option. For example, if you had of invested in silver just prior to the pandemic at the end of January, it would be showing outperformance vs the S&P500.

Risks for silver in 2023

I see the risks for silver now are more to do with if I am wrong on the general direction of the USD, price of gold, and US interest rates. For context, my base case is that the weakening USD trend of 2023 will continue, and the gold price will keep rising. I also believe the Fed will have to cut rates later in the year and we will experience persistent negative real rates. I expanded more on these views in a recent article on Sprott Physical Gold and Silver Trust that I linked to earlier.

I could be wrong of course, and for those investors in the camp that the Fed can engineer a soft landing and control inflation well in the medium term, the silver price may underperform.

Whilst I have made the points about industrial demand for silver holding up better than the market anticipates in a hard landing, there are of course risks to that view also.

Conclusion

Like many, I see a good chance that the US and many other parts of the world slip into recession as we get late into 2023. Where my views differ to some, is that the silver price can overcome the perception that it is vulnerable to slumps in industrial demand during recessions.

This time silver is outright cheap, and cheap compared with gold. The S&P500 still looks expensive on CAPE ratios when considering earnings expectations are also likely to trend down. There is also a positive longer-term structural demand for silver.

These factors usually didn’t exist in past major recessions in recent decades. Still, silver has often performed fine during past turbulent economic times. I expect it to perform even better in the future if we are faced with a recession soon.

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