2023-07-17 08:04:56 ET
Summary
- While silver is no longer significantly undervalued relative to a basket of gold and the commodity complex, it is still far below the levels seen at previous bull market peaks.
- The technical picture continues to improve following the SLV's recent hold above its previous lows, and strong support exists around $20, creating a potential launchpad for significant further gains.
- While silver is unlikely to rise if gold prices decline, the relative outlook for silver from a risk-adjusted perspective is extremely strong.
- Despite a 30% fall in ounces under management since January 2021, the SLV ETF is still the largest and most liquid silver ETF with $11.4bn in assets.
I have been bullish on silver and the iShares Silver Trust ETF ( SLV ) over the past few years due to its undervaluation relative to the price of gold and the broader commodity complex. The recent rally in the metal relative to both gold and commodities has seen this valuation discount narrow sharply, but there is still significant room for silver prices to rise. Silver bull markets tend to end with the metal spiking beyond its fair value and I expect history to repeat.
The SLV ETF
The SLV ETF has tracked the spot price with very little tracking error and an expense fee of 0.50%, which is far lower than the spreads on buying the physical metal, although slightly higher than some competing ETFs such as the abrdn Physical Silver Shares ETF ( SIVR ). SLV is the largest and most liquid silver ETF with $11.4bn in assets, but ounces under management actually peaked in the reddit-inspired silver short squeeze in January 2021 and have since fallen by over 30%.
In my previous article on the SLV on April 6 I argued that silver's undervaluation and the strong price action in the metal suggested a potential parabolic spike in the metal and the SLV. Since then they have pulled back in an orderly fashion and established another higher low, creating a potential launchpad for a move higher.
The rally in silver from its 2022 lows has reflected a narrowing of the metal's undervaluation when compared with the price of gold and the Bloomberg commodity index. After trading around 40% below fair value in October (see ' SLV: Signs Of A Major Low '), silver is now less than 10% undervalued based on its correlation with a 50:50 basket of gold and commodities.
Bloomberg, Author's calculations
No Longer Significantly Undervalued But Far From A Bull Market Peak
Silver's gains have come despite an ongoing decline in the commodity complex, with industrial metals in particular failing to join in the silver price rally. However, I remain strongly bullish on the metal. The recovery in risk appetite last week on the back of the weak CPI release and falling interest rate expectations saw a broad-based decline in dollar and rise in real assets, which I expect to put a floor under commodity prices, providing support to silver and the SLV.
Silver bull markets tend to end once the metal becomes overvalued relative to gold and the commodity complex. As the chart below shows, silver prices spiked into overvalued territory in 2004, 2006, 2008, 2011, 2016, and 2020 before the bull markets ended, and we should expect to see another such move before the current bull market is over. Options markets continue to show low levels of implied volatility. Previous rallies such as the one seen over the past week have tended to occur alongside rising call option volatility as traders anticipate further upside volatility, yet the latest rally has seen little demand for speculation of further sharp gains. This means that silver bulls can now take large bets on significant silver upside at relatively low cost, raising the potential for upside in the metal. This contrasts greatly with the early-2021 period where widescale anticipation of further gains in options markets created the conditions for a downside reversal.
Reconciling Bullish Silver View With Bearish Views On Gold
Readers have recently pointed out the seeming contradictory bullish view on silver and bearish view on gold. As the two metals share a very close correlation it is unlikely to see silver rise while gold falls. In fact, this has almost never happened. Furthermore, silver has actually tended to weaken relative to gold when gold prices fall due to its higher degree of volatility.
However, the key point to note is the risk-reward trade-off. What I am ultimately trying to get exposure to is the outperformance of silver in risk-adjusted terms. The following chart shows the performance of gold relative to silver over the past 20 years after adjusting for the higher relative volatility of silver. While silver has significantly underperformed over this period, there have been a few periods when it outperformed. The most notable being from August-2010 to April-2011 when silver rose much faster than gold even adjusting for the former's higher volatility. Another such occurrence came from April 2020 to March 2021, even as gold fell for much as this period. My expectations is for a repeat of such outperformance, potentially via a spike higher in silver.
Gold Vs Silver Adjusted for Silver's higher Volatility (Bloomberg, Author's calculations)
Conclusion
The SLV ETF has a long record of tracking the price of spot silver with minimal tracking error and reasonable charges and should benefit from the metal's continued rise from undervalued levels. Silver bull markets tend to end with a spike higher during which the metal outperforms both gold and the commodity complex, and option market positioning suggests investors are underpricing the potential for such a move.
For further details see:
SLV: Wait For The Big Spike