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Demand for Silver Beats Gold in Current Market

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EDITOR NOTE: Since the pandemic low in March of 2020, silver has far outperformed gold. Year to date, silver is still outperforming gold. And given its price level, affordability, and other factors beyond safe haven demand, silver might indeed make for the better investment of the two. Silver is something of a hybrid asset--it’s a traditional monetary metal whose use as money goes back thousands of years, while at the same time, it’s a critical industrial component that will make the future of (green) energy possible. Supply chain disruptions following years of low production have also brought forth a depletion of the white metal’s stock amid increasing demand for silver. In short, if you’re looking to accumulate non-CUSIP silver, there isn’t much time left before it breaks out of its 8-month pullback, meaning now is the time to pull the trigger.

The Appeal and the Flaw

Silver (XAGUSD:CUR), like gold, was first deemed precious due to the incredible reflectivity of the metal. In layman's terms, they're both really shiny. However, of all the known metals, silver is the shiniest, reflecting 95% of all white light. The next closest metal to it is aluminum, reflecting 90%. Thus, the extreme luster that results from the metal's polished surface is highly desirable in jewelry.

Yet, although falling second to silver, aluminum is the metal that NASA selected for use in its Hubble Space Telescope as the reflective element of the device's primary mirror. This comes down to silver's single major flaw. It's not that, like gold, it is too soft in its pure form. That's easily solved with the creation of different alloys. No, the issue is the rate at which the metal oxidizes.

If you've ever owned silver, you are likely rather familiar with the process that I describe. Without regular polishing, the metal will quickly tarnish and turn a dull, splotchy, gray. This rapid decay of silver's most desirable trait is clearly an issue for those hoping to make use of it. NASA needed a material that would stand the test of time and, therefore, chose aluminum, which would prove to be the better choice over its years of use despite its weaker initial performance. This compromise is repeated in the jewelry industry regularly, though it's often made with another precious metal rather than aluminum.

I did say previously that the issue wasn't with the softness, and it's not, but the solution to its softness has also become a bit of an issue. Silver is often combined with nickel, a metal that about 20% of the population is allergic to. Sustaining prolonged contact with nickel, for those allergic, can be incredibly irritating, even causing blistering. That, even without the dulling of the metal, is enough for a sizeable level of the population to not even consider donning silver in the first place.

Fixing the Issues

With all of this, it seems that silver's use in jewelry has nowhere to go but down. However, that may not be the case. Tudor, a subsidiary of the famed watch company Rolex, recently debuted a new watch utilizing a silver case. The Tudor Black Bay Fifty-Eight 925 utilizes a 925 silver alloy for the case, many comparing it to the company's bronze offerings due to the patina that is expected to appear. However, there are some small differentiations that may carry some huge implications.

On the case of Tudor's bronze watches, the company doesn't actually use any bronze. Instead, Tudor uses anodized steel to achieve a similar look, but avoid staining the wearer's wrist with oxidation or irritating the skin with nickel (found in most bronze alloys). The difference in color is slight and, as it's on the back of the watch, would be known by no one but the wearer. The picture below offers a visual aid to this explanation.

Tudor could have easily done the same for their new silver watch, but they didn't. The luxury brand certainly doesn't wish to upset their customers with stained wrists or irritated skin. However, etched onto the back of one of the lugs, the watch reads "Ag925/Al". Again, the photograph below illustrates this.

This inscription suggests that, rather than a silver-nickel alloy, or an alloy with a duller metal, Tudor has used aluminum to retain the shine of silver without bringing the high tarnish or irritability caused by other alloys. Finally, a bright silver that is wearable for years. The alloy hasn't been created by Tudor, but a company such as American Elements may be behind the watch's construction. This means that others are more than capable of following suit, from competing watch brands to dedicated jewelry manufacturers.

Room for Growth

Tudor on its own is not impactful enough to bring silver back as a top metal in jewelry, but it is a strong enough catalyst to demonstrate its wearability. As Rolex's sole subsidiary, the dominating swiss brand is often associated with Tudor's own production. Watches are one of, if not the, most popular jewelry accessories for men and Tudor's cachet certainly has the power to make silver fashionable in wristwatches again.

Tudor doesn't really carry any weight on the female jewelry front but is simply indicative of the possibility for adoption. Modern materials technology has enabled silver to become a dominant precious metal in the industry once again and demand is likely to rise. According to the Silver Institute, demand for the metal is already expected to rebound quite strongly off of the back of the pandemic.

The report expects the global demand to rise to 1.033 billion ounces in 2021, up from 896.1 million ounces last year, while supply will rise to 1.056 billion ounces, up from 976.2 million ounces in 2020. This yields a 23.3 million ounce oversupply, which isn't great, but is still down from last year's oversupply of 80.1 million ounces. More importantly, demand figures exclude ETF stockpiling -- which is expected to account for an additional 150 million ounces. This means that there is actually expected to be a 126.7 million ounce production deficit.

While a major return to jewelry is looking likely, silver is also looking to improve its industrial usage with Goldman Sachs (GSnoting that silver's outperformance of gold is in line with the global industrial recovery. Industrial applications for silver are expected to rise to a four-year high, further bolstering the precious metal's recent run. With growth expected, even without the emergence of new materials science to return it to the forefront of jewelry, demand for silver is looking fairly set to outpace its supply.

Value During Inflation

One of my recent articles explores the idea of prolonged inflation, exasperated by widespread wage inflation. I believe that the scenario of high inflation is becoming increasingly more likely and, as such, investors should begin to reallocate funds accordingly. One of the most popular investments during times of inflation is gold, due to its stability and its tendency to outpace inflation. However, this is an article about silver - which I believe to be the better investment.

So why choose silver over gold? For starters, gold's pretty expensive right now. Compared to silver, there's a ~6,700% premium. But what's even more important to look at is the premium that gold currently holds over silver. With the exception of major economic events, silver tends to trade at a fairly similar rate to its more valuable cousin. However, gold has been steadily climbing at a rate faster than silver in recent years and, leading into a potential upcoming inflation event, is overvalued -- especially relative to silver. The average gold-to-silver ratio in modern times is 1:60 and is currently 1:67, down from its five-year high of 1:124 in March 2020. While this shows that the gap is closing a bit, there is still a fair bit more to close.

Beyond this, silver is the more active inflation hedge. While a 1%YoY gain in inflation correlates, on average, to a 6.3% rise in gold prices, silver averages a 17.4% gain in the same period. The metal trades with a fairly strong correlation to gold, .8, meaning it tends to trade in the same direction as the precious yellow metal. This serves to strengthen the investment thesis of silver as a strong inflationary hedge. Silver's boost in industrial applications is expected to further bolster its performance in the coming years, as it prolongs record growth and serves as a better-performing inflation hedge than gold.

Investor Takeaway

The safest way to play silver remains iShares' Silver Trust ETF (SLV), a physically-backed silver fund. The fund trades in line with the performance of silver prices and is a relatively cheap way to capitalize off of any potential price gains. However, I prefer ProShares' Ultra Silver ETF (AGQ) because it is a 2x leveraged fund. While not a physically-backed fund, it seeks to correspond 2x to the daily performance of the Bloomberg Silver Subindex. Silver tends to be relatively muted in its trading and, if you're trying to outpace inflation, a bit more trading power is appreciated. AGQ has a pretty fair expense ratio of .95%.

With all of the information presented, I feel confident that silver will gain. Jewelry is not currently the dominant component in the overall usage of silver, falling to a distant second behind industrial applications, but a surge in silver aluminum alloys may cause this gap to shrink dramatically. Although, even without prolonged demand via jewelry, demand will continue to rise in the short-term via rising industrial demand.

However, the main takeaway for investors from this article is that silver may be able to return to the limelight as a precious metal in jewelry, which will also aid in making it a solid hedge against inflation. Formerly a symbol of royalty, silver's prestige is nowhere near where it once was. While the possibility of returning to such heights may have already passed at this point, silver does have the potential to be held in the same conversation as other, more popular, precious metals.

As an asset to protect against inflation, I believe that silver is one of, if not the, best assets to own at the moment. With greater value growth during times of inflation, investors can put less money into silver and achieve greater inflation protection than if they were holding gold. By holding AGQ, this advantage is made even greater and investors are provided with plenty of excess capital to allocate funds in areas that may be better suited for value growth than an inflation hedge. Additionally, with prices set to rise even without inflation, due to growing demand and a wide gold to silver ratio, silver offers a more well-rounded investment than gold.

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All articles are provided as a third party analysis and do not necessarily reflect the explicit views of GSI Exchange and should not be construed as financial advice.

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