Silver Stocks Are a Screaming Buy Based on This Metric
Following what was a steady march higher for the stock market in 2017, this year has turned into something of a roller-coaster ride for investors. Having undergone 37 corrections of at least 10% in the S&P 500 since 1950 (about one every two years), the market has endured two of those corrections since January 2018.
In spite of this volatility, the S&P 500 is nearly 300% higher from its Great Recession bottom in March 2009. It's also up roughly 32% over the trailing five-year period. In other words, it's unlikely long-term investors are hurting, even with these recent hiccups in the stock market.
However, this isn't the case with the silver market. Less than two weeks ago, physical silver neared a three-year low by closing below $14 an ounce. Even following a brief rally, the shiny silver metal has shed 14.5% of its value over the trailing 12-month period, and declined 27.5% over the past five years. It's underperformed the broad-based S&P 500 by nearly 60 percentage points over five years. Yuck!
This metric says you're smart to buy silver stocks
But despite this weakness, there may be light -- or should I say luster -- at the end of the tunnel. One metric, the gold-to-silver ratio, would suggest that physical silver and silver stocks could be screaming buys right now.
The gold-to-silver ratio describes how many ounces of silver it would take to purchase one ounce of gold. Throughout the 20th century, this ratio averaged 47-to-1. This past week it hit a 25-year high of 85.94-to-1, according to data provided by Kitco.
Why does this matter, you ask? Historically, when this ratio has dropped well below 50-to-1, it's signaled that gold is the more attractive of the two metals to buy. Conversely, when the ratio far exceeds 50-to-1, it's usually signaled an opportunity to scoop up silver as the more attractive of the two metals.
Over the past decade, the gold-to-silver ratio has eclipsed 80-to-1 on three occasions. The first, following the Great Recession, led to a more-than-400% increase in physical silver's spot price in three years. In 2015, the ratio topped 80 again, and was followed by a roughly 55% move higher in spot silver's price. And finally, the latest move above 80 to a ratio of nearly 86-to-1, with an outcome yet to be determined.
Tangible measures back up the "buy silver" thesis
While this ratio alone has proven to be an accurate indicator of silver's potential to outperform gold in the past, there are tangible reasons to be a believer as well.
For example, The Silver Institute released its annual report earlier this year detailing global silver supply and demand over the past decade. The industry has seen five consecutive years of demand outpacing physical supply by between 26 million ounces and 138 million ounces. Based on economic principles, demand consistently outpacing supply should provide an upward lift on silver's spot price.
To boot, we're seeing a concerted effort by silver mining companies to focus on only their most profitable assets. After peaking in 2015 at 895 million ounces of production, supply has tapered in each of the past two years from miners. Similarly, scrap supply has been nearly halved since 2011. The silver market is in no danger of an oversupply shock.
The case could also be made that the future for physical silver demand is bright given the need for silver in photovoltaic cells. In plainer English, silver is a critical component in the manufacture of solar cells. As countries like China and the U.S. push to expand solar power systems, demand for silver should rise.
If physical silver rises significantly, these silver stocks stand to benefit
Presumably, miners with the highest percentage of revenue derived from silver would have the most to gain if silver rose and significantly outperformed gold. That would make First Majestic Silver (NYSE: AG) one of the top stocks to own.
No mining company is expected to generate more of its sales from silver than First Majestic. Following its acquisition of Primero Mining, it's forecasting that nearly 60% of annual sales will be derived from silver, with the remainder coming from gold (and to a lesser extent lead and zinc) in 2018.
First Majestic has seven operating mines in Mexico, including the newly acquired San Dimas, as well as La Guitarra, which was placed on care and maintenance due to its higher costs in August. This year, San Dimas adds 7.1 million to 7.7 million silver equivalent ounces (SEO) of production. All told, guidance for 2018 entails 12 million to 13.2 million silver ounces, and 20.5 million to 22.6 million SEO.
Looking ahead, First Majestic foresees 67% of its revenue coming from silver in 2019, with the start-up of a roasting circuit at La Encantada adding 1.5 million ounces of silver production per year. Even further down the road, the commissioning of La Luz and Plomosas could add 2 million ounces of annual silver production a piece within a few years. In sum, 30 million to 35 million SEO with declining all-in sustaining costs is very achievable for First Majestic Silver. With $0.94 in cash flow per share projected by Wall Street in 2020, and the stock closing at $5.56 a share on Wednesday, Nov. 21, it looks to be a bargain.
Wheaton Precious Metals (NYSE: WPM) would be another prime beneficiary. Wheaton is a royalty company that has made more than a dozen deals with mining companies. In exchange for upfront capital that mining companies can use to develop a new mine or expand an existing asset, Wheaton Precious Metals receives a percentage of production (often for the life of the mine) at a below-market rate. In the most recent quarter, Wheaton had an average cash cost of $5.04 per silver ounce and $418 per gold ounce, yet recognized an average selling price of $14.80 an ounce for silver and $1,210 an ounce for gold. That's why the company was able to generate $108.4 million in cash flow from operations.
In terms of sales, Wheaton does generate a bit more from gold than it does from silver ($108 million vs. $74.3 million in the latest quarter). Then again, the company is just a deal away from completely readjusting its production mix. As a royalty company, it's immediately impacted by moves higher or lower in precious-metal prices. This makes it a prime candidate to benefit if silver outperforms in the months or years that lie ahead.
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Sean Williams owns shares of First Majestic Silver. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.