It's been a volatile month for precious metals, with the price of silver (SLV) briefly spiking above the $27.00/oz level before retreating below $25.00/oz this week. However, while this has put a minor dent in short-term momentum, key ratios continue to point to higher prices ahead for the metal. If we combine this with the silver's bullish posture on its long-term chart and the position of real rates, I see several reasons to be bullish over the next year. Let's take a closer look below:
(Source: TC2000.com)
While there was much anxiety about the 1st rate hike in years by the Federal Reserve this month, the chart below shows that we've seen no real change in real interest rates, hence no change in the bullish picture for precious metals. This is because even though the 3-month Treasury Yield has increased to 0.40%, CPI readings soared to 7.9% last month, up another 40 basis points. This more than offset the recent 20 basis point increase in the 3-month Treasury Yield, leaving real rates sitting deep in negative territory at (-) 7.3%.
Generally, precious metals perform much better in periods of negative real rates, given that there is no opportunity cost to holding physical metals due to the extremely low interest rates. In fact, there's an opportunity cost to holding excess cash, given that inflation is eating away at the value of money sitting in cash. With real rates sitting in the deepest negative territory they've been in for decades, this is an extremely favorable backdrop for precious metals, suggesting that dips will continue to be bought in gold (GLD) and silver.
(Source: YCharts.com, Author's Chart)
Moving over to a couple of key ratios below, we also see a bullish posture. Historically, silver performs much better during periods when it's outperforming the S&P-500 and Nasdaq Composite, and this also happens to be the case currently. As the charts below show, silver has regained its key moving averages relative to the S&P-500 and Nasdaq, a similar setup to June 2020. History does not have to repeat itself, but over the following two months in the prior signal, silver enjoyed a 50% return, soaring from $19.40/oz to $29.70/oz. So, as long as silver stays above these key moving averages, this indicator will remain on a bullish reading as well.
(Source: TC2000.com)
Finally, and most importantly, silver's long-term picture continues to remain bullish, with the metal trading in a massive base-on-base pattern. These base-on-base patterns typically resolve to the upside if prior resistance becomes new support, and this is exactly what we've seen with silver. While these base-on-base patterns can be volatile, and they do not preclude 8-10% corrections, it's a relatively safe bet to enter new positions in the bottom half of the base, with stops below the prior resistance level (new support). This coincides with the $21.50/oz level.
(Source: TC2000.com)
So, what's the best course of action?
Based on the favorable fundamental and technical backdrop for silver, I believe it makes sense to accumulate some of the highest-quality miners on weakness, and two names that stand out in the silver space are Wheaton Precious Metals (WPM) and Discovery Silver (DSVSF). The former is a high-margin precious metals streaming company that receives a portion of future revenue from mines in exchange for an upfront payment and has impressive growth over the next several years. The latter appears to be a potential takeover target, with a massive deposit (910 million silver-equivalent ounces) in Mexico that has the potential to produce over 25 million silver-equivalent ounces per annum.
This significant production profile makes Discovery one of the more impressive projects sector-wide, and the project has very reasonable upfront costs of ~$370MM despite its scale. Notably, the project is very straightforward, being an open-pit mine with favorable metallurgy that benefits from existing local infrastructure and a strip ratio below 2.5 to 1.0. Given the attractive economics, I would not be surprised to see the company acquired in the next two years, and a takeover offer would likely come in north of US$2.50 per share, pointing to more than 65% upside from current levels.
However, for investors that prefer to play it safe and own physical silver, I see the ideal buy zone coming in at $23.80/oz or lower. A dip to this level would place the metal back in an oversold condition and allow for a relatively tight stop relative to key support at $21.50/oz. For now, I have no position in SLV with the metal outside of its low-risk buy zone. However, I remain long Discovery Silver and GLD and I expect much higher prices by year-end.
Disclosure: I am long GLD, DSVSF
Disclaimer: Taylor Dart is not a Registered Investment Advisor or Financial Planner. This writing is for informational purposes only. It does not constitute an offer to sell, a solicitation to buy, or a recommendation regarding any securities transaction. The information contained in this writing should not be construed as financial or investment advice on any subject matter. Taylor Dart expressly disclaims all liability in respect to actions taken based on any or all of the information on this writing. Given the volatility in the precious metals sector, position sizing is critical, so when buying small-cap precious metals stocks, position sizes should be limited to 5% or less of one's portfolio.
SLV shares were trading at $22.92 per share on Tuesday afternoon, down $0.36 (-1.55%). Year-to-date, SLV has gained 6.56%, versus a -5.52% rise in the benchmark S&P 500 index during the same period.
About the Author: Taylor Dart
Taylor has over a decade of investing experience, with a special focus on the precious metals sector. In addition to working with ETFDailyNews, he is a prominent writer on Seeking Alpha. Learn more about Taylor’s background, along with links to his most recent articles.
Key Ratios Point To Higher Prices Ahead for Silver StockNews.com
