Ready or not, here comes the gold market in full rally mode. Since the beginning of the year, spot gold prices have jumped by nearly 16%, and they're higher by better than 18% since touching a 52-week low of $1,128 an ounce back in December 2016.
Explaining gold's recent ascent
A confluence of factors have come together to give the lustrous yellow metal a lift. At the top of the list, at least in the short term, has been rising levels of uncertainty. This includes the increasing potential for conflict with North Korea following its latest round of nuclear tests, as well as the possibility that Donald Trump's proposed tax cuts for corporations may be delayed or lower than expected. After all, the Republicans had no luck in repealing the Affordable Care Act despite multiple attempts.
This uncertainty is a breeding ground for investors' imaginations, and it's the perfect excuse for some investors to seek the safety that gold is perceived to provide.
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Weakness in the U.S. dollar has also been a major positive for gold prices. The dollar generally weakens when the outlook for the U.S. economy gets cloudier. The aforementioned lack of progress on legislation in Washington, coupled with weaker inflation data, has been weighing on the dollar for most of the year, pushing it to new multi-year lows against the euro. Gold and the dollar usually move in opposite directions, meaning the dollar's pain has been gold's gain.
There has also been no reason for investors to sell gold despite the Federal Reserve's tightening of monetary policy. Even with the Fed having raised its federal funds target rate by an aggregate of 1% since December 2015, yields on interest-bearing assets haven't moved much higher. Generally, a rising-rate environment is bad for gold, since gold has no yield. However, if yields on interest-bearing assets remain below the national inflation rate, the opportunity cost of owning gold will stay low.
The surprising beneficiary of gold's recent surge
On the surface, the recent upside in spot gold would logically mean good things for gold stocks. As long as exploratory and ongoing mining expenses aren't rising at a quicker pace than spot gold, higher margins should be possible throughout the gold-mining industry. However, it's silver stocks that could wind up being the biggest beneficiary, for two key reasons.
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To begin with, most silver stocks have diversified their production portfolios in recent years as a result of spot silver's volatility. This diversification has led many to reduce their exposure to silver and increase their exposure to gold, thereby reducing realized price volatility on what they sell.
A good example is SSR Mining (SSRM 0.54%), which recently changed its name from Silver Standard Resources to reflect its shift in production. SSR's two primary gold-producing properties, Marigold and Seabee, are expected to account for approximately 80% of its revenue in 2017. Comparatively, just 20% will come from the sale of silver stockpiled at its Pirquitas property. Though the company recently signed a joint venture with Golden Arrow for the Chinchillas Project, bringing in a new source of silver production by the second half of 2018 as its old source dries up, SSR Mining will still remain heavily influenced by gold in the meantime.
Don't forget about the gold-to-silver ratio
The other catalyst here is that a boost in gold's spot price could widen the gold-to-silver ratio, which simply describes how many ounces of silver it would take to equal the price of 1 ounce of gold. As of the close for both metals on Sept. 6, 2017, it would take 74.8 ounces of silver to equal the price of an ounce of gold.
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During the 20th century, this ratio averaged about 47-to-1. For investors, it suggests that the best course of action is to buy silver or silver stocks when this ratio is significantly higher than 47-to-1, and to buy gold or gold stocks when it dips markedly below the historical average. At nearly 75-to-1 right now, the ratio would suggest that silver may have a chance to outperform gold, although both metals have room to run higher.
If the gold-to-silver ratio is at the forefront of investors' minds, then First Majestic Silver (AG 2.06%) would be among the biggest beneficiaries. Among all silver stocks, none has more of their production committed to silver (roughly 70% of total sales) than First Majestic Silver, at least according to early-year production estimates from the Bank of Montreal. Reinvestment in existing and new mine development is expected to yield in the neighborhood of 20 million silver ounces of production annually by the end of the decade, which would be up nicely from the 11.9 million ounces of silver produced in 2016.
While rising gold prices should be good news for gold stocks, it may be even better news for silver stocks.
