Gold is exciting, but what about Silver? Baker Steel’s David Baker, Episode 2

Turning to silver and silver miners, Baker describes the current market as “complicated”. “You can basically buy 100 ounces of silver with one ounce of gold,” he explains. “It is very rare that you see the gold-silver ratio over 100x – in 2011, for example, the ratio was 30x – and any time it has been over 100, typically, six months later, silver has outperformed and done rather well. The confusion you have in the market now, however, is how deep the recession is going to be, and how deep the slowdown is with the tariffs. It is going to resolve, I think, but for now there are still question marks.”

Nevertheless, Baker continues, the outlook for silver is underpinned by industrial demand in high-growth areas – led by solar-panel production. “Our view is that demand is going to carry on growing,” he concludes. “We might have a bit of a hiccup this year but most of the demand is in areas where there is still a lot of growth – whether that is solar, the green economy, data-centres, electronics, EV cars and so on. So I don’t think industrial demand for silver is going to collapse. At the margin, you might see a bit of weakness and the market will play that weakness – but, anytime you see that gold-silver ratio over 100x, I would argue silver is an interesting play.”

Transcript of Baker Steel ‘Special’ on gold, silver and other precious metals, Episode 2:

David Baker, with Cherry Reynard

CR: Hello and welcome to today’s webinar. I’m Cherry Reynard and with me today is David Baker, managing partner at Baker Steel and manager of the Baker Steel Gold & Precious Metals Fund. We are going to be talking a little about the recent gold run, but also about opportunities in silver and other precious metals. So welcome, David – thanks so much for joining us today.

DB: Hello – and it’s a pleasure.

CR: Now, since we last spoke, the gold price has soared to new highs – although it has taken a bit of a pause over the last week or so. Let’s talk a little bit about what is driving the price at the moment. Is it mostly a sort of ‘Trump effect ‘and a response to macroeconomic uncertainty?

DB: I think it is a number of things. It is the geopolitical issues – the fact that, you know, the market is getting worried about the debt levels in the US – and the US has got to refinance a lot of debt coming up. And I think that, with the tariffs, people are just a bit wary. You know, they are seeing what Trump is doing – he is using this kind of ‘chaos theory’ and bringing tariffs in and then being a bit random. So a lot of the governments of the world are looking at this and thinking – Actually, do I really want so many US dollars? Do I really want to leave all my reserves in US dollars? And so there is a shift into gold.

And you can see that because the central banks are continuing buying – they’re buying about 1,000 tonnes a year – and that’s fairly consistent. You are starting to hear rumours of, you know, more governments or more countries settling trade with gold instead of dollars. And there are all types of new infrastructure that is going to be built or is being built for that – particularly for the ‘BRIC’ economies. And then I think also, we know that the US and Trump want to lower the US dollar – and that is generally good for gold and other commodities as well. So I think there are plenty of reasons to be optimistic on gold.

Catch up with Episode 1 of Baker Steel’s Gold & Precious Metals Special – ‘Investing in gold’ here

That said, we have run hard and, when the market runs hard, normally you have to have some kind of consolidation – you’ve got to shake the tree a bit and basically get rid of some of the ‘loose holders’, as it were. And it’s got to test you – you know, you have to think, Why did I buy that? And that type of thing. So, as we speak, gold is up 26% so far this year and gold shares are up about 42% so I think we’re going to have a bit of a consolidation – that is how we have structured our portfolio and we have taken some profits from some of the really strong performers.

Having said that, though, I think the long-term outlook for gold is fantastic. I think central banks are going to carry on growing their reserves. You have to remember that, in the 1970s, gold was 40% or 45% of central bank reserves, now it is 22%, so there is still a long way to go there. Also, there has been talk about the ‘gold revaluation’ – I think we might have mentioned that in Episode 1 of this podcast. A lot of the central banks in the world have been building up all these liabilities and one way to restore their balance sheets – instead of defaulting on their bonds – is to increase the asset side. And, since they all own gold, the argument is they revalue gold and that helps basically balance some of the balance sheet going forward.

CR: Great, thanks. You mentioned gold equities there – and we talked in Episode 1 about the relationship between gold-price movements and gold equities. At the time, gold equities had not kept pace with the soaring gold price but it sounds like that has recalibrated. Please could you unpack that a little more?

DB: Yes. If you look at the number of shares on issue in GDX – which is an ETF of all the mining companies – it has been falling. So, despite gold shares going up, the money flowing into ETFs is falling. So I think there is a bit of scepticism by some players as to whether the mining companies are going to perform. That said, we have just started the reporting season on the gold side – and I have to say it’s very positive. You know, the results have been good; the mining companies are buying back more shares; and they are paying good dividends.

So they are not looking at squandering their money and building new projects, which is effectively what they did between 2000 and 2011 – they squandered a lot of their excess cash and basically tried to grow. Now it is more about returning cash to shareholders. I don’t think we are going to see massive increases in the dividends –it’s more that companies are just going to increase their share buybacks. So the results we’re seeing are positive and particularly some of the second-liners as well – the midcaps – they are starting to generate some good cash.

And we have also seen a bit of M&A, which is encouraging. We have seen a few ‘mergers of equals’ – which is good as it means companies are not paying massive premiums to the other party – and I think there is a feeling we are going to see more consolidation. So, yes, I think it bodes well. True, while we are seeing this correction in the gold price, it is inevitable we will see some weakness in gold equities – but, I mean, does it correct by 10% or 15%? I just don’t see a 35% correction or a 20% correction.

So, you know, when I am looking at the results, I’m kind of saying, These are good results. The gold price, I think, can probably fall back to $3,000 but I don’t think it’s going to go back to $2,500 – I think there are too many positives. So we’re going to carry on and, while the correction may be down to $3,100 or $3,000, the equities market is not really factoring in the current price in any way. So we will have some correction but I don’t think it is going to be a deep correction and we are looking at that as an opportunity basically to buy some of these really good midcaps we are seeing.

CR: So there are still factors that could drive stronger relative performance in gold-mining equities?

DB: Yes. I think the quality of the assets is good. The companies are generating cash. They are returning a lot of cash to shareholders. The companies we really want to find are the ones that are basically able to fund share buybacks and dividends and so are returning cash to shareholders and, at the same time, are growing their companies as well. That is the ‘Holy Grail’ – where you can get the cash return as well as a bit of growth.

CR: OK, great. Now, while gold tends to command all the attention, silver could, if anything, be more interesting – so let’s take a look at the dynamics of the silver market. First, what is the relationship between silver and gold and how have the two been correlated historically?

DB: The silver market is just so complicated at the moment – because you can basically buy 100 ounces of silver with one ounce of gold! And it is very rare that you see the gold-silver ratio over 100x. You know, to give you an example, in 2011, the gold-silver ratio was 30x – so it has gone from 30x to 100x. And any time it has been over 100, typically, six months later, silver has outperformed and done rather well. The confusion you have in the market now, however, is how deep the recession is going to be, and how deep the slowdown is with the tariffs. I think it is going to resolve but there are still question marks over that.

And silver certainly has more of an industrial focus – you know, if you look at silver demand, the biggest slice is industrial demand, which is probably in the region of, or upwards of, 70% of demand. What is interesting is that silver demand has been growing – so, if you look over the last 10 years, the industrial demand for silver has grown by around 60%. And it just carries on growing – you know, silver, in my view, is very cheap. It goes in a lot of electronics. It goes in solar panels. It goes in lots of things. And if you look at the supply-and-demand fundamentals for silver, since around 2000 we have been in a supply deficit of anything from 15% to 20% and it just doesn’t look as though that is going to get resolved in the near term.

I was reading a report today one broker put out and they can see 20% deficits in supply till the end of the year. You know, we are not seeing any growth in mine supply. There is just no growth in mine supply – it is not coming. I spoke to one mining company the other day that had done an acquisition and asked, Why did you buy that? He said, David, we looked everywhere and we just couldn’t find a better asset. And this is a small asset – equivalent to around 60,000 ounces of gold production – and these small assets just don’t turn you around.

So our view is that demand is going to carry on growing. We might have a bit of a hiccup this year but most of the demand is in areas where there is still a lot of growth – you know, whether that is solar, the green economy, data-centres, electronics, EV cars, all that type of thing. So I don’t think industrial demand for silver is going to collapse. It didn’t in 2020 – but, at the margin, you might see a bit of weakness and the market will play that weakness. But anytime you see that gold-silver ratio over 100, I’d argue silver is an interesting play. And if you look at the silver equities versus the gold equities, they are tracking that gold-silver ratio – so they have been fairly poor performers so far this year as well.

CR: Just before we move on to looking at those industrial drivers in a bit more detail, presumably silver also has a role as a financial asset. So to what degree does that play a part in demand and to what extent does each element drive the price of silver?

DB: Well, what you have seen is a big growth in the ETF physical demand for gold. You have seen some growth in the ETFs for silver – but by no means as much as you’re seeing with the gold ETFs. Now, you could start to see increases in that demand for silver on the ETFs – but what could drive that? You know, lower interest rates or QE; people basically deciding, Well, I think I’ve missed the gold market. Should I buy silver just in case? You know, I don’t really want to pay up for gold but, if I buy silver, I think I’m going to do relatively well on that. So we are watching those ETF flows and, at the moment, we are seeing some increase – but not as much increase as we’re seeing on the gold side.

Remember though – the gold price is $3,300 now, so you need a lot of demand to absorb that and it is not going to take much of a flick in demand for the silver ETFs to really have an impact. We know the market is tight – you know the supply and demand fundamentals are interesting. The market has been in a deficit for five years, as I said – the last couple of years, it has been around 150 million ounces and the silver price has increased by about $10 an ounce over that period, without any ETF flows or anything. So I think you’re underpinned at $30 an ounce – maybe – and if we carry on seeing some growth, if we carry on seeing more of that industrial demand just basically eat into inventories, the price is going to carry on rising. So I wouldn’t give up on silver. And like I say, at 100-to-1, I think that is a bet I’d probably be taking. It is a bet we’ve taken in our fund. It has probably caused a bit of underperformance but, you know, we have not done too badly at all, despite having that – and we’ve still got all that optionality on the silver to come.

Also, though, there are just not many silver producers you can buy – you know, we don’t want to go into the ‘rats and mice’ as we think they are too small. And with lots of the main silver producers, the gold in their byproducts pays for all their costs – so effectively you get all the silver for free. The problem with silver is, we have been through such a long bear market that the companies haven’t really resolved all their balance sheet issues – but they are starting to get there. The cash is starting to flow and they are starting to make some good money with this silver price. So we think it is a very interesting option – you know, they are not going to go bust and, if the silver price goes up, I think there will be a switch back into these companies.

CR: OK. Now, you mentioned some of the industrial uses of silver and they all seem like high-growth industries, such as electric vehicles, solar panels and AI hardware. Are there other notable ones?

DB: Jewellery demand is a big part and AI, like you say, for the data-centres – but solar is the big one. Solar is probably now about 35% of industrial demand – but the growth in solar has just been phenomenal. There has been ‘thrifting’ in silver – so the amount of silver that is used in solar panels has fallen quite dramatically – but the growth in solar installations has outpaced the thrifting. So you are still seeing growth – I think it’s probably in the region of 10% to 15% this year, up to around 235 million ounces of silver.

And the outlook going forward is that the constraint on installing solar is more on the grid than actually putting the solar in – but that should resolve itself. So we are quite optimistic – and, particularly with places like India, there is very strong demand. So it is fascinating that silver is so cheap they are putting 235 million ounces a year into solar panels that basically they won’t be able to get for 25 years – you know, they are ordered up for 25-plus years. So, you know, gold demand by the world’s central banks is around that similar 25% to 35% level that the solar industry has for silver.

CR: Do you expect the same relationship between the silver companies and the silver price as you do between the gold companies and the gold price – where, in normal circumstances, silver companies would be a leverage play on the silver price?

DB: I think so. Like I say, if you look at the performance of the collective of the silver shares versus the gold shares, the silver shares have underperformed. And, if you look at the gold-silver ratio, the market is playing that through the silver shares. So does that rotate if that gold-silver ratio comes down? I think it will – but it is teasing us. You know, it hasn’t come down yet – and that is the uncertainty in the market. Having said that, also, the point is the main silver producers are not in dire straits – you know, they are generating good cashflows. They are on free cashflow yields of anything from 10% to 15% of today’s metal prices. That is because most of them have to produce gold as well as silver – you know, they’re gold producers with silver. Fresnillo, for example, has been a real win – it’s just been fantastic. That has nearly doubled and it is paying a healthy dividend. The other ones are not quite to that stage yet but I think that is coming.

CR: Great. Let’s spend the last few minutes looking in a bit more depth at how precious metals can be used in a portfolio. How do you believe investors should think about balancing exposure to gold, silver and other precious metals miners in a portfolio?

DB: Well, I think that, up to now, everyone has tended to play the 60/40 portfolio before – you know, 60% equities and 40% bonds. Now, I think it is clear you have got to add a bit of gold as well – and whether that is 10% or 20% is up to the individual. Arguably you want some physical gold – but the equities are now, I think, going to start outperforming physical gold. So if you get into that – you know, the gold equities have underperformed physical gold over the last 10 years but I think now we are starting to see signs they can start to outperform. So I would certainly put some gold equities in. The gold equity market is a very small market – you know, it is probably $600 bn or $800bn, which is minute in the context of the financial world.

So if people do start allocating – and I would argue they haven’t been allocating at the moment – then I think it is going to do well. But the key is that the companies are behaving – you know, they are returning capital and they are being disciplined – and that will gain more interest from the generalists and from investors. So I certainly think there is a role for gold and gold equities – we have seen it with the negative correlation between the S&P500 and gold. I just think, personally, that that relationship has moved very quickly – you know, gold is outperforming the S&P very dramatically this year – and you need a bit of a breather before it carries on. I might be wrong on that but I would just be looking at opportunities to accumulate on any weakness.

CR: Let’s wrap up with a quick portfolio update – what are your principal allocations currently in the Baker Steel Gold & Precious Metals Fund?

DB: I think we are nearly 70% in gold, with just under 20% in silver and we have a few of the ‘PGMs’ – the platinum group metals. And that is an interesting market in itself because the platinum market is very tight – you know, mining companies have been losing money there and they have been closing mine – so we think the outlook for the PGMs isn’t too bad either. Again, though, you have the caveat of how much of a slowdown we see and the tariffs – but I do think the tariffs are going to get resolved. I mean, we are just seeing this brinkmanship at the moment between the US and China – you know, that is the nervous thing – but I think that is going to get resolved at some point. I mean, if it doesn’t – you know, batten down the hatches! Because I think it’s going to be very tough – but I just don’t think Trump is going to take us to the wire. Although, you never know!

CR: Well, let’s hope not! There has been slightly more encouraging news in recent days, so let’s hope that continues. OK, David, thank you – that is great. We will wrap up there. Thank you so much for your time today – and, as always, thank you to our listeners for tuning in. Until next time.

DB: It was my pleasure. Thank you very much.