Oil shocks: The silver lining

I've followed many of the notable local silver stocks here on-and-off over the years, some of which I still hold. I am still a holder in Investigator, having clung onto about half of my original position in the company since I first built up a position in the stock years ago.

Naturally enough, the forums of stocks such as IVR and SVL have always been a magnet for silver enthusiasts, eager to share their conviction of a pending 'silver surge' with other true-believers, and the start of the Ukraine crisis has (unsurprisingly) charged-up the talk of a potential silver-storm. Personally, While I have never discounted the possibility of a silver surge, I have tended to take such forecasts with a grain of salt.

However, in this instance, I am increasingly feeling that the silver-believers might be about to have their day in the sun.

My strengthened conviction around silver is influenced by one development overnight, namely the decision by the United States, the UK and the European Union to ban or restrict imports of oil and gas from Russia. You would have to assume that this will lead to a higher oil price in the months ahead, and this in turn is likely to have profound implications for the price of silver.

Energy prices have always had a heavy bearing on the silver price: perhaps this even more so today than ever before, given the use of silver in solar panels.

It makes sense on a practical level. If you go to your local bullion dealer to purchase $10,000 dollars worth of gold, the purchased gold would be small and light enough to throw into your pocket and walk off with.

But if you were to purchase $10,000 dollars worth of silver, you'll probably need to take the car, as the purchased silver is going to weigh in at several kilos.

You tend to find that dramatic shifts in the gold-silver ratio over history are often influenced by techonolgical revolutions in energy. A major example of this is in the shift in the gold-silver ratio that took place between the late19th century and the early 20th century.

For most of the 19th century, one ounce of gold was worth about sixteen ounces of silver. While the precise ratio fluctuated from year to year, the deviation from the norm was never dramatic.

But in the forty years from 1870, the value of silver to gold fell dramatically, from 16:1 to nearly 40:1 in 1910.

This fall in the value of silver was almost certainly related to the emergence and use of fossil fuels as an energy source, first in the form of steam-power, and then via the internal combustion engine. Fossil fuels made it much more efficient to shift goods from one locality to another, and silver, the heaviest precious metal by far, lost some of its premium.

For the same reason, every time there is some kind of 'oil shock', the gold-silver ratio narrows. As it is more expensive to shift goods from point a to point b, silver regains some of its lost lustre.

With restrictions being placed on Russian energy exports, the world now seem to be entering into a classic 'oil shock' paradigm.

In some respects, we've seen the movie before. In 1973, the oil-embargo by the Arab members of OPEC lead to a surge in the oil price. Between October 1973 and March 1974, when the embargo ended, the oil price surged more than 100%.

Over the same time-frame, the silver price also surged by around 100%. The price slumped in the middle of 1974, but it recovered in the mid-70s, and charged to all-time highs a few years later.

Silver outperformed gold in this period, due to a narrowing of the gold-silver ratio, from 38:1 in 1973 to 28:1 in 1979. The narrowing of the ratio was almost certainly driven by the sky-high energy costs that characterised the decade.

By way of contrast, in recent days, we've the price of another metal flying. Commodity traders have rushed into nickel, prompted by fears around supply shortages, given that around 10% of the world's nickel is produced by Russia.

In the wash-up, though, silver may ultimately prove to be one of the biggest winners from the current crisis. My reasoning is not so much because Russia is a major producer of silver (it produces about 5% of the global supply) but because of energy prices have a such a strong bearing on the price of silver.

By my reckoning, at current, Investigator is one of the best options for those seeking a silver-haven.

I am familiar with three silver-stocks listed on the ASX, Silvermines (SVL), Investigator (IVR) and Thomson (TMZ).

At time of writing, Silvermines has a market cap of $335 million, Investigator is worth just under $100 million, and Thomson valued at $35 million.

By my estimation, IVR is the best value of these at current. Although TMZ has a much smaller market-cap, In my view, their silver assets are rather second-rate.

On the other hand, while I think both Silvermines and Investigator have top-tier silver assets, the market cap of IVR is significantly lower than that of SVL, which I find hard to rationalise.

So, if oil prices continue their upward march in the months ahead, and this seems likely, it is probable that the silver price will follow its lead. Based on the current share-price, Investigator looks as if it might be one of the most rewarding silver plays.