Situation: Stocks and bonds have been at or near the tops of their historic valuations for over 5 years. No corner of those markets has been overlooked; “crowded trades” are everywhere. In such circumstances, investors will reach for value by looking at alternative asset classes. Real Estate Investment Trusts (REITs) are my favorite (see Week 274). The goal is to find assets that are a) “non-correlated”, i.e, have low Beta because price-action is often out-of-sync with the market, and b) have enough economic utility to occasionally generate Alpha, which is a high “return on investment that is not a result of general movement in the greater market.”
Why is silver interesting, given that it has only gained 3.9%/yr in value over the past 30 years? For comparison, the lowest-cost S&P 500 Index fund (VFINX) has gained 9.4%/yr and the lowest-cost investment-grade bond index fund (VBMFX) has gained 6.0%/yr. Reason #1: A key use for silver is growing exponentially, which is the build-out of solar power toward a United Nations goal of generating 30% of the planet’s electricity by 2030. Copper and aluminum can be used in solar panels instead of silver, but those substitutes are less efficient and have not proven to be commercially viable, partly because the amount of silver needed per solar panel continues to decrease.
Silver has a fascinating history. For example, in 1979 the Hunt brothers attempted to “corner” the silver market and were able to borrow enough money to buy 1/3rd of the world’s supply outside government hands. This resulted in more than a 700% price increase but brought attention to the high leverage used in purchasing commodities. After the commodity exchange (COMEX) adopted “Silver Rule 7” on January 7, 1980 (to restrict the ability of speculators to purchase commodities on margin), the price of silver promptly fell 50% and the Hunt brothers were unable to meet their bank’s margin call for $100 million. They ultimately declared bankruptcy.
Could this happen again? Yes. Silver prices fluctuate more dramatically than gold prices, since silver has greater industrial demand and lower market liquidity. The rapid proliferation of solar panels will no doubt aggravate that problem; sovereign wealth fund managers will be tempted to hoard silver. Let’s do the math. World silver reserves are just under 600,000 tons. Solar panels in currently contain ~2/3rds of an ounce of silver: A ton of silver is consumed to make ~44,000 solar panels, and 4 panels are needed to make a kilowatt-hour (kWh) of electricity. So, a ton of silver generates 11,000 kWh. A billion kWh = 1 TWh (terawatt-hour). Currently, ~21,000 TW are used every hour on our planet (https://yearbook.enerdata.net/electricity-domestic-consumption-data-by-region.html). A goal of producing 30% of electricity from solar panels by 2030 implies that those panels would need to generate ~11,000 TW per hour (after allowing for population growth). A ton of silver generates 11,000 KW per hour, so a billion tons of silver is needed to generate 11,000 TW per hour. Assuming that an ~10-fold increase in efficiency will be achieved by then, only 100 million tons of silver will be required. World silver production in 2015 was ~31,000 tons. Multiply that by 13 yrs and you get ~400,000 tons. Adding that to the current reserve of 600,000 tons, you’d have one million tons available for all industrial uses on the planet through 2030. Where are the remaining 99 million tons going to come from?
Mission: Examine ways to invest in silver, using our standard spreadsheet analysis.
Execution: (see Table).
Administration: There are 4 ways to invest in silver:
1) Purchase ingots, coins, or shares in a silver ETF (SLV).
2) Purchase stock in a silver mining company, the largest and most successful being First Majestic Silver (AG).
3) Purchase stock in a financial company that loans money to silver miners in return for claims on the “stream” of the silver produced. The main silver-streaming company is Silver Wheaton (SLV) but the dominant company for financing both gold and silver mines (in return for gold royalties or a stream of silver production) is Franco-Nevada (FNV).
4) Purchase shares of a gold mining company that produces large amounts of silver as a by-product. Both companies having the largest reserves are based in Canada: Goldcorp (GG) and Barrick Gold (ABX).
Bottom Line: This is gambling, on steroids. To be successful, you’d need to have infinite patience and have enough time to update information on silver inventories every week, as well as work-in-progress for solar panels relative to demand. You can probably do well by gradually building a position in silver or the silver ETF (SLV). Professional stock pickers who focus on natural resources like to stick with the companies that a) have the largest reserves and b) develop new reserves at least as fast as they consume reserves. Barrick Gold (ABX) wins on both counts.
Risk Rating: 10 (where 10-Yr Treasuries = 1, S&P 500 Index = 5, and gold bullion = 10).
Full Disclosure: I have no silver-related holdings.
Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
Sunday, May 14
Week 306 - A-rated Dividend Achievers That Have Outperformed The S&P 500 For 25 Years At Lower Risk
Situation: Some companies have served investors well over the past 25 yrs, compared to an investment in the Vanguard 500 Index Fund (VFINX). If we define “gambling in the stock market” as a statistical probability of losing more than you would from VFINX in any given market calamity, we find that 10 of those outperforming companies aren’t gambles. As long as those companies retain their management culture, as well as their competitive advantages, they’ll continue to outperform at less risk vs. the S&P 500 Index.
Mission: Subject those 10 companies to our standard spreadsheet analysis, except that in calculating Net Present Value we’ll use the rate of price appreciation over the past 25 yrs instead of 16 yrs, i.e., the BMW Method.
Execution: see Table.
Administration: Our conditions for inclusion are that companies must meet a high standard of quality. S&P ratings for both their stock and bond issues cannot be lower than A-. Balance Sheets must be clean, meaning that Long-Term Debt cannot constitute more than a 1/3rd of total assets, Tangible Book Value cannot be negative (we grant a little leeway in the event of a recent acquisition), and dividends have to be paid from Free Cash Flow (FCF). Companies must have annual revenues that are high enough to warrant inclusion in the Barron’s 500 List of large US and Canadian companies.
Bottom Line: These 10 companies represent 6 of the 10 S&P Industries (see Column Z in the Table). Each stock’s predicted risk of loss (at 2 Standard Deviations below trendline price appreciation per the BMW Method) is less than the S&P 500 Index’s projected loss (see Column M in the Table). All 10 have positive NPVs at a 9% Discount Rate, suggesting that you’re likely to realize at least a 9%/yr total return over a 10 year Holding Period, whereas VFINX has a negative NPV (see Column Y in the Table). Hormel Foods (HRL) and NextEra Energy (NEE) have the highest NPVs.
Risk Rating: 5 (10-yr Treasury Notes = 1, S&P 500 Index = 5, gold = 10)
Full Disclosure: I dollar-average into NEE, and own shares of TRV, ABT, MMM, and HRL.
NOTE: Metrics are current for the Sunday of publication. Red highlights denote under-performance vs. VBINX at Line 18 in the Table. Purple highlights denote Balance Sheet issues and shortfalls. Net Present Value (NPV) inputs are described and justified in the Appendix to Week 256: Briefly, Discount Rate = 9%, Holding Period = 10 years, Initial Cost = average stock price over the past 50 days (corrected for transaction costs of 2.5% when buying ~$5000 worth of shares). Dividend Growth Rate is the 3-Yr CAGR found at Column H. Price Growth Rate is the 25-Yr CAGR found at Column K (http://invest.kleinnet.com/bmw1/). Price Return (from selling all shares in the 10th year) is corrected for transaction costs of 2.5%. The Discount Rate of 9% approximates Total Returns/yr from a stock index of similar risk to owning shares in a small number of large-cap stocks, where risk due to “selection bias” is paramount. That stock index is the S&P MidCap 400 Index at Line 23 in the Table. The ETF for that index is MDY at Line 17. For bonds, Discount Rate = Interest Rate.
Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
Mission: Subject those 10 companies to our standard spreadsheet analysis, except that in calculating Net Present Value we’ll use the rate of price appreciation over the past 25 yrs instead of 16 yrs, i.e., the BMW Method.
Execution: see Table.
Administration: Our conditions for inclusion are that companies must meet a high standard of quality. S&P ratings for both their stock and bond issues cannot be lower than A-. Balance Sheets must be clean, meaning that Long-Term Debt cannot constitute more than a 1/3rd of total assets, Tangible Book Value cannot be negative (we grant a little leeway in the event of a recent acquisition), and dividends have to be paid from Free Cash Flow (FCF). Companies must have annual revenues that are high enough to warrant inclusion in the Barron’s 500 List of large US and Canadian companies.
Bottom Line: These 10 companies represent 6 of the 10 S&P Industries (see Column Z in the Table). Each stock’s predicted risk of loss (at 2 Standard Deviations below trendline price appreciation per the BMW Method) is less than the S&P 500 Index’s projected loss (see Column M in the Table). All 10 have positive NPVs at a 9% Discount Rate, suggesting that you’re likely to realize at least a 9%/yr total return over a 10 year Holding Period, whereas VFINX has a negative NPV (see Column Y in the Table). Hormel Foods (HRL) and NextEra Energy (NEE) have the highest NPVs.
Risk Rating: 5 (10-yr Treasury Notes = 1, S&P 500 Index = 5, gold = 10)
Full Disclosure: I dollar-average into NEE, and own shares of TRV, ABT, MMM, and HRL.
NOTE: Metrics are current for the Sunday of publication. Red highlights denote under-performance vs. VBINX at Line 18 in the Table. Purple highlights denote Balance Sheet issues and shortfalls. Net Present Value (NPV) inputs are described and justified in the Appendix to Week 256: Briefly, Discount Rate = 9%, Holding Period = 10 years, Initial Cost = average stock price over the past 50 days (corrected for transaction costs of 2.5% when buying ~$5000 worth of shares). Dividend Growth Rate is the 3-Yr CAGR found at Column H. Price Growth Rate is the 25-Yr CAGR found at Column K (http://invest.kleinnet.com/bmw1/). Price Return (from selling all shares in the 10th year) is corrected for transaction costs of 2.5%. The Discount Rate of 9% approximates Total Returns/yr from a stock index of similar risk to owning shares in a small number of large-cap stocks, where risk due to “selection bias” is paramount. That stock index is the S&P MidCap 400 Index at Line 23 in the Table. The ETF for that index is MDY at Line 17. For bonds, Discount Rate = Interest Rate.
Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
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