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The last 2 times this happened, silver surged higher

The Motley Fool logo The Motley Fool 4/20/2018 Sean Williams
A silver bar on a dark background. © Getty Images A silver bar on a dark background.

In recent months, the stock market has had the full attention of investors. Since February began, the nearly 122-year-old Dow Jones Industrial Average and broader-based S&P 500 have recorded some of their single-day largest gains and declines in history. Also included was the first stock market correction investors have seen in two years. Historically speaking, stock market corrections are a great time to buy high-quality stocks and hang onto them for the long run.

But unbeknownst to most investors is the fact that big things are happening in the precious-metals markets. As noted recently, gold's spot price has now treaded water above the $1,300-per-ounce mark for its longest stretch of time since mid-2013. A confluence of factors, including a reasonably constrained supply of gold, investor emotions, and a Federal Reserve that's walking on eggshells with regard to stepping up interest rates, has helped bring back gold's luster.

Yet gold isn't the only precious metal that should be on your radar.

Is silver about to rocket higher?

Over the trailing year, silver has underperformed its shiny yellow counterpart by a significant amount. Whereas gold has increased in value by nearly 5%, silver's spot price has dipped by just shy of 6% through midday April 18, according to data from Kitco. As a result, the popularly followed gold-to-silver ratio -- a measure of how many ounces of silver it would take to purchase one ounce of gold -- has been on the rise.

Throughout the 20th century, the gold-to-silver ratio averaged about 47-to-1. This average has been somewhat pivotal among precious-metals investors in determining which of the two metals they believe will outperform in the months and years that lie ahead.

Generally speaking, if the gold-to-silver ratio is below 50, gold is considered the better long-term play. And if the opposite is true and the gold-to-silver ratio is above 50, silver has the perceived best chance to outperform gold.

A 24-hour chart of the gold-to-silver ratio. © www.Kitco.com A 24-hour chart of the gold-to-silver ratio.

Where are we now? As you can see, the gold-to-silver ratio is hovering around 78.5 at the moment and recently hit a high of 81.8 in the early weeks of April. By historical measures, this would suggest that silver offers greater return potential than gold.

But history may be able to teach us even more.

A 10-year chart of the gold-to-silver ratio. © www.Kitco.com A 10-year chart of the gold-to-silver ratio.

According to data from Kitco, the gold-to-silver ratio over the past 10 years has topped 80 on three occasions. It first did so following the Great Recession, with the price of spot silver rallying approximately 400% in the three years that followed. It also did so in late 2015.

Following this move above 80, silver's spot price surged by approximately 55% in a matter of months. While I want to be clear that this could be nothing more than coincidence and no causation can be proven by solely examining the gold-to-silver ratio, the sheer fact that silver surged both times the gold-to-silver ratio previously hit 80 should fully have the attention of precious-metal investors given that we're there, once again.

Silver mining stocks I like (and own)

If silver is set to outperform gold, which is something I believe is possible in the coming years, silver-mining stocks could be set to run circles around the overall market. Here are two silver stocks that I personally favor and currently happen to own.

Wheaton Precious Metals

The interesting thing about Wheaton Precious Metals (WPM) is that it isn't a traditional mining company. Rather than being responsible for the day-to-day activities of mines, including exploration and production, it acts as a royalty and streaming middleman.

Mining companies looking to expand existing mines or develop new ones often need a lot of capital. Wheaton Precious Metals provides this capital upfront in exchange for concessions. These concessions include a percentage of gold and/or silver production from the mine in question -- about half of Wheaton's total sales are from silver -- as well as the ability to acquire these metals for a well-below market rate. Thus, Wheaton is able to turn around and sell the production it receives at market rates, pocketing the difference as profit.

It's also worth noting that Wheaton Precious Metals has numerous deals with mining companies, ensuring that it isn't too reliant on any single asset. This proved valuable in 2017 when Primero Mining's gold- and silver-producing San Dimas mine in Mexico experienced labor strikes and equipment issues. Wheaton Precious Metals, which has a streaming deal with San Dimas, wasn't affected too much, thanks to its other deals and ever-growing streaming and royalty portfolio.

In the third quarter, Wheaton Precious Metals reported a cash operating margin of $887 an ounce for gold and $12.44 an ounce for silver. Because it's a royalty and streaming company without day-to-day operating mine expenses, it's the immediate beneficiary of any long-term and stable uptick in precious-metal prices. Since it has roughly half of its revenue tied to silver, it could be set to significantly outperform the broader market. 

First Majestic Silver

Though I don't directly own First Majestic Silver (AG), I soon will, by default. I'm a shareholder in the aforementioned Primero Mining, and First Majestic Silver is in the process of acquiring Primero and its San Dimas mine, with the deal expected to close by the end of April. When it does, my Primero shares will be exchanged for shares of First Majestic, giving me ownership in the mining company that's most levered to silver -- about 70% of its sales are a result of silver production.

First Majestic, which has six operating mines (soon to be seven) in Mexico, is expected to deliver organic growth with many of its existing mines, as well as expand its operations with new production coming online within the next two to four years. The commissioning of a roasting circuit at La Encantada, along with a processing increase at La Guitarra, will be instrumental in incrementally increasing silver production in 2018 and 2019.

Meanwhile, two late-stage projects, La Luz and Plomosas, have the potential to deliver 2 million silver ounces of production each, annually. The company is aiming for about 20 million ounces of annual silver production by perhaps 2020 or 2021, which is close to double what it produced in 2016. 

As icing on the cake, it's adding the San Dimas mine, which should boost silver and gold production. Plus, a new streaming deal with Wheaton Precious Metals for the San Dimas mine should dramatically increase cash flow. Needless to say, I'm bullish on First Majestic in the years to come, and it very well could be worth a closer look for precious-metal investors.

Related video: Why water is the only smart investment for the future (provided by CNBC)

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Sean Williams owns shares of Wheaton Precious Metals and Primero Mining. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.

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