February 2013 | Thunder Road report

Thunder Road
report
Silver: right now (probably) the best asset in the world
For more than a century, the silver price has correlated most closely with a cycle based on the combination of two further statistically significant cycles in silver prices lasting 5.58 years and 31 years, respectively. The next peak in this combined cycle is forecast for July-August 2013, which would imply a new all-time high in the silver price in excess of US$50/oz (the current price is US$31.47/oz.). Having underperformed significantly from their most recent price relative peaks in 2011, the risk/reward tradeoff for premier silver mining stocks, like Fresnillo (quoted in London) and Pan American Silver (North America) looks favourable.

Paul Mylchreest Market Strategy +44 (0) 20 7107 8049 paulmylchreest@seymourpierce.com

This is a marketing communication. It has not been prepared in accordance with legal requirements designed to promote the independence of investment research and is not subject to any prohibition on dealing ahead of the dissemination of investment research.

| February 2013 | Thunder Road report

Silver price basing pattern

Meanwhile, the silver price has been undergoing a lengthy bottoming out phase following the spike up to US$49.50/oz on 28 April 2011.
Silver price (US$/oz.) since January 2010
55.00 50.00 45.00 40.00 35.00 30.00 25.00 20.00 15.00 10.00 Jan 10

Apr 10

Jul 10

Oct 10

Jan 11

Apr 11

Jul 11

Oct 11

Jan 12

Apr 12

Jul 12

Oct 12

Jan 13

Silver (COMEX:^SI) - Day Close Price

Source: Capital IQ

Before we touch briefly on silver fundamentals, there are grounds for believing that the next six months could be very positive for the silver price and, therefore, for silver mining stocks.

Silver price cycles

Cycles in silver prices detected in the 1970s

In the early 1970s, Gertrude Shirk of the Foundation for the Study of Cycles (FSC) concluded that: the 5.58 year cycle appears to be the dominant component in silver prices. Another analyst, Jack Gillen, using a different methodology, concluded that there is a 5.64 year cycle in silver prices. Why the silver price displays this pattern of cyclical behaviour remains unclear. It has nothing to do with silver production, which the FSC determined to follow a 12.5 year cycle. Edward R. Dewey, who founded the FSC in 1941, found scores of cycles in financial markets and could only conclude that there was Something out there which was responsible.

The predictive ability was excellent back then

Gertrude Shirks analysis was based on silver prices dating back to 1850. In simple terms, her methodology was to de-trend the data before measuring the resulting amplitude of price deviations. What was so impressive about Shirks work in the 1970s was its accuracy with regard to predicting price moves in silver. For example, her assertion in October 1974 was that: The cycle analysis indicates that 1974 may be a peak year. The silver price peaked at US$6.70/oz on 26 February 1974 and didnt regain that level until early-1979. Secondly, Shirk argued in 1979 that the model was predicting: An ideal crest at 1980. Thanks to the efforts of the Hunt brothers, the silver price famously peaked at US$50/oz on 21 January 1980.

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Silver price (US$/oz.) 1973-75

Silver price (US$/oz.) 1979-80

6.50

5.50

4.50

3.50

2.50

1.50 Feb 73

Apr 73

Jun 73

Aug 73

Oct 73

Dec 73

Feb 74

Apr 74

Jun 74

Aug 74

Oct 74

Dec 74

Jan 75

Silver (COMEX:^SI) - Day Close

Source: Capital IQ

The 5.58-year cycle

The next chart shows the close correlation between the actual de-trended price of silver versus the predicted 5.58 year cycle during 1901-82. The predicted 5.58-year cycle in the silver price is shown by the dotted line and its actual outcome by the solid black line.

The 5.58 year cycle in the silver price 1901-82

Source: Seymour Pierce

Out of 14 full cycles, the silver price tracked the 5.58 year cycle in broad terms on 11 occasions. On 6 occasions, there were large upward spikes in the silver price which corresponded almost precisely with the predicted peaks in the 5.58-year cycle. These culminated with the two peaks 1974 and 1980 mentioned above.
Cycle inversion in the period following the 1980 all-time high

After the 1980 peak, as you can see from the chart below, something strange happened and the silver price moved out of sync with the predicted 5.58 year cycle for the next four cycles. Indeed, in the period that followed the all-time high in the silver price and the subsequent low in 1982, silver actually moved TOTALLY out of sync with the cycle. The silver price made lows or intermediate lows when it should have been making highs.

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One might conclude that the historic correlation of the silver price and the 5.58 year cycle had come to an end. However, two points are worth making. Firstly, from its extensive research, the FSC concluded that so-called cycle inversions are fairly common: The subject of inversions is very controversial in the study of cycles. It is founded upon the fact that 65% of cycle turns yield profits, however, while cycle timing can identify about 78% of the market turns, an unidentified 13% is the result of inversions. We believe this information to be valuable. And: Cycles invert about 12-15% of the time
But the correlation has improved again in recent years

Its more interesting that the silver price has reverted back to a much closer correlation with the 5.58 year cycle during recent years for example, the close correlation with the predicted peak at the end of 2007 (see below). If the silver price has reverted to the 5.58 year cycle and if we align the cycle with the all-time high on 21 January 1980, the next peak in the cycle is predicted as 16 July 2013, i.e. just over six months away. If we use Jack Gillens estimate of a 5.64 year cycle, the next peak is predicted as being just over a month later on 22 August 2013. The chart below shows how close we are to the next predicted peak.

The 5.58 year cycle in the silver price 1901-2013

Source: Seymour Pierce

We shall see.
The 31 year cycle

Gertrude Shirk also discovered evidence of other possible cycles in silver prices, including one of 31 years in length albeit not as statistically significant as the 5.58 year cycle. The Hunt brothers all-time high in silver was made in early 1980. Moving
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forwards 31 years takes us to 2011, which marked the recent high in the silver price of US$49.50/oz. on 28 April that year which suggests that the 31 year cycle is firmly in play. Please note: the intra-day highs are not visible in the chart below which plots monthly averages.
Silver price (US$/oz.) since 1979
60.00

50.00

40.00

30.00

20.00

10.00

0.00

-10.00 Jan 79

Sep 81

Jun 84

Mar 87

Nov 89

Aug 92

May 95

Jan 98

Oct 00

Jul 03

Apr 06

Jan 09

Oct 11

Silver (COMEX:^SI) - Day Close Price

Source: Capital IQ

Combining the two cycles

In the next chart we have combined the 5.58 year and 31 year cycles which gives an even better fit between the predicted cycle in the silver price and the actual outcome. More importantly, it is also predicting a new cyclical high in 2013 which would imply a new all-time high in the price of silver at something over US$50/oz.

The combined 5.58-year and 31-year cycle in the silver price 1901-2013

Source: Seymour Pierce

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More on the investment case for silver and silver equities

Aside from the analysis of silver price cycles, there is a strong investment case for silver and the related equities and it is worth highlighting a few key issues.
Above-ground silver stocks are estimated to be lower than those for gold

Silver is unique as it is both a monetary metal and an industrial metal. Unlike gold, there are limited above-ground stocks of silver because so much has been consumed in industrial applications. Almost all of the gold ever mined is still available as theoretical supply in the form of bars, coins or jewellery. The official (significantly understated) estimate for the world gold stock is approximately 185,000 tonnes, or 6 billion oz. Nobody knows the level of above-ground silver stocks, although the majority of estimates are in the 1.0-2.0bn oz. range, i.e. between one sixth and one third of the comparable figure for gold. Of the estimated 185,000 tonnes (6 billion oz.) of above-ground gold stocks, approximately 31,500 tonnes (1 billiion oz.) are reportedly held by the central banks. These institutions are able to lease this gold into the market to affect the price. Central banks, as far as we are aware, have divested their silver reserves. The long-term gold/silver ratio is currently 49.0x but has averaged 15-16x for several thousand years and, at times, has been considerably lower than this. For example, the ratio was 12.5x during the era of Alexander the Great in the fourth century B.C. and was fixed at 12.0x during the Roman Empire. The ratio started to rise with the progressive demonetisation across Europe and the US in the late nineteenth century, which culminated in China jettisoning the silver standard in 1935. For more than a decade, however, the gold/silver ratio has been on a declining trend for more than a decade. Taking the latest annual data for mined silver and gold production, there was only 8.3x more silver mined than gold in 2011. Further reversion to the mean seems inevitable during the coming years.
Gold/silver price ratio since 1687

A significant proportion of gold reserves are held by central banks

Gold/silver ratio has averaged 15-16x over the last two thousand years

More reversion to the mean is likely

Source: Measuring Worth

If we add the recycling of silver scrap, total annual incremental supply of silver was 1,018m oz. in 2011 according to the GFMS consultancy. GFMS estimated that total fabrication demand for silver in 2011 was 877m oz. Fabrication is defined as industrial applications, photography, jewellery, silverware and coins & medals. This left only 141m oz. of incremental supply for Implied Net Investment which is nothing more than a balancing figure in the GFMS analysis. At an average silver price of US$35.12/oz. in 2011, this amounts to a miniscule sum (in terms of global financial markets) of less than US$5.0bn.

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Investment demand will compete with industrial demand going forward

Going forward, it is inevitable that the investment demand for silver increasingly competes with the industrial demand for silver providing further support to the silver price. If we look at the price relative performance of the premier silver miners on both sides of the Atlantic, Fresnillo in Europe and Pan-American Silver in North America, they are trading far below their peaks reached in 2011. The possibility of a new cyclical high in the silver price later in 2013 makes the risk/reward in buying these shares look very favourable.

Favourable risk/reward for leading silver mining stocks

Fresnillo price relative since 2011

50.00%

Pan American Silver price relative since 2011

40.00%

30.00%

20.00%

10.00%

0.00%

-10.00%

-20.00%

-30.00% 40,547.00 40,609.00 40,675.00 40,738.00 40,801.00 40,863.00 40,928.00 40,990.00 41,057.00 41,121.00 41,184.00 41,246.00 41,311.00 Fresnillo PLC (LSE:FRES)/FTSE All-Share Index (GBP) (^ASX) - Share Pricing

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Capital IQ

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