The PureFunds ISE Junior Silver ETF (SILJ) was the first of its kind, offering exposure to the small cap silver mining world. Though it struggled in 2013, the fund has come roaring back this year, outdoing much of its competition and catching the eye of investors everywhere. We had the opportunity to speak with Andrew Chanin from PureFunds to discuss the ETF and why it has been on a tear in 2014 [for more ETF news and analysis subscribe to our free newsletter].
ETF Database (ETFdb): SILJ, along with the entire precious metals space struggled last year, what was the reason behind this weakness in the space?
Andrew Chanin (AC): I think last year was very much a momentum story. Right out of the gate there was so much bearish talk about these metals with so many people piling on the short side. I really think that we saw the miners reach a level that was very overextended, as well as the metals themselves. A lot of mining companies have a problem of operating profitably at the prices that we were experiencing last year.
2013 was certainly a momentum story and one that may have gotten a bit carried away, especially with regards to miners. Some of the companies were trading below book value, which typically stems from an overreaction. I think a lot of contrarian buyers have started to look at this space and are taking advantage of the bounceback that we have currently had.
ETFdb: Looking at 2014, SILJ has been one of the best performing ETFs. What turned around for this fund and the silver mining space?
There are several things lifting the space this year. The first catalyst towards the upside that we saw was a couple of the smaller junior names in the silver space become acquisition targets. The M&A aspect of mining is so important for the space; it had been very difficult for companies to get financing over the last couple of years as M&A pretty much dried up.
There were actually two firms in our index that were acquired within a week of each other in December. It was around that time that we saw a near-term low for SILJ and we have started to see a rally since then. The M&A activity brought some confidence back to the space because investors saw that larger companies were willing to pay a multiple for junior miners, creating a sense of, “what are these companies seeing that the market is not seeing?” A lot of contrarians are very comfortable looking at the space as a deep value opportunity.
I think the M&A activity really lit the fuse and a lot of people are realizing that 2013 was more of a technical move down; a lot of the fundamentals for the metals are still strongly intact. People are also looking at a stock market that has run up to record highs and are searching for sectors that have underperformed. Many are looking to take some of their profits from their winning bets from the last couple of years and possibly move that into a sector that has dragged behind the overall market.
ETFdb: The solar industry has heavy ties with silver yet it is rarely discussed. Why is silver so important to the solar industry and vice versa?
AC: Silver is the number one conductive metal for electricity and heat. It is one of the most reflective substances and is also anti-microbial, giving it some incredible industrial applications. What we are seeing now is an incredible surge in investor demand. One of the biggest industrial users for silver is the solar industry.
In 2013 we saw solar stocks have an incredible year and silver’s role in that industry is often overlooked. Though solar panels have become more efficient and require less silver than they used to, the industry has nearly reached maximum efficiency with minimal silver and maximum output. As long as solar companies continue to produce new solar panels, especially using the current technology they have, silver will continue to be a vital input. As solar panel production increases, the amount of silver required for that industry looks like it could continue to go up.
ETFdb: What is the advantage of SILJ investing in the small cap space?
AC: Comparing juniors to another kind of industry, I almost look at it as a pharmaceutical company in a stage 2 or stage 3 process for getting approval for their new drug. The risk of it not getting approved may be similar to the risk of a company not being able to put a mine into production at the costs that they were expecting. So because it is kind of an early stage company, it typically trades at a discount to the larger firms. So they can essentially have the same amount of assets in the ground but because they don’t actually have a producing mine with a revenue stream, they can be valued at significant discounts.
It is also advantageous because the junior miners are often takeover targets. As large companies mine and dwindle their reserves, they eventually may want to acquire a smaller firm to unlock new reserves an opportunities, a common practice in the space.
Author’s note: Junior silver miners will typically display a high beta, which makes them something of a leveraged play on the metal. Silver is more volatile than gold, the miners themselves more volatile than the actual metals, and the juniors more volatile than their senior counterparts. For someone with a high conviction in the silver mining space, SILJ has strong potential. That volatility works in both ways, however. There is a big risk/ big reward mentality to these kinds of investments.
ETFdb: Looking forward for SILJ and the industry, what trends excite you the most?
AC: No one talks about supply crunch in this space, upcoming or in the future, really. But I think the fact that nobody is talking about it is why it could become a major issue down the road. Right now, people have been afraid to hedge based on the price of silver, because they saw so much volatility as of late and people got whipsawed.
I think if we saw a rise in the price of silver, you would start to see some companies that use silver in some of their applications begin to start stockpiling. This creates a sort of tug-of-war between the newfound investment demand coupled with the need for the industrial players to hold silver. If the industrial players start to stockpile to alleviate supply crunch concerns, that could bring silver prices to levels that have not been seen yet before.
I think that is the long-term potential wow-factor catalyst there. It is certainly not an impossible scenario where there is a supply crunch and the companies that use silver need to start stockpiling. This could cause investment demand to pick up even more, and you can get an even more exacerbated scenario. So I think there are certainly some catalysts out there that could be incredibly robust for silver prices, and the junior space could provide an interesting opportunity for investors.
Follow me on Twitter @JaredCummans.
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Disclosure: No positions at time of writing.