Gold:Silver Ratio - A Pointer to Higher Prices all Round?


"Silver defies its fundamentals in maintaining a price ratio that relates to gold and the movement in this is taken by many silver investors as a guide to forward prices."

What has been making something of a difference recently is the rejuvenation of gold:silver ratio trading. Technical analysts have been looking favorably on silver since the start of the year and the gold: silver ratio has come increasingly onto the radar screens. Technically-driven trading of the ratio has also been important, with the 10-day and 20-day moving averages defining the upper boundary of the ratio's path.

Obviously the ratio, of itself, does not drive markets. It is normally a result of the inter-related moves of both gold and silver, but now and then it does have an impact on the metals' prices - much more so on silver than on gold.

What has lain behind the changes in the ratio this time? Certainly not the silver market's fundamentals in terms of marginal costs of production against the balance between industrial supply and demand (and this includes jewelry demand but not investor interest), which are not looking favorable. Silver may often be regarded as a precious metal by virtue of its historic connection with currencies and its lingering jewelry market but jewelry, silverware and coins+medals between them comprise less than 30% of silver demand, against nearly 80% in the gold market; on a purely fundamental basis, therefore, silver belongs in the industrial camp.

Sentiment and perception are important market elements, however and silver's long-standing relationship with gold is a vital influence on prices and investment activity. Essentially, because of silver's intrinsically higher volatility than gold, some speculators and investors use exposure to silver as a means of gearing up their exposure to the latter. If gold is going up, silver typically goes up further, so a combination of the two is a stronger performer than gold on its own. This does not work for the whole time, obviously, but it is a well-entrenched mechanism and has been playing an important part in silver's price performance over the past two months since the gold:silver ratio briefly exceeded 80.

This has been no more evident than in the exchange traded funds and the London ETC. When the gold:silver ratio reached its maximum in mid-December 2008, these funds harbored 7,661 tonnes of silver in their coffers. In the two months since then this has shot up to 8,734 tonnes, an increase of 1,073 tonnes and on annualized basis this is the equivalent of 6,096 tonnes per annum (196 million ounces) or almost 25% of global industrial demand. Over this period the silver price has increased by 21%, from just over $11 to just less than $13.40. Gold has risen by 13% and copper, 12% over the same period.

With this degree of uptake it is not surprising that silver has outshone gold recently and left copper some way behind. Although gold and copper have improved by similar amounts, silver's correlation coefficient with gold over the period has been a healthy 90%, while that with copper, although still impressive, has been lower at 63%.

Silver's outright fundamentals do not justify prices at these levels, but for as long as the market retains its bullish stance and investors keep coming for the metal then any industrial surplus this year stands a good chance of being absorbed and when investors like the look of gold, some of them will like the look of silver even more. This metal is, however, flying almost as high as Icarus and when that ratio starts to rise, then silver speculators had better be watching very closely.

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