Gold Silver Ratio Indicates Strong Demand for Silver in 2008

February 12th, 2008 • Related • Filed Under

Filed Under: Featured • Precious Metals

When Amazon.com recently reported its top-selling items from the Christmas season, there was a surprise. The surprise wasn’t that consumers are still spending money despite the gloomy news from the stock market. The surprise was that the top selling item from the world’s largest on-line retailer was silver jewellery.
Maybe it shouldn’t be so surprising. Silver is cheaper than gold. You can buy a nice pendant or a brooch for less than US$50. And silver, like gold, still means something to people. It’s a precious metal. You feel like you own something of real value when you own silver.
But despite the secure feeling owning precious metals may give you, is there an investment argument to be made for them? Commodities prices are soaring. Oil is at US$100. Soybeans have reached 34-year highs on a spike in demand. Gold is within shouting distance of US$1,000. Yet the best performing metal and commodity of 2008 may well be silver.
Historical Gold Silver Relationship Suggests Rising Silver
Before the modern era of floating currency exchange rates-where the relationship between currencies varies based on their respective strengths and weaknesses-the world was on a gold and silver standard. Precious metals were money, and the ratio between the gold price and silver price historically was around 15:1.

Gold has always been more valuable than silver, at least as money. Gold is harder to find and mine. Silver is relatively more abundant and can be consumed in industrial processes. Gold is more durable.
But in the last thirty years, the gold silver ratio has exhibited quite a bit of volatility. A higher ratio shows both gold strength and silver weakness. When the ratio declines-as it appears to be doing right now-it means silver is getting stronger. It should be noted that a declining ratio doesn’t mean the gold price is falling. It could mean that both metals are rising, but that silver is rising faster than gold. In fact, I believe that’s what the following chart shows.
Gold Silver Ratio Shows Silver Strength

In 2001, the gold silver ratio spiked up to 80. That means it took you 80 ounces of sliver to buy one ounce of gold. But since then, the ratio has declined. You might be surprised to know that despite gold’s headline-grabbing move to US$894, silver has actually outperformed gold since late 2001. In November 2001, silver hovered at just US$4.05 / oz. In recent trading in New York, it touched US$16.19-for a gain of around 300? the last seven years. In that same time frame, gold has increased too, but not as much. Gold traded at US$280 in late 2001 and now trades nearer to US$900, which gives it a gain of about 219?he gold silver ratio chart below contains two other pieces of information worth noting. First, the ratio began increasing in mid-2007 as gold moved up in US dollar terms. This was in reaction to both geopolitical events and the housing market crash in the U.S., which has forced the U.S. Federal Reserve to cut interest rates, weakening the dollar and strengthenin
g gold.
Silver has not followed gold’s 2007 move up. But I believe it will in 2008, which brings me to the second piece of information on the chart worth noting. During the last great inflationary boom in precious metals, a speculative blow-off top drove the gold silver ratio back down below its historic level of 15. Will that happen again?
In 1980, when the Hunt brothers nearly cornered the silver market in New York, silver prices went as high as US$48/oz. But that doesn’t tell the real story. Adjusted for inflation, the 1980 price was more like US$129 in today’s rapidly depreciating U.S. dollars. The following chart shows the historical silver price, adjusted for inflation. You can see that while silver has begun to move up, it hasn’t come close to imitating its performance during the last precious metals bull market. If it does, a new high in inflation- adjusted terms is not just likely, it’s probable. The gold silver ratio is currently around 55. Let’s say the ratio begins to narrow again and goes to 30. At a current gold price of US$894, you’d have silver at $US29.80/oz. (894/30=29.8). If the ratio narrows even further, the possibility for a much higher silver price also exists.
US$30 Silver is Closer Than You Think

Investment and Speculative Demand Driving Prices
One reason silver tends to lag gold is that silver is treated more as an industrial commodity than a precious metal. In fact, according to industry statistics, 45? the demand for silver comes from the electronics industry. Thirty percent of demand is from the jewellery industry, twenty percent from silver’s use in photography, and just five percent from investment demand.
Increased investment demand should drive the silver price higher in 2008. There is precedent for this with gold. The first exchange traded fund for gold in the US came out in late 2004, when the gold price was just above US$400. The creation of an easy way to be “long gold” for institutions and individual investors stimulated demand for gold itself. With investment demand unleashed, it became easier than ever to hedge against inflation and uncertainty by owning a gold ETF.
A silver ETF began trading in New York in mid-2006, trading at ten times the spot price of silver. The ETF tracks the silver price, and as you can see from the chart, it’s been in a choppy trading range. However it’s latest move signals good things for silver bulls. There are never any sure things in the investment world (or life, for that matter). Silver may continue to underperform gold for years, as gold behaves like money and sliver behaves like an industrial metal. But even a modest uptick in investment demand for silver will push it to new highs. If silver is embraced again as money and shows even a hint of the monetary demand gold enjoys, watch out. The rising prices will attract even more investor attention.
Perhaps that is the biggest yet most irrational reason for silver’s bright future. In the speculative phase of a bull market, people buy because prices are rising. That is not the best reason to buy, of course. You’d much rather buy earlier, when there are still fundamental reasons to buy and BEFORE the big moves have been made. The good news is that for silver, the big moves may be just ahead.
Dan Denning
The Daily Reckoning Australia

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