Investors in silver and gold made a nice profit this month as the two metals continued their incredible rally. Gold is up nearly 35% year to date while Silver is up about 49%. The figures look even better if you had bought during the March lows. Why the surge?
A weak US dollar and murky economic outlook have a lot to do with it. The precious metals are still seen as a reliable store of value and have predictably rallied when economic conditions are poor and/or deteriorating. Silver investors see more volatility owing to the metal’s industrial use but its still a monetary metal at its core.
What’s interesting about this rally is the divergence in the spot price between gold and silver. (Spot price is what you could get if you bought or sold it immediately “on the spot”). This is measured in the gold/silver ratio, i.e. how many units of silver does it cost to buy one unit of gold? This oscillates over time and economic cycles, but for about the last hundred years the ratio has hovered somewhere around 40 to 60 units of silver for a unit of gold.
The last few months have been quite a different story. The ratio is at historic highs. In March, it was at 100 to 1. As of this morning the ratio was about 75 to 1.
*Graph courtesy of zerohedge.com
Let’s split the difference and say that historically it cost 50 units of silver to buy a unit of gold. If it now takes 75 units of silver to do the same thing, then either silver is on sale or gold is overpriced, or both. The idea that investing in silver is a bargain after a near 50% run up in its price in just eight months seems farfetched, but the numbers bear it out.
The metal is still a long way off from it’s highs. It hit close to $50/ounce in 1980 and again in 2011. It’s currently trading at about $28.50/ounce. To close the gap on gold and hit a 50 to 1 ratio, well within historic norms, the price of silver would need to rise to about $41/ounce (assuming gold stopping climbing and stayed level). That’s about a 44% upside from where it closed on Friday.
Supply and demand fundamentals look good for silver as well. Strong growth in silver-backed ETFs have driven up demand for the metal, while shutdowns in several silver mines due to COVID are putting an additional squeeze on supply. Both suggest higher prices are likely.
In the immediate here and now, both gold and silver look exceptionally overbought on a short-term basis. A pullback in gold would help with a reversion to the mean in the gold/silver ratio without a corresponding rise in the price of silver. We believe gold and silver prices could pause given their recent sharp run up. A subsequent ramp back up to new highs would likely follow given the current environment. We like the long-term outlook for both of the monetary metals.