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Why Is Silver so Sluggish?

28 June 2019

Precious Metals Commentary

After such a sharp rally it only made sense for gold to consolidate somewhat, so we see a pullback to $1,405 this week with silver trading back to $15.25 per ounce.

It has been a wild week at ABC Bullion with a big uptick in trading volumes. Shortly after last week’s update, gold broke through $1,400 per ounce and reached highs of around $1,436 before taking a breather. In AUD terms, we reached highs of $2,063 before a quick correction back to $2,012 at time of writing.

The multi-year breakout can be seen in the below chart and as we know nothing moves in a straight line, we expect some sideways action in the interim, at the very least. After such a significant breakout an asset can often come back to trade near previous resistance, as this area should be new support. Not sure if gold will get back to $1,360 but we think any reasonable pullback close to this level will be met with strong buying.

Gold Price Week Ending 28 June 2019

We won’t try to guess gold’s next move too much and always prefer dollar-cost-averaging into the dips. One thing to watch is the potential breakdown in the USD Index as we are coming off a pretty high base. If there is plenty of room for USD weakness then there is plenty of room for gold to rally in the medium to long term, and the switch to an easing bias from the Fed has only just happened, so the overcrowded long USD trade of the past few years may have some unwinding to do yet.

$USD Gold Price Chart

What’s up with Silver?

Since precious metals bottomed toward the end of 2015, gold has moved from USD$1,045 to $1,405 – a gain of 34%. Silver, however, has only risen from $13.65 to $15.25 – or 12%. One way of looking at the relative performance of gold and silver is via the gold:silver ratio, which divides the gold price by the silver price.

The ratio can be thought of as the “price” of gold in ounces of silver. As with any price, if it is going up then you are better off. In the case of the gold:silver ratio, up means gold is outperforming, down means you are better off with silver.

Below is a chart of the gold:silver ratio since the price of both metals bottomed in late 2015.

Gold Silver Ratio Chart
While silver outperformed gold in the first half of 2016, gold then took the lead with the ratio trending continually higher. Gold’s recent break through its long-term resistance has seen the ratio surge to above 90, a figure last seen over 26 years ago in 1993.

So what is up with silver and why has it underperformed?

First, consider these factors that we have seen mentioned recently in the media by commentators as to why gold has been going up:
  • falling yields
  • total negative-yielding debt exceeding $13 trillion (26% of global sovereign debt)
  • geopolitical tensions
  • Iran downing US drone
  • continued trade tensions
  • central-bank buying, particularly those in conflict with the US
  • dovish central banks
If you put yourself in the shoes of a large investor like a pension fund manger or a hedge fund looking to protect themselves against these developments, is your first thought to buy silver, or gold? BMO Capital Markets expressed this in institutional geek talk by saying that “while gold continues to receive ‘annuity’ demand from macro asset allocation trends, silver does not”.

We note that while all of the above risks have been known about for some time, once the market attitude changed and sentiment shifted, it should not be surprising that gold is the go-to safe haven asset.

The second reason is that the majority of silver’s demand is industrial in nature. As the chart below shows, over half of silver demand is industrial/photography with less than 20% as investment coins and bars.

Silver Demand Chart

A weak global industrial environment, particularly in China, and increasing trade tensions has put pressure on industrial usage and, according to Metals Focus at the recent Asia Pacific Precious Metals Conference, has resulted in supply chains being wary of holding too much stock. Metals Focus also noted that silver has been in surplus for the past few years, although this surplus has been declining.

Silver Physical Surplus Deficit

The above means that, for the moment, professional investors see silver as an industrial metal and thus trade tensions and geopolitical risks mean they look to bet against silver on the back of declining usage while favouring gold as a safe haven.

So is silver done for? Hardly.

At the conference, Metals Focus said that as both metals move into a bull market, silver should outperform gold because the silver market is far smaller than gold’s, which means inflows of investor money have more impact. They see the gold:silver ratio reaching the low 70s in late 2019.

Mark Valek, from Incrementum, also sees silver outperforming, in the following “sequence”:
  1. Strong USD and deflationary pressures
  2. Inflation expectations collapse
  3. Gold anticipates reflation first (rising gold AND rising gold/silver ratio)
  4. Rate cuts/QE
  5. Commodities inflation rise
  6. Silver outperforms BIG
Earlier this week, Shae Russell of Daily Reckoning Australia suggested with the gold:silver ratio above 90 that silver “might actually be a better strategy to play the gold rally … and then ‘convert’ those silver ounces to gold when the ratio falls back to the long-term average”.

We think Shae makes a good point but would also suggest that this does not mean an all-or-nothing “only buy silver”. In our experience, clients generally fall into three groups:
  1. Only invest in gold
  2. Only invest in silver
  3. Invest 50% in gold, 50% in silver
Just as any financial planner would tell you not to put all your eggs in one basket, but diversify across different asset classes, we think there is merit in diversifying your precious metal basket across gold and silver.

How you could apply that strategy using the gold:silver ratio is to start with your “core” preference, be that 100% gold, 100% silver or a 50:50 split but adjust that allocation as follows:
  • when the ratio is high, increase the amount of silver you hold,
  • when the ratio is low, increase the amount of gold you hold.
For example, if you generally prefer to hold 100% gold, when the ratio is high you might look to hold, say, 20% into silver and then go back to 100% gold as the ratio falls. For a 50:50 type investor, you could shift to 30% gold and 70% silver and then rebalanced back to 50:50 as the ratio declines.

So when is the gold:silver ratio “high” or “low”? The ratio chart below gives you a 50-year big picture view.

Gold Silver Ratio Chart  - Highs and Lows

In the 1970s, the ratio traded between 15 and 45 (red lines) but from the mid 1980s, it shifted to the green line channel with 45 being the floor and 80 as the top.

There are a number of reasons for the shift, with the silver market undergoing structural changes like:
  • sale of 140 million ounces from the US strategic defence stockpile starting in 1986
  • launch of the US Eagle bullion coins (also in 1986)
  • decline in photographic silver demand (which used to be around 200 million ounces a year in 2001 down to now only 40 million ounces)
  • rise of photovoltaic systems (around 80 million ounces a year)
Based on this chart, it would be reasonable to consider 55 as a low and 75 as a high for the ratio if one was looking for a tradable signal that would have worked historically. We do note that the ratio did stay above 80 for three years in the early 1990s.

At 92, the current ratio is unusually high and this would indicate that the probabilities favour a weighting towards silver at this time.

As to how to execute a gold:silver ratio trading strategy, for those with a regular savings plan, be it automatically via our Gold Saver Account or manual purchases, just direct all future purchases to silver until the target allocation to silver is reached. This way you can minimise transaction costs.

If you have a more stable holding, then ABC Bullion can facilitate a rebalancing from gold to silver (or the other way) at a preferential rate by reducing the buy/sell spread and you can call us on 1300 361 261 to find out more.

Taking a Breather

With gold having made a run up of $100 from $1,340 to $1,440 over the space of 10 days, it is not surprising that it has taken a breather towards the end of the week.

The meeting between President Trump and President Xi this weekend in Japan does present a risk that gold will fall if a deal is made, but even so we do not see the price going back under the 5-year resistance at $1,375 now that this level has been broken (previous resistance becomes support, as technical traders say). Those “reasons gold has been going up” bullet points we listed earlier are still around and the market, it seems, has finally woken up to them.

While a number of commentators have pointed out, the overbought nature of this move, based on technical indicators like the relative strength index (RSI), we like this chart from Charlie Morris of Atlas Pulse which takes a broader view.

Gold held in ETFs Chart 2009

With ETF holdings as a percentage of the US total equity market having fallen from 1% at the peak of the (previous) bull market in 2011 to only 0.3% today, we agree with Charlie that gold doesn’t seem like a crowded trade at this time, so things are just getting started.

Until next time,
John Feeney and Bron Suchecki
ABC Bullion
If you have any questions or feedback about this week’s report, we would love to hear from you. You can contact John Feeney (@JohnFeeney10) and Bron Suchecki (@bronsuchecki) directly on Twitter, otherwise please feel free to send us an email at [email protected], or call us during trading hours on 1300 361 261.

ABC Bullion National Conference 2019
This publication is for educational purposes only and should not be considered either general or personal advice. It does not consider any particular person’s investment objectives, financial situation or needs. Accordingly, no recommendation (expressed or implied) or other information contained in this report should be acted upon without the appropriateness of that information having regard to those factors. You should assess whether or not the information contained herein is appropriate to your individual financial circumstances and goals before making an investment decision, or seek the help the of a licensed financial adviser. Performance is historical, performance may vary, and past performance is not necessarily indicative of future performance. Any prices, quotes, or statistics included have been obtained from sources deemed to be reliable, but we do not guarantee their accuracy or completeness.