Gold and silver
02 Aug 2019 | By Ned Naylor-Leyland

Hi Ho, silver’s shining

As the Nobel Laureate Milton Friedman famously said, “The major monetary metal in history is silver, not gold"

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Silver has always been the money of the individual, with gold the money of the king. Although unlike gold, which is a well-publicised asset class, silver has less of an investment profile, so it can take a while for flows to pick up.

Silver, which is considered both a currency and a commodity, is consumed in a number of ways in industry, such as in electronics, solar and medical instruments. The benefit of this is that its return profile is roughly double that of gold, meaning that it increases in value much faster than gold when precious metal prices are rising, although it declines faster when prices are falling.

Making a move

The gold/silver ratio (measuring the amount of silver it takes to purchase an ounce of gold) is currently at around 88:1 (as at 19 July 2019). When gold embarked on its upward trajectory in late May 2019 the ratio was at a similar level but initially, in a somewhat counterintuitive fashion, it moved upwards, peaking at 93:1 on 12 July. This shows that silver initially suffered in comparison to the yellow metal, although it is now starting to perform and outperform. The initial increase in the ratio appears to be a function of investor apathy and a reluctance to buy gold and silver on the first move.

2016 was the last time the market went dovish (on the back of bad data from Asia) leading to a rise in the gold price. This initial move in Q1 2016 was also met by a period when the gold/silver ratio rose. These early periods when silver lags gold are known as “show me” phase; gold is rising but most investors are reluctant to jump in, fearing the reappearance of the bear market conditions that had been in place for an extended period. In Q2 2016 we moved from the ‘‘show me’’ phase into the participation phase; asset allocators moved on the new trend and capital flows suddenly turned towards the asset class. The ratio then dropped quickly from around 83:1 to 65:1 in 14 weeks, reflecting silver’s naturally higher beta and sensitivity to capital flows. The 2016 gold rally was halted by Donald Trump’s election, which saw the bond market, that had been expecting a dovish Democrat in the White House, turn suddenly hawkish. Such a switch from dovish to hawkish looks a long way off this time and could support an even greater drop in the gold/silver ratio than we saw three years ago.

A similar ‘‘show me’’ set up occurred in 2002, which followed a 20 year monetary metals bear market. That time, due to the extent of the previous bear market, it took a whole year for the wider investment community to believe a real structural shift had occurred. By 2003 investors had started to buy into the new trend and the ratio fell over three years from a high of around 80:1 to a low in the mid 40:1 area (in 2006).

The timing is right

With central banks seemingly removing rate hikes from this year’s playbook, the current macro-economic environment is highly supportive of gold and silver which, as inflation-busting assets, perform well during times of traditional currency weakness. The snag is that, following years of central banks supposedly pursuing a “tightening strategy”, it may take a short while for investors to believe this is a genuine U-turn. It appears that the market is finally starting to accept the new narrative and the gold/silver ratio has already started to fall. Silver could well be off to the races.