Silver Rally to Catch Up With Gold
I rarely talk about silver.
And I should.
Silver — more so than gold — is a crucial metal for modern society.
In your phone, laptop… In fact, pretty much in any electronic device you own.
Anything with a circuit board will have a small component of silver.
Your microwave, washing machine, oven and camera equipment.
All those new, shiny trucks driving past you on the freeway? Yep, their circuit boards contain silver too.
The ‘other’ precious metal is easily forgotten about.
At roughly AU$25 per ounce, you can buy two ounces of the stuff with a 50 buck note.
And let’s be honest. The moves in gold are much more exciting than moves in the silver price. Gold can jump US$20-30 per ounce in a day.
Heck, there’s been times when it moves US$100 in an hour.
But silver would be lucky to move a buck or two in response.
The lack of volatility — or excitement — is one of the reasons why many people never cover it.
Right now, silver has failed to catch up to gold as it rallies.
However, if history is anything to go by, we could be on the precipice of a new silver rally.
By that, I mean the gains in silver could be bigger than the gains in gold.
I’ll hand you over to Jim to show you exactly what I mean.
Until next time,
Silver to Catch Up With Gold
Not many people have ever heard of the Central Bank Gold Agreement (CBGA), also called the Washington Agreement on Gold. But it’s an interesting side note to the history of government manipulation of gold markets.
The agreement was first signed in 1999 and was renewed for five-year terms in 2004, 2009 and 2014.
The signatories included central banks in France, Germany, Italy, the Netherlands, Belgium and the European Central Bank, as well as non-eurozone central banks in Switzerland and Sweden.
The US was never a member of the agreement, but it did supervise the implementation of the agreement closely, as did the Bank for International Settlements (BIS).
The CBGA is a gold seller’s cartel, similar to the notorious ‘London Gold Pool’ of the late 1960s.
During the long gold bear market (1980-1999), central banks were active sellers of gold.
There was some fear that the selling would spin out of control and hurt the value of remaining reserves more than was already the case.
The CBGA set limits on total sales and individual sales by member countries as a way to allow some ongoing sales without sinking the entire market. There was only one problem.
The sales had largely dried up by the time the agreement was put in place.
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After ‘Brown’s Bottom’ — named after UK Chancellor of the Exchequer Gordon Brown, who sold about half the UK’s gold reserves at an average price of US$275 per ounce between 1999 and 2002 — there were few significant sales of gold by the CBGA signatories, except for 1,000 tonnes by Switzerland in the early 2000s and 400 tonnes by the IMF in 2010.
There have been no sales by any signatories since 2010.
The agreement is up for renewal in 2019, but it has long been a dead letter.
Now, the agreement is being allowed to lapse.
Of course, other central banks — including those in Russia, China, Vietnam, Turkey and more — have been voracious buyers of gold since 2009.
As of now, the age of central bank gold sales is officially dead and the age of central banks as gold buyers has returned.
This is just one more reason why gold prices have been on a tear.
What about silver?
Gold is up 40% in four years. Whereas the white metal, silver, has risen just 23% in the same time.
It is time silver caught up. But how far can silver move?
Many investors assume there is a baseline silver/gold price ratio of 16:1.
They look at the actual silver/gold price ratio of 100:1 and assume that silver is poised for a 600% rally to restore the 16:1 ratio.
These same investors tend to blame ‘manipulation’ for silver’s underperformance.
I believe that analysis is almost entirely nonsense.
There is no baseline silver/gold ratio.
The ‘16:1 ratio’ is an historical legacy from silver mining lobbying in the late 19th century — a time of deflation, when farmers and miners were trying to ease the money supply by inflating the price of silver with a legislative link to gold.
The result was ‘bimetallism’, an early form of QE.
The ratio had nothing to do with supply/demand, geology or any other fundamental factor.
Bimetallism failed and was replaced with a strict gold standard in 1900.
This does not mean there is no correlation between gold and silver prices.
As the gold and silver chart below reveals, there is a moderately strong correlation between the two.
The coefficient of determination (expressed as r2) is 0.9.
This means that over 80% of the movement in the price of silver can be explained by movements in the price of gold.
The remaining silver price factors involve industrial demand unrelated to gold prices.
Gold and silver prices over six months
Source: Thomson Reuters Eikon
Recently, a huge gap has opened up between the rally in gold prices (shown in blue with a right-hand scale) compared to silver prices (shown in orange with a left-hand scale).
Given the historically high correlation between gold and silver price movements, and the recent lag in the silver rally, the analysis suggests that either gold will fall sharply or silver will rally sharply.
Since we have articulated the case for continued strength in gold prices, our expectation is that silver is set for a strong ‘catch-up’ rally with gold, possibly to the US$16 per ounce level or higher.
In this environment, gold is performing well. But looking at this chart, we can see that there is potential for significant price movements for silver.
All the best,