Silver Rebounds

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 Silver has unique characteristics. It is both a precious and an industrial metal. Silver, like gold, is a hard asset. It has a long and glorious history as a currency; a means of exchange. In 1792, the U.S. Congress based the new nation’s currency on silver and its relationship to gold. In the middle of the sixteenth century, Spanish explorers discovered a mountain of silver in Peru that yielded 45,000 tons or over 1.44 billion ounces of silver making Spain the richest country in the world, for a time.

In generations past, coins in general circulation were often made of silver. Silver was a synonymous term with the change in one’s pocket.

Gold and silver are the two major precious metals that trade as commodities and currencies. However, there are vast differences between the two. Central banks around the world hold or hoard gold as part of their foreign exchange reserves. They rarely hold silver for this purpose. Gold production is primary; producers around the world explore for gold reserves and extract them as the central focus of their mining business. These days, the lion’s share of silver production comes as a byproduct of other metal production. The ores of copper, lead, and zinc are rich in silver content. When it comes to production, silver is an afterthought. Silver has industrial applications as it is an excellent conductor of electricity.

Silver metal tarnishes, but its luster quickly returns when polished.

Investment demand tends to drive the price of silver. Silver is far cheaper than its precious cousin gold. When the price of gold rises silver tends to attract demand and the price increases. When gold is not in vogue, the price of silver tends to tarnish and drop. Historically, silver is a more volatile metal than gold – the price tends to appreciate on a percentage basis more than the yellow metal, and it tends to drop faster.

That is the reason that silver has attracted a great deal of speculative interest over the course of history. The same holds true today.

A bear market since 2011

Silver hit highs of $49.82 per ounce in April 2011, a price just shy of its all-time nominal modern day highs on the COMEX division of the CME futures exchange of $50.36 in January 1980. Around the same time, gold hit all-time nominal modern day highs of $1920.70 per ounce. Over the following years, the prices of these two precious metals plunged as investment demand decreased and precious metals took a back seat to other assets. By late 2015, gold declined to lows of $1046.20—a decrease in value of 45.5% from its 2011 highs. At around the same, silver traded down to $13.635 per ounce – silver shed 72.6% of its value. As you can see, the price action in the silver market was more volatile than in gold.

Silver follows gold higher in Q2 2016

In early 2016, the price of gold began to appreciate once again. On the first trading day of the year, a plunge in the Asian equity markets reverberated around the world and other markets fell. The caused a great deal of fear and uncertainty amongst traders and investors around the globe. Many market participants sought a safe haven for their capital, and some turned to gold.

The price of gold appreciated in response to volatility in world markets. At first, there was little reaction in the silver price.

One of the measures of value, rather than price, in the precious metals market, is the silver-gold ratio. This metric tells us how many ounces of silver it takes to purchase an ounce of gold. Think of it like coins and bills. It takes 100 cents to purchase a dollar bill. However, that relationship is fixed. When it comes to silver and gold, the relationship floats, it is not a constant. Over the past forty-plus years, the average of the silver-gold ratio has been around the 55:1 level. It has cost an average of 55 ounces of silver to purchase one ounce of gold. When the ratio moves below 55:1, silver tends to be expensive compared with the price of gold. We witnessed this in 2011 when the ratio fell below 40:1.

When the ratio moves above 55:1 silver is historically cheap compared with the price of its precious cousin.

At the end of February and in early March 2016, the silver-gold ratio rose to over 83:1, the highest level for the price relationship in twenty-one years. On a historical basis, silver was cheap, and gold was expensive. The move in the ratio was a historical divergence. Over the course of the past four decades, each time these divergences have occurred they tend to correct themselves. The eventual correction is a mean reversion; the price of the relationship tends to extend in one direction only to eventually return to the long-term average level.

In April 2016, silver began to appreciate. Given the volatility of “poor man’s gold,” the volatility of the rally exceeded strength in the price of gold. The silver-gold ratio moved from over 83:1 in early March 2016 to 73.7:1 by early May. The price of silver stood at $17.50 per ounce on May 6, 2016, after reaching highs of $18.06 on May 2, 2016. Since the lows in late 2015, silver has increased by over 28%. Meanwhile, as of the same date, the price of gold has appreciated by 22.2%.

Over time, silver is a more volatile metal than is gold. Early in 2016, the price of gold led silver as gold was the first precious metal to appreciate. However, once silver starts to move, its price trajectory can dwarf moves in gold. For example, in October 2008, gold traded to lows of $681 per ounce. It then proceeded to rally to highs of $1920.70 in 2011 – an increase of 182%. During the same time, silver moved from $8.40 per ounce to $49.82 – an increase of 493%,

Positive signs for Silver

At the beginning of May 2016, precious metals were some of the best-performing assets of the year. Both gold and silver posted sizeable gains, up 21.8% and 26.7% respectively on the year. There are many signs that these precious metals have ended four years of bear market trading conditions. The U.S. dollar has moved lower over recent months. Given the historical inverse relationship between the dollar and precious metals, a lower dollar is positive for gold and silver prices. Additionally, interest rates around the world are historically low. In the United States, short-term interest rates remain at levels below 1%. In Europe and Japan, short-term interest rates are negative. Precious metals are assets that do not pay a rate of return; therefore, they must compete with assets that yield interest for investment capital. The current environment of low interest rates is another positive for the price of precious metals.

Finally, because of their long history as currency, hard money or a means of exchange, precious metals tend to do well when the faith in and the credit of nations that print paper currency declines. Turbulent market conditions around the world have caused years of central bank stimulus. That stimulus amounts to printing more paper currencies that have the backing of nothing more than the full faith and credit of the nations that print the money.  More money in the system could eventually translate to more inflationary pressures on the global economy. Gold and silver are both finite monetary assets.  The amount of these metals is limited to their production; governments cannot print more gold and silver. Therefore, these precious metals are often seen as the ultimate hedges against inflationary conditions.

In April 2016, the price of silver began to move higher, and it reached new highs in May. In the world of commodities and precious metals, nothing is for certain. However, if history is a guide, the one thing we can count on is continued volatility in these metals as we progress through 2016.