Silver is shining more than gold in 2016. And although silver prices are up 23 percent already, it might just be getting started.
Gold gets all the headlines and attention. The price of gold is up 19 percent so far this year – 4 percentage points less than silver’s gain. That compares to 13 percent for the S&P GSCI index, which tracks the price movements of the world’s major commodities.
Silver is used in products needed for everything from photography to solar energy to mirrors. More than half of global silver demand is for industrial use. This means that silver prices are more affected by changes in the global economy than the prices of many other commodities. Higher economic growth tends to boost silver prices, as shown below.
One good reason to think that silver still has a long way to go is the gold-to-silver ratio, which reflects how much silver is needed to buy one ounce of gold. Over the past 30 years, this ratio has moved in a range between about 45 and 80, rarely going beyond either end of the range.
This means that when silver prices are high compared to gold prices, it takes 45 ounces of silver to buy one ounce of gold. But when silver prices are at a low point, it takes 80 ounces of silver to buy one ounce of gold. The ratio is useful to see whether silver is overvalued or undervalued relative to gold. For the past 10 years, the ratio has averaged 60.
One study looked at what would happen if you had 100 ounces of gold 30 years ago – and simply swapped the gold for silver when the ratio hit 80, and then exchanged that silver back into gold when the ratio reached 45. The analysis found that 100 ounces of gold would have appreciated to 562 ounces in 30 years.
Whenever the ratio has approached the 80 level, it has reversed course sharply as investors have bought relatively undervalued silver (and sold gold.) This could be because the ratio has become self-reinforcing – when it hits 80 enough people believe it’s time to buy silver that the price starts to rise because of the increased demand.
The ratio is currently just below the 80 mark, after being slightly above it a few days ago. This suggests that silver was viewed as undervalued, despite the price rally this year, and a lot of investors likely started buying more of it when the ratio hit 80.
Why does the gold-to-silver ratio work? There’s no particular reason. Kind of like “sell in May and go away,” it just does.
Aside from the gold-silver ratio, the real long-term catalyst for silver is that production isn’t enough to meet demand. Commodities researcher CPM projects that silver output from mines will drop 2.4 percent in 2016. That’s the first time in over a decade that silver production will fall.
At the same time, CPM forecast that “fabrication” demand – that is, what industrial companies will need to build solar panels, electronics and jewellery, as well as coins – will rise by 1.6 percent in 2016.
For the past few years, silver demand and silver supply have been nearly balanced. But rising demand as supply declines should support silver prices.
Silver is often a by-product of other metals, including lead-zinc, copper, gold and copper-nickel ores. Other than gold, most other metals are also struggling with low prices. As a result, mining companies – facing falling metals prices – have cut costs. This has led to a lower by-product production of silver.
Global economic growth – and growth in China in particular – will be a critical driver of the price of silver. China is the world’s largest buyer of silver and the world’s major manufacturing centre. Stronger growth in China will support the price of silver.
The easiest way to invest in silver is through an exchange-traded fund (ETF). The most popular ETF is the iShares Silver Trust (ticker: SLV), which trades on the New York Stock Exchange. It tracks the price performance of the underlying holdings in the London Silver Fix Price. So it provides exposure to the day-to-day movement of the price of silver bullion. In Hong Kong, you can use the ETFS Physical Silver ETF (code: 3117).