Last week, the gold:silver ratio fell to just below 87, a ten-week low and so a far cry from the multi-decade high of 93.5 recorded on 3rd July. Even so, the ratio remains well above its long-term average of 58 for 1971-2019. In isolation, this suggests that there should be room for it to fall significantly further. Although we believe the gold:silver ratio will decline, it may take some time before it falls notably from current levels. Furthermore, in the short-term, we may actually see silver under perform gold before the ratio witnesses a more sustained decline.
Before looking ahead, it is worth understanding why silver has under performed gold for such a long period. From a low of 30.5 in April 2011, the gold:silver ratio climbed almost uninterruptedly to its early July peak (the highest ratio since 1991). Unsurprisingly, the low coincided with silver’s April 2011 high of $49.80. Fast forward to this year and, until recently, professional investors had largely shunned precious metals in favour of equities, as several key stocks markets established successive highs. In addition, any bouts of investor liquidations were viewed as part of a healthy up-cycle for equities, rather than potentially signalling the start of a bear market. As such, this encouraged bargain hunting in the equities space rather than a shift in favour of safe haven assets.
As a result, the occasions when safe haven demand emerged were often satisfied either by buying defensive stocks, currencies perceived as safe havens (such as the yen or Swiss franc) or bonds; precious metals rarely featured and, when buying did emerge, this often centred on gold. This in turn helps explain silver’s under performance. Periods when the gold price firmed often occurred without a similar response from silver. However, when gold eased, silver was often dragged lower.
That said, over the past week this dynamic may have finally changed. Dovish commentary from the Fed on 16th July boosted gold and it was only then that silver properly enjoyed spill over from the yellow metal, allowing it to break through $16 to reach $16.59 on the 19th.
This in turn reflected improved investor activity, especially in ETPs and on Comex. ETP holdings have risen this year by almost 7% ytd to 675.9Moz and this means global silver ETP stocks are now just 1.6% below their all-time high (of 686.6Moz on 18th July 2017). ETP demand picked up sharply when the gold:silver ratio reached 90 and silver was still below $15, a sign that some believed silver was undervalued. Interestingly, as silver climbed towards and then through $16, ETP demand held firm. However, as holdings are now close to their previous high, it looks doubtful that ETP demand can maintain this pace. That said, given the importance of retail investors in the silver ETP market (in contrast to gold, where institutional investors have a greater presence), we expect these holdings to remain relatively sticky.
Comex data was similarly bullish; figures released for 16th July (which do not capture investor positioning when silver broke through $16) shows that net managed money longs rose to 139Moz, a marked turnaround from the net short of 190Moz from just a few weeks before. In spite of that swing, the latest positioning still remains relatively light (even allowing for expected growth in the net long over the past week), compared with that seen in 2017, when the net managed money long exceeded 400Moz. As a result, should sentiment turn increasingly positive towards precious metals, there will be room for long investor exposure towards silver to grow quite significantly. This contrasts with gold, where net managed money Comex longs are already elevated.
A clear negative for silver investment is relatively weak coin and bar demand. Although ytd Eagle coin sales in the US have been far higher
y/y, this partly reflects product shortages in H2.18, some of which were fulfilled this year. More revealing, therefore, has been the slowdown in Eagle sales over the last 3-4 months. This subdued retail investment in the US (and India) means that the global total remains well below its 2015 high. As such, an ongoing physical surplus still weighs on silver.
In our view though, the macro backdrop remains key to delivering price upside and, as we expect global growth to slow, we also foresee weaker equities. The rotation that is likely to follow into precious metals will initially benefit gold, before silver gains from spillover effects. As a result, silver’s far smaller (and less liquid) market will see it outperform gold, driving the ratio lower, both later this year and into 2020.