Could Silver Break-out like it did in 2011? / Commodities / Gold & Silver 2020
Silver is expected to begin the 2020s newly burnished, through acombination of higher industrial and investment demand, and tightened supplyowing to mine production issues and output cuts. If it does, it would be thecontinuation of a trend that started last year.
2019 was an excellent year for gold and silver. Both metalsbegan to run last summer after the US Federal Reserve started cutting interestrates. In July the Fed lowered rates three times before freezing the(benchmark) federal funds rate at a range of 1.5 - 1.75% in November. Themarket is reportedlyexpecting multiple cuts in 2020.
That, along with similarly dovish policies among other centralbanks, a record $17-trillion of negative-yielding sovereign bonds, and freshsafe haven demand due to tensions with Iran, and a lack of progress on tradetalks, to name two key issues, powered precious metals to new heights.
Spot gold and silver both peaked in early September at arespective $1,552.00/oz and $19.67/oz. Taking a long-term view of silver andgold prices reveals that the precious metals move in almost identical patterns.Over the last year gold and silver have each gained about 25% (trough to peak);over the last five years gold gained 45% to silver’s 40%.
Charting the metals back to 2010, the correlation is tight. Whengold goes up, it almost always takes silver with it.
It’s actually fascinating to examine these charts closely. Atface value the red lines appear to show a very similar pattern. The spike inboth gold and silver happened in 2011, when gold shot up to a record $1,900 anounce and silver approached $50/oz. But in fact, silver’s streak occurred inApril, five months before gold’s bigrun. This contradicts the prevailing wisdom that silver prices follow goldprices.
The fun for precious metals investors was short-lived; by theend of 2011 silver had dropped to below 2010 levels, and gold fell to under$1,600. In 2012, as the Federal Reserve implemented its third round ofquantitative easing, both metals rebounded - gold took off above $1,900 andsilver pushed back up to near $50.
Then the crash of 2013, when gold prices plunged agravity-inducing $200 an ounce over two days, and silver fell even more on apercentage basis, sinking below $25 for the first time since 2010.
Silver and gold trade fairly closely for the next six years butdiverge towards the end of the chart; notice the column between Jan ‘19 and Feb‘20. At the start of 2019 gold turns sharply upward, for a whole year, eventouching $1,600 very recently. Silver’s move is much more modest; it onlyclimbs one square on the chart to gold’s three squares - representing $15 to$20 an ounce versus gold’s $1,300 to $1,600.
What happened to cause this anomaly in 2019? We’re not sure butwe do know that a reliable way to evaluate gold and silver prices is to look atthe gold-silver ratio.
The gold-silver ratio is simply the amount of silver one can buywith an ounce of gold. To find the ratio, divide the current gold price by theprice of silver.
On June 12, the gold-silver ratio hit a 26-year high by breaking through the90-ounce mark - meaning it took over 90 ounces of silver to purchase one ounceof gold. The higher the number, the more undervalued is silver or, to put itanother way, the farther gold prices are pulling away from silver prices.
The gold-silver ratio tells precious metals investors, which isunder-valued (or over-valued), silver or gold? At the current ratio of 88:1, atrader who has an ounce of gold could sell his gold for 88 ounces of silver,compared to the historical average of 56 silver ounces to one gold ounce.Historically, then, silver is right now extremely under-priced compared togold.
Incidentally, the 2019 gold-silver ratio of 86:1 ranks among thehighest 2% of all time, dating back to 1687! There have been only two yearssince the US government removed the dollar from the gold peg - 1991 and 1992 - that there were higherratios.
If silver is so under-valued, we got to thinking, what would ittake for silver prices to rise to the levels of nearly a decade ago? What werethe silver market conditions in 2011 that could reveal clues as to where silveris going in 2020? This article attempts to answer these questions.
2011 boom and bust
There are numerous suppositions as to why silver climbed 175% inone year before suddenly falling “off a cliff”. (silver plummeted over 25% intwo days).
Many observers looked to investment banks like JP Morgan,suspected of manipulating the silver market, which at the time was known to beshorting silver even though prices kept rising. Conspiracy theorists recalledwhat happened to Warren Buffet’s ill-fated silver squeeze in the 1990s thatpropelled the price up 80% before crashing.
Dovishmonetary policy at the US Federal Reserve was another reason to be bullish onprecious metals in early 2011. Three years after the Great Recession, the USeconomy was still reeling from the mortgage crisis and collapse of LehmanBrothers. Confidence in the US economy was at a record low. The eurozone was introuble, with Greece, Ireland, Portugal, Italy and Spain all reportingfinancial problems.
The Fedannounced a third round of quantitative easing and reaffirmed it would holdinterest rates at zero for at least two years. In August 2011 the SwissNational Bank stunned financial markets by promising to print the Swiss francin “unlimited quantities” as necessary, to maintain a peg between the franc andthe euro - resulting in a flood of investments out of the franc and into othersafe-haven currencies or precious metals.
Elsewhere inEurope, central banks remained committed to resolving the debt crisis by evenmore borrowing.
The result ofall of these economic factors, including a belief that the dollar was undersiege, was for investors to seek safe-haven assets like gold and silver.
A moreintricate reasoning for silver’s rise involved the use of silver in solarpanels. This theory begins with the belief that industrial demand for silverwas surging in 2011, due in part to the photovoltaic industry consuming silverin much higher quantities than previously. Supply wasn’t able to keep up,leaving a shortfall. This, it turns out, wasn’t quite true. While the industrydid experience massive growth between 2008 and 2011 - silver demand rose 338%!- it barely registered as a demand driver, according to BullionVault.
The silvermarket was also thought to be tight due to a shortage of high-purity barsrequired for the silver paste that goes into solar panels. These 0.9999 finesilver bars are less common than the regular 0.999 bars, so when the supply ofhigh-purity bars ran low, corresponding with the hike in the silver price, acause and effect was assumed. There was in fact a shortage of 0.9999 bars, butthe supply of raw-material (mined) silver remained well stocked. Between 2003and 2012 the silver market was in a significant surplus six times, BullionVaultnotes.
Whatever thereason, or reasons, for its jump, silver’s surprising journey to $49 stoppedabruptly in mid-September, 2011. Initiated by then-Fed Chairman Ben Bernanke’sdecision not to proceed with more quantitative easing, Money Metals Exchange explains what happened next:
Disappointed “long” traders began selling their contracts. Asprices fell, the margin calls began – forcing weak hands to sell. Then major U.S.and Asian exchanges increased margin requirements. The result of theserapid-fire events was a near-term rout in the paper prices for gold and silver.
The preciousmetal plunged from a peak of $49 an ounce to under $40 within a week - silver’sbiggest three-day plunge in 28 years.
Silverinvestors and traders know the metal to be thinly traded and thereforevolatile, but the scope of the correction raised eyebrows.
Some tradersblamed the unwinding of the long-silver, short-dollar hedge for the scale ofthe correction. The Telegraph quotes the president of the precious metals trading firm Dillon Gage, saying “US investors bought silver and gold as a way to hedgeagainst further erosion in the dollar's buying power.”
Conspiracytheorists appeared to be validated when a rumor circulated about massiveselling out of George Soros’s hedge fund. In the following weeks a lawsuit wasfiled against JP Morgan and HSBC, alleging market manipulation. However boththe CFTC and a New York appeals court found no indications of collusion orcriminal abuse of the silver market.
Gold-silver ratio as indicator
Wouldn’t it begreat if we had a tried and true forecasting tool that could tell us whensilver (and gold) prices are going to take off? Of course possessing such athing would stand to make us A LOT of money! Sadly, we don’t.
What we dohave is the gold-silver ratio, and the knowledge that the precious metalsusually move in the same direction - although silver historically leaps fasterand higher than gold.
As mentionedat the top, the current gold-silver ratio of 88:1 is near historic highs. Forthe ratio to drop, either gold needs to fall or silver to rise. The questionsilver investors want answered is, when are rising silver prices going to bringthe ratio down to a more reasonable level, that reflects the bullishfundamentals for silver?
We get somehelp here from a May 2019 column in Kitco, authored by renowned mining investor and commentator LoboTiggre. He notices that since 2011, instead of trailing along with gold, silverkeeps getting cheaper and cheaper relative to gold. So what gives?
We don’t knowthe answer to why silver investors aren’t acting on the flashing-red neon “Buynow!” sign indicated by the high gold-silver ratio. But according to JasonHamlin, a commodities analyst writing in Seeking Alpha, the ratio is one of themost reliable “buy” indicators for silver whenever it is above 80. (ie., now)
Silver MinesLtd. Managing Director Anthony McLure confirms this, reportedly telling the Denver Gold Forum last September that the higher-than-normal ratio is oftenthe “precursor to a [silver] bull run.”
Peter Schiff, in a recent column,states that because silver is, despite its many industrial uses, still amonetary metal, it tends to trackrelatively consistently with gold over time. When gold goes up [as it is doingnow], it almost always takes silver with it.
Furthermore, it may well mean the silver-gold ratio will shrinkagain as it did in the years after the ’08 crash. Historically, during a bullmarket in gold, silver outperforms. If this holds trues, that ratio will close.
Conclusion
The silver markettoday is obviously quite different fromthe one in 2011 that saw silver jump to an all-time high of $49 an ounce. Couldit run that far again? We believe so.
Consider:industrial demand for silver, particularly photovoltaics, is heading up, andshould get another lift if and when the trade war with China is put to rest.Investment demand for silver also looks solid, with no end in sight to thelow-interest-rate policy direction of central banks.
Add higherdemand to shrinking supply, lower grades, and less silver by-product creditsfrom falling lead and zinc mine production, we see a floor forming under silverprices.
The 88:1 gold-silver ratio is very high by historicalstandards. This is a warning to investors that at any time, the ratio couldcorrect, either meaning a move up in silver prices or a move down in goldprices. Gold is holding up very well despite a Phase 1 trade deal with China, acontinued strong dollar and higher sovereign bond yields in the US thanelsewhere. At AOTH we do not believe the gold price is going to fall, quite theopposite.
Peter Schiff,states, Silver has hit an all-time highof $49 per ounce twice – in January 1980 and then again in April 2011. If you adjust that $49 high for inflation, you’re looking at aprice of around $150 per ounce. In other words, silver has a long way to runup. As one analyst put it, “With the long-term downside potential of silververy low versus its current valuation, the risk/reward is one of the bestinvestments on the planet.”
We don’t knowwhat will be the catalyst that makes silver leap again, like it did in 2011, orwhen it will happen, but one thing is for sure: when silver runs, volatilitywill be high. It will likely spike fast, without warning, and probably, percentage wise, much higherthan gold.
By Richard (Rick) Mills
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