Silver Penny Plays

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If you believe gold’s going to go up, buy silver

Gold’s more volatile sibling, silver, could be a considerably better investment in a rising gold price scenario, but it still depends on whether or not gold has bottomed.

Lawrence Williams
Tuesday, 23 Jul 2013

LONDON (Mineweb) -

In yesterday’s trade gold moved up nearly $40 an ounce and has maintained its higher level overnight. Silver was initially slow to move, but then also managed a gain of close on $1 per ounce.

While still far short of getting anywhere near their levels of two years ago, this does look as though it could be the start of a general recovery in precious metals prices. The big question, of course, is: is this the beginning of an upwards re-rating, or will we see another stutter and fall back? And, if the former, how high can the momentum carry it?

If the gold pundits are right in their assumptions, then this could indeed be the start of something big. The gold bulls believe the big money has been driving gold downwards, closing off short positions and is now poised for taking it back up again – and this time, if they have indeed managed to exit the shorts, then the sky could be the limit. Gold could be set for a rise equally as fast, and as steep as the recent downturns – or so the argument goes.

But, there is one big flaw in the assumptions. On the way down it was strongly believed that the big money taking gold downwards was in collusion with the central banks of this world, and the U.S. Fed in particular, and while the big money can perhaps now see big profits on the horizon through buying low and then helping drive up the price, surely this is contrary to central bank desires?

While most central banks will deny that gold is, in reality, money any more, they do claim to hold vast reserves of the precious metal and it does tend to be viewed as an indicator of currency strength and thus of economic health.Add to that the theory that the central banks have leased out so much gold that their vaults may be rather emptier than official figures would suggest, a move to replenish these becomes more and more costly, and difficult to achieve, if gold is back on the rising path again.

Silver is not beset by quite the same strictures though. It’s not a metal the central banks care about overmuch so is thus even more open to overt manipulation by the big money than its yellow sibling. Regardless, it still tends to move with gold, but in a more exaggerated manner.

Some analysts point to a big supply/demand surplus, but that ignores investment demand (which they do tend to take into account with gold) which is in reality what actually drives the price. As gold fell, silver fell further with the gold:silver ratio currently sitting at around 65.

Over the past century this ratio has fluctuated between peaks of around 100 and 15, but for part of this silver was still a monetary metal, while now, arguably, its price is driven by jewellery, industrial and investment factors, with the latter the key in terms of price fluctuations.

The last time the gold: silver ratio got down to its oft touted ‘historic’ level of 16:1 was when the Hunt Brothers tried, and nearly succeeded, in cornering the market. Unless one or more of the megabanks tries the same thing again, and this is doubtful as well as probably illegal, we don’t see the ratio ever returning to this kind of level without its original monetary underpinning.

More recently the ratio has moved between 85 and 35, but mostly it sits in the 45 to 65 range, with the ratio moving lower when gold rises and higher when gold falls which gives silver its reputation for its higher volatility among the precious metals.

Thus, were gold to climb back to its $1500 level (a rise of around 13%) in the relatively near future, as many reckon and which can’t be beyond the bounds of possibility, then a ratio of 65, as at present would see silver at $23 (a similar rise), but at a ratio of 45 silver would get to $33 – a much bigger increase of around 62%. Even at a comparably small fall in the ratio to say 57, a level seen only 3 months ago, silver would rise by 30%.

Given the gold:silver ratio’s propensity to come down as gold rises, in a stronger gold price scenario then a sharp reduction in the gold:silver ration, and thus a far bigger percentage increase in the silver price, would seem more likely than not.

Yes, it is perhaps more of a gamble to invest in silver rather than gold, because of the increased volatility factor as silver investors have found during gold’s poor performance of late. But, if you firmly believe that gold has bottomed and is set to start to rise again then silver looks to be the better bet in terms of percentage appreciation.

Silver guru Ted Butler would agree. In his latest weekly review he points to three years ago when both the gold:silver ratio and the absolute gold price were at similar levels to those seen recently (gold was at around $1250 and silver at $18).

From that point gold rallied to a peak of $1920 around a year later ( a gain of 50%), while silver took a little longer to peak to $49 the following April ( a massive gain of around three times that of gold) before silver was dramatically taken down – in a similar manner to gold earlier this year.

Butler reckons that it’s not hard to imagine a similar scenario to occur in the near future. Whether though the kinds of extremely rapid rises which led to the gold and silver peaks, and may ultimately have led to their downfall as the huge short position holders with massive financial backing needed to redress the situation, will re-occur, at least in the near future, may be unlikely given how short a time has elapsed since those peaks, but a more gradual, and controlled, rise could well be on the cards.

But – as we noted earlier, everything depends on the movement in the gold price. If the big price takedowns by the big money are now over, then gold should rise regardless of Fed tapering.

The global economy remains in a mess while the Detroit bankruptcy, which could be followed by a whole spate of other mega municipalities in a similar situation, will surely bring home to the U.S. public that things are not quite as rosy as the politicians and economists try to make out.

The Eurozone has other shocks to come on the world stage. Gold supposedly thrives on uncertainty. At some stage it will turn upwards and when it does silver will too – but faster.

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