Since gold and silver are both precious metals, the general assumption is that they would move in tandem. But, if you look at the recent trend in the Indian context, there have been numerous cases of divergence. While gold has been getting pricier, silver has not given commensurate gains. For example, gold at Rs.40,000/10 grams is already at a life-time high but that is not the case with Silver which is still some distance away from its former peak. One reason could be that gold prices are mainly functions of international gold price and of the rupee-dollar movement. Silver has a lot of industrial applications too. Let us look at this divergence in greater detail.
In global and domestic markets, Gold and silver prices have started diverging, with silver being the classic under performers. What are the reasons for the divergence between the movement of gold and silver prices? Broadly there are two reasons for the divergence. First reason refers to shifts in the gold/silver ratio, a formula traders use to assess the value of one metal versus the other. Another reason, as we stated above, is the more rudimentary differences pertaining to the demand and applications of gold and silver.
Reason 1: Shifts in the Gold / Silver ratio
Gold and silver are thought to move together, and often they do. There are periods where the Gold Trust (GLD) and Silver Trust (SLV) move in opposite directions and periods where one metal outperforms the other. The gold silver ratio has typically varied between 60 and 80. Check the 5 year comparative chart of gold and silver to get a better idea.
Chart Source: Bloomberg
There have been sharp divergences in price between gold and silver in the last five years. For example, the gold has given positive return of 22.5% over the last five years whereas silver has given negative returns of -17.9%. The divergence between gold and silver gets divorced from its mean of 60x in times of extreme uncertainty and in times of extreme optimism in economic growth. In times of extreme uncertainty and caution (as we are seeing now) the ratio moves higher towards the 80 mark. In terms of sharp economic growth, the silver prices gain compared to gold and this compresses the ratio well below the 60 mark.
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In the aftermath of the first rate hike by the Fed in 2015 December after a gap of nearly 10 years, it resulted in high levels of growth pessimism leading gold prices sharply higher. At this point of time, the gold out performance relative to silver was very noticeable in early 2016. During this period, the gold/silver ratio went closer to 77.5. Back in 2011 when all the European economies also saw rate cuts to boost growth, silver sharply outperformed gold. That had led the gold/silver ratio to below the 40 levels. This ratio is both a cause and an outcome but normally, like the P/E ratio, it is this ratio of gold/silver that determines the direction of both the metals.
Reason 2: Demand structure of gold and silver
Supply and demand also play a role though. While both the metals are mined and supply is limited, the demand patterns tend to diverge and that also creates price divergence between gold and silver. One key driver of gold’s strength has been central bank buying, which between 2015 and 2019 is near its highest levels in decades. Central banks are buying gold for various reasons. Firstly, they are trying to create a solid pile of the yellow metal in the event of an economic crisis as it is one asset class that does not lose value. Secondly, gold and uncertainty are great friends and gold prices always tend to appreciate in times of uncertainty. This makes gold the best bet in such times. With a trade war, slowdown in China, BREXIT worries and the Middle East uncertainty, the situation is ripe for gold purchases. Thirdly, central banks are also adding gold as an alternative to dollar as the Chinese central bank and many European economies are trying to hedge against currency volatility.
Supply and demand for gold and silver are closely related to economic and industrial output. Gold is primarily used for aesthetics and for investments. Nearly 46% of the gold demand comes from jewelry while 22% comes from the storage demand for coins and gold bars. According to the World Gold Council, while this is the major source of demand accounting for 70%, the swing trade in gold is caused by central bank buying and ETF buying which has a significant impact on gold prices.
The converse is true in the case of silver. For silver, industrial fabrication and electronics consume more than 75% of silver supply as per the Silver Institute. This makes silver a lot more dependent to industrial cycles compared to gold.
Divergences in gold and silver prices are not new and have always been sharp around the times when either there is global uncertainty or when there is industrial optimism. The winner is decided accordingly.