Precious Metals Watch – Silver’s revenge

by: Georgette Boele

Silver is back in favour… because of an improvement in the industrial demand outlook… and demand from investors. Silver prices have rallied sharply … and there was a sharp drop in the gold/silver ratio. We think that it is far from over … and our silver forecasts are under review.

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Silver is back in favour…

Silver has been the strongest performing precious metal year-to-date rallying by more than 23% versus the US dollar. Initially silver prices profited from the rally in gold prices at times that market sentiment deteriorated. More recently the behaviour of silver prices has changed. Whereas the rally in gold prices hit a ceiling of around USD 1,280 per ounce in March, silver prices have continued to rally. The overall outlook for silver has improved resulting in a sharp surge of investor positioning into silver. Why is silver back in favour?

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…because of an improvement in industrial demand outlook…

The main difference between gold and silver is that silver has substantially more industrial applications than gold. When the overall outlook on China became less negative as Chinese data stabilised, the industrial demand outlook for platinum, palladium and silver improved. Also a stabilisation in the global PMI has helped. As a result, the negative sentiment towards these cyclical precious metals eased and they have started to outperform gold prices.

Another factor that has played a role in our view is the announcement on 29 February of the Indian government to levy a 1% tax on gold jewellery. The government has as aim to reduce the current account deficit; gold and oil imports are mainly responsible for this deficit. It continues to take measures that aim to reduce gold imports. This could have supported Indian silver imports. If this proves to be correct the divergence between gold and silver imports should continue (see graph below).

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…and demand from investors

In the period 2011 to 2015 silver prices fell by more than 55% or 71% from its peak set 28 April 2011. No other precious metal has lost so much of its value up to now. This made silver a relatively cheap precious metal at the start of this year. This could have been an important reason for consumers and investors to buy silver. Silver prices are supported in a risk averse environment as it moves in tandem with gold prices while it also profits from a lower US dollar and improvement in the industrial demand outlook. As a result, investors have piled into silver positions. Speculative long positions in silver have risen to a new all-time high, while net-positions (longs minus shorts) are at excessive levels not seen since 2005 (graph below). Total ETF positions have also risen again.

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More upside in silver prices from here?

There is one remarkable feature about silver price behaviour. In the period 2012 to mid-2013, behaviour of speculative investors dominated the direction in silver prices. Since then swings in net-positioning have been more substantial than absolute price movements (see first graph above). What is more, changes in total ETF positions seem not to have been a crucial driver of silver prices since 2011 (this in sharp contrast to gold prices that has a strong positive relationship with total ETF positions). In fact these positions have modestly increased while silver prices fell sharply (see graph below). Therefore, we are more cautious in concluding that the silver rally is over because speculative long positions are at all-time high.

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We have also looked at various other silver ratios. For a start, Brent oil/silver ratio is on very low levels and we expect a pick-up because of Brent oil prices outpacing silver prices before the end of this year. The copper/silver, platinum/silver and palladium/silver ratios are relatively low and we expect some higher levels going forward. Last not but least, the gold/silver ratio has dropped by around 12% over the recent weeks. This may be a considerable move, but in historical context it is just a start (see graph below).

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The long-term average in the gold/silver ratio is around 57 (since 1970s). We think that a move back to 60 in the gold/silver ratio is quite likely. However, this means that silver prices will have to rally far beyond our current silver price forecasts while gold prices will then only rise modestly.

China’s support measures are supportive for car sales and fears that China’s commodity demand is plunging are receding. In addition, we expect economic data from the US and the eurozone to improve during the course of this year and next year. Hence, the demand outlook for platinum, palladium and silver will likely improve resulting in further upside in prices. Overall it looks like that our forecasts for cyclical precious metals and especially silver are too conservative.

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