Silver Outperforming Gold During September; Trend May Continue

17 September 2010, 2:27 p.m. EST
By Allen Sykora
Of Kitco News

(Kitco News) -- Silver has outperformed gold so far during September, and the trend may well continue for the foreseeable future, traders and analysts said.

“In a normal bull market for the precious metals generally, one of the hallmarks would be that silver gains upon gold,” said Dennis Gartman, publisher of the widely followed The Gartman Letter. “That is in fact what is going on right now.”

The performance of the two metals against one another is commonly measured by the gold/silver ratio. This is calculated by dividing the price of an ounce of gold by the price of an ounce of silver. If the ratio rises, gold is doing better. But if the ratio falls, it means silver has the upper hand.

The latter has been the case lately. At the end of August, the ratio for the Comex December gold and silver futures contracts was 64.34. As of Thursday’s close, the ratio had fallen to 61.32.

“We can expect to see the gold/silver ratio continue to decline and that the precious metals will probably continue, on balance, to advance,” Gartman said. “And we’ll get an inkling that the bull market in precious metals is ending when we have several days when prices are going up and gold actually begins to gain upon silver. That would be a signal to be concerned that you’re getting close to the end of the bull move.”

Based on average monthly prices for the metals, the average gold/silver ratio since January 1998 has been 67.56, said Bart Melek, global commodity strategist with BMO Capital Markets. Going back to 1976, the ratio averaged 59, with a low of around 18.55 in January 1980 and a high of 97.72 in February 1991.

BMO looks for gold to average $1,300 in 2011 and silver to average $21. This would be a ratio of 61.9.

“But that’s an average,” Melek said. “I could see it going below 60, certainly.”

Some market participants try to profit by betting on the ratio. Somebody who expects silver to outperform might buy silver, but sell gold, normally in equal dollar amounts.

This in fact has been occurring in recent weeks, said George Gero, vice president with RBC Capital Markets Global Futures. “I expect it to go below 60, maybe to 50-55,” he said.

Gijsbert Groenewegen, managing partner of Silver Arrow Capital Management, looks for the ratio to eventually fall below 52. “You could see a catch-up in silver,” he said.

The decline in the ratio seemed to gain technical-chart momentum as it broke through the 66 to 67 area, said Peter Grant, senior metals analyst with USAGOLD - Centennial Precious Metals. “I think the ratio could ease a little bit more,” Grant said.
Liquidity Issues, Industrial-Use Outlook Helping Silver Outperform Gold

Groenewegen said that the liquidity difference between the two markets often means silver makes bigger moves than gold.

“The silver market is much thinner than the gold market, which is really deep,” he said. This means smaller orders have greater potential to move the silver market. “So when a big investor comes and scoops up some silver, you could percentage-wise see a much higher, higher price.”

As gold becomes more expensive per ounce, investors sometimes turn to silver as a cheaper alternative, observers said.

In fact, the number of open positions in Comex silver has risen more dramatically than gold so far this month, Gero said. As of Thursday, gold open interest was up 3.4% so far for the month to 597,207 lots. However, silver open interest was up 11.9% to 146,441, according to data on CME Group’s Web site.

Also, Barclays Capital said Friday that the amount of silver held in the world’s silver exchange-traded products has risen by 155 metric tons so far this month, while gold holdings were nearly flat. ETFs trade like a stock but track the price of the commodity, with metal put into storage to back the shares.

Meanwhile, whenever hopes arise for a stronger global economy, silver has the advantage in that more demand comes from industrial uses.

“We’re actually quite positive on silver,” Melek said. “In fact, we’re more positive on silver and PGMs (platinum group metals) than we are gold.”

Silver is benefitting from its role as a precious metal, just as gold is, Melek said. Investors buy them as a safe haven in times of economic and geo-political uncertainty.

In addition, some investors are said to be looking to gold as a hedge against inflation that they fear may come about whenever the economy recovers, particularly due to fiscal-stimulus spending and loose monetary policy.

“During those periods where there is general optimism in the world, you would probably have better demand on the industrial side for silver,” Melek said. Slightly more than half of silver’s annual demand is for industrial uses, such as electronics, solar panels and health-care applications, while a small percentage of gold’s demand is industrial.

For many of these industrial applications, the silver is essentially used up, with quantities in some products so tiny that it’s hard to recycle the metal.

By contrast, Gartman said, “you never lose gold.” The yellow metal tends to end up in investment bars, coins or jewelry, all of which can be resold, thus does not disappear like other commodities such as oil, corn or sugar.

“On the other hand, silver is lost in its various usages through industry,” Gartman said. “So silver is almost always in deficit production. It’s always been that way, and I’m sure it will always be that way.”

While the economy remains soft in many Western nations, there are expectations for a recovery, meaning more manufacturing demand for silver, Melek said. “Combine that with a somewhat constrained supply side of the equation…silver is going to get relatively scarcer,” Melek said.


By Allen Sykora of Kitco News;