Confident in Gold? Perhaps, Now Is The Time To Buy Silver

If you have confidence in gold, now could be the time to buy silver

Recent days have seen a sharp falling off in the gold price post the comfortable Macron victory in the French Presidential election. This is a major turnaround for gold.

Many had seen the metal heading to $1,300 and higher. This consequently has led to an even bigger percentage drop in the silver price. This fact is illustrated especially well through the Gold–Silver Ratio or GSR.

Essentially represented by the weight of silver it takes to buy the same weight of gold, the GSR is at its its highest level since mid 2016.  At the time of writing, it was sitting at over 75; three weeks earlier it was sitting at under 69.

What is the Gold–Silver Ratio?

The late Ian McAvity, who passed away just over a year ago, was one of the most perceptive of commentators on the GSR.

He noted that over the years it's likely the ratio’s ranges had changed. Out and out silver bulls tell us that the historic ratio is around 16:1 and thus silver is hugely underpriced vis-à-vis gold.  It is worth noting though that the last time the GSR saw this level was 37 years ago when the metals’ price was hugely distorted by the Hunt Brothers’ nearly successful attempt to corner the silver market and make an enormous investment killing.

McAvity thus suggested that the silver investor should keep the current high and low GSR numbers range in mind. He recommended that if you can get an ounce of gold for 40 or less ounces of silver, then you should take the gold. On the other hand, if an ounce of gold can be exchanged for 80 or more ounces of silver, take the silver.

Fluctuations in the GSR over the past 30 years do suggest that this would have been a very profitable policy, but it does fall at the extremes and we feel that a narrower range to follow may be even more apposite.

Silver Becomes Core Asset in Bullish Markets

However, McAvity warned, "But don't ever forget that silver is a smaller market with much greater price volatility. A big part of that decision should factor in just how much sleep you are willing to sacrifice... as silver tends to be a real 'tummy tester' when silver interest is running high. That's how I view silver as a core asset. In bullish markets, it often becomes 'Gold on Steroids...'"

Personally, I would thus narrow the markers somewhat to a GSR of 75, or thereabouts, to buy silver and 50 to switch to gold, but note that there is a huge overhang in silver with JP Morgan reportedly having built up an enormous silver inventory. At the same time the bank apparently holds perhaps the largest short position in silver.

This may appear to be something of a contradiction – but one that enables the bank to pretty much control the silver price.

The Key to Silver is Hidden in Gold

Whether JP Morgan is breaking regulations — or even the law — is something of a controversial issue. If it is breaking the law, its regulator is turning a blind eye, and has been for some time.

JP Morgan’s silver dominance can be traced back to when it was coerced by the Bush Administration to take on the failed Bear Stearns bank back in 2008. Changes at the regulator may lead to increased questioning of JP Morgan’s and other banks’ roles in silver price control, but don’t hold your breath!

The overriding key to holding silver almost certainly remains the strength of the gold price. History has shown that in a gold bull market the more volatile silver tends to outperform its yellow cousin. This is what McAvity referred to as ‘gold on steroids.’  But this, too, can yield a separate spate of problems. Assuming it does reach this level, it's recommended to switch into gold at a GSR of 50:1.

Small Market, Big Money

Silver investors tend to get carried away by seemingly unending price growth prospects when the metal is doing well. One only has to look back six years to see what effect this can have.

In early April 2011 the silver price peaked at around $50, after a meteoric rise from around the $20 level only nine months earlier. Then the banks and the big money cried ‘enough’ and used the futures' markets to bring the price back down sharply.  Silver is a relatively small market, so with some highly vulnerable short positions exposed, the big money moved to protect itself and bring down the price.

This is akin to when the Hunt Brothers had managed to drive the silver price up to a similar level based on the London silver fix back in early 1980s. At the time, the spot price actually went far higher. In the case of the Hunt Brothers, this was aided by new legislation on margin calls, probably implemented after substantial lobbying by the bullion banks, which the brothers were initially unable to meet.

More recently the GSR actually rose to over 80 last year, providing a great buying opportunity on the McAvity recommendation. Those who bought silver at that level will have seen some very strong gains if they had then sold at the GSR level of 68 or 69 we saw only a few weeks ago. We think that under a current GSR scenario, a level of between 75 and 76 represents another excellent buying opportunity as gold would still seem to have a good upside, despite its recent weakness.

Gold Demand Still Strong in China & India

If gold does get to $1,300 or higher, as it could easily do with more geopolitical worries ahead, then we could see the GSR perhaps coming down to 65, or even lower.

This scenario would put the silver price back at $20 – around a 24% gain at the time of writing. Some groups, like Credit Suisse, are still predicting gold hits $1,400 this year.  The prospective gain then could be even greater if the GSR continues to fall, as it tends to do when the gold price rises.

There is mixed opinion on global gold demand. The World Gold Council (WGC) in its latest Gold Demand Trends publication sees gold demand in Q1 sharply down on that recorded at the same time last year. Still, within the overall mix demand seems to be picking up strongly in India and China. Between them they imported at least 250 metric tons of gold in March alone.

Given that the amounts of smuggled gold into India are anecdotally still running high, and that Chinese gold imports are calculated from known sources only, there’s a strong likelihood that March demand from these two leading gold consuming nations may have exceeded the total amount of newly mined gold produced globally that month; we estimated this number to be around 260 metric tons.

It seems bar and coin demand in China and India may have been sharply higher than a year earlier.

Elections in Europe Affect Precious Metals

European investment demand was also strong because of the political uncertainties in the continent. This demand was engendered by upcoming elections in France, the Netherlands, and Germany, as well as ongoing uncertainties over Brexit. But, judging by the extremely low levels of gold coin sales by the U.S. Mint, investment demand in the United States was extremely muted.

Gold ETF inputs, although positive, were sharply down a year earlier as well. These coupled with assumed lower Central Bank purchases led to what the WGC estimates to be an 18% decline in global demand after last year’s record Q1 levels.

Of course, this estimate is largely due to China reporting a zero increase in its gold reserves ever since the yuan was admitted as a constituent of the IMF’s Special Drawing Rights in October last year.

Silver: The Devil's Metal

Silver does offer increased volatility over gold, which could be seen as a benefit or a danger.

After all, it’s not known as the 'Devil’s metal' by some traders without reason. While an investment in silver is probably not for the proverbial widows and orphans, it still can be a great choice in a rising gold price scenario. Downside risk is probably limited too.

And, of course, the big bullion banks currently holding and shorting silver could easily change tack. They have the potential of making enormous profits should they wish to do so. At some stage they are almost certain to.

If and when this happens, silver investors could be in for a very strong ride indeed. It will happen eventually, but there's no telling when exactly for sure.

However, in the meantime it could be well worthwhile putting some of your precious metals investment into silver. There probably won’t be any warning when gold eventually takes off, but when it does look out for the silver ‘steroid effect.'

The gains could be very strong indeed.

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