Silver prices have underperformed gold for most of the time since 2011. Annual average gold prices rose more than those of silver every year from 2012 through 2019 with the exception of 2016, and into the first quarter of this year. During this time many proponents of silver investments have repeatedly suggested this would reverse imminently. This year, it has, but only after the price of silver fell to a historically low value relative to that of gold. The gold:silver price ratio rose to a record 126:1 in the middle of March 2020. Since that time it has fallen to 74:1.

In the third week of July 2020 silver prices broke out of the $14 to $20 price range in which they have been caged for the most part since the second half of 2014. After breaking out of this long held range, silver prices raced sharply higher, rising to an intraday high of $29.91on 7 August basis the nearby active September Comex contract. If past performance is any indicator, this could be the start of another sharp run up in silver prices. And past performance has been a fairly consistent indicator in illustrating that silver prices outperform gold in a time when gold prices are rising sharply, a gold price rally. As can be seen in the table below, silver prices have outperformed gold almost every time during periods of rising gold prices since gold prices were freed from their dollar peg in 1968.

CPM Group has stated that silver prices out-perform gold ‘most of the time’ when gold prices are rising, or are in a bull market. We were asked to study the extent to which this was true and/or if silver always out-performed gold. The table here shows the data used in the study.

Based on this data and its analysis, it can be seen that silver in fact almost always but not always out-performs gold during a gold bull market. The quantitative relative performance depends in part on the time frame over which silver’s performance is measured. Two sets of silver price increases are measured here. The first set of silver price data uses the same dates as gold’s troughs and peaks for measuring silver’s performance. The second set of silver price data is measured from silver’s troughs and peaks that are close to or ‘in the same cycle’ as the periods of gold price increases. When using the same dates as gold, silver outperformed gold on every occasion but one (more detailed discussion on this later). When using silver’s troughs and peaks that were close to or ‘in the same cycle’ as the periods of gold price increases, silver always outperformed gold and the percentage gains were also much stronger than when using the other time frame.

What Contributes To Silver’s Out-Performance

There are several reasons why silver often lags gold in starting a major upward price move, but then rises faster in percentage terms. One of the most important is that the silver market is significantly smaller than the gold market. In 2019, for example, the dollar value of the gold market was around 5.5 times that of silver. {The market size for gold and silver is defined here as the summation of annual physical supply (comprised of newly refined mine output, secondary recovery from scrap,  and in the case of gold net official transactions in those years when the official sector has been a net supplier of gold to the market), futures and options exchange trading volume, and London Bullion market clearing volumes.}

Given the smaller size of the silver market it takes less effort for investors to move the price of the metal higher or lower. The smaller size of the market essentially increases volatility, which while supportive of outperformance compared to gold when prices are rising also adds risk to the performance of silver as a stand-alone asset and to any portfolio in which precious metals are included. (This is a topic discussed in greater depth in the second part of this series.)

Also, while the silver market is very liquid, it is relatively less liquid than the gold market both in terms of depth and breadth, with fewer institutional investors, retail investors, bullion banks, and trading companies interested in the silver market versus gold. This lack of liquidity also contributes to sharper moves in silver relative to gold.

Silver Typically Lags And Then Outperforms Gold

It has been repeatedly observed that the gains in silver prices typically lag those of gold. There are various factors at work that are potentially responsible for this. For one, as mentioned before, more investors and more types of investors buy gold than silver. Some not all, gold investors jump the gun on buying gold at the first whiff of economic or financial market troubles. Other gold investors and silver investors as a group appear to be more circumspect and hold their fire for a while longer.

Furthermore, silver investors repeatedly have demonstrated a willingness to sell their silver when the positive sentiment toward the metal fades. As a group, investors have repeatedly been net sellers of silver for long periods of time, showing themselves to be much more opportunistic than many but not all gold investors.

This is not the case with gold. Gold investors tend to buy less gold when the sentiment sours but they only rarely and for short periods of time turn into net gold sellers as a group. Since silver investors will sell silver, some of that silver will back up in market makers’ inventories. These market makers tend not to be particularly price sensitive since they are hedged. Market makers by definition sell when investors or others in the market want to buy and buy when investors want to sell. Because silver investors turn net sellers when sentiment sours, those stocks that were sold earlier by investors get backed up in market maker inventories and they come out sooner, keeping the silver price down longer than gold, which does not face this challenge.

Lastly, because silver has several industrial uses, economic distress hurts fabrication demand for silver more than for gold, which initially weighs on silver’s price. Silver investors are and have always been a more dominant force in influencing prices than fabricators. Generalist investors typically divert their attention toward silver only when gold starts to rise strongly, however. This delayed attention from generalists also tends to contribute to the lag in silver price performance relative to gold.

What We Expect This Time

From the end of 2019 through 14 August 2020 the price of silver was up 46% basis the nearby active Comex contract. Almost all of these gains have occurred since 20 July 2020. Silver prices were up only 10% between the end of 2019 and 17 July. Prices have softened in recent days: Silver prices had been up 54% on a settlement price basis on 10 August from the end of 2019.

            Is silver playing catch up or is it out-performing gold?

After years of underperformance relative to gold, reflected in the sharp increase in the gold:silver ratio, the silver price is now playing catch up with gold. The ratio has slipped lower but is still at historically elevated levels.

Furthermore, while the daily gold price broke its past record and already has made several new ones, the price of silver at the height of its current run up on 7 August 2020 at $29.91, still is 39% below its record high in 2011. That said, since July 17 2020, the price of silver has outperformed that of gold, rising 32% versus gold’s 7% gains over the same period.

To date, silver is playing catch-up. For a new investor entering the market as a buyer now, silver is outperforming gold. For a long-time holder of these metals, silver is playing catch up. The answer lies not in the actual price performance but in the perspective of individual observers and investors.

            How sustainable is the strength? 

Even though silver prices already have risen sharply so far this year, there is more potential for upside in the short to medium term. There are several key resistance levels to be crossed but a run to silver’s past record should not be entirely surprising.

Some readers of this note will question the strength in silver prices given the weakness in silver fabrication demand resulting from the decline in economic growth. While fabrication demand no doubt plays an important role in the silver market, investment demand always has been the more dominant factor in influencing the price of the metal. Silver’s investment demand is driven by both expectations of fabrication demand for the metal as well as a hedge against macroeconomic and political risks. At present, the more dominant factor driving silver investment demand is its use as a hedge against risk.

Investor sentiment toward silver is turning extremely positive. This positive investor sentiment is being driven by investors looking for a hedge to the heightened political and economic risks around the world coupled with silver’s relative value to gold.

Additionally, the recent break out of silver prices is likely to attract generalist investors looking for relatively undervalued assets to park their funds and the negative yield on the 10-year TIPS certainly makes assets like gold and silver attractive. The upcoming U.S. election, Brexit, deteriorating U.S. –China relations, and the pandemic give further reasons for investors to add gold and silver to their portfolios, which should help sustain the strength in prices.

While silver prices could potentially rise back to their record levels, they may not be able to sustain those high levels for an extended period of time, with some of the shorter term investors locking profits and fabrication demand being hurt by the high price. That said, while prices may not stay at those past record levels for too long and will come off they should not be expected to sink back to the levels experienced in recent years, or even earlier this year, in any hurry. The fallout from the pandemic should help to keep the prices of these metals at elevated levels for a long time.

The key to future silver, and gold, price trends lies less in the levels to which these metals prices already have risen and will be more a function of the underlying environmental factors, economic, financial, political, social, public health, that push investors to buy more or less silver and gold. That will determine the peak, more than any given price level.

The pandemic and subsequent global lockdown have shaken the global economy to the core, and the negative economic fallout of these events is expected to have a lasting negative impact on commercial real estate values, air travel, and jobs due to the acceleration of automation, to name a few. Governments and central banks around the world have rushed to provide support to the economy from this shock, which has injected a flood of money in the markets that is looking for yield. The increased liquidity in the market has pushed rates into negative territory, making non-interest bearing assets like gold and silver appealing to investors. These all are expected to be important factors stimulating investment demand and consequently pushing silver prices up in the near to medium term. Additionally, while silver prices have reduced the deep discount at which they were to gold prices only recently, silver still is undervalued relative to gold. This suggests more room for silver prices to rise in the medium term. The gold and silver bull markets appear to be still in their early days; this is especially the case for silver, which has begun rising sharply and has broken out of some critical resistance levels only three weeks ago.

            Where do the two metals’ fundamentals factor in?

The already sharp increase in gold and silver prices coupled with relatively weak economic conditions in the near to medium term should both weigh on fabrication demand for these metals. Strong investor demand for these metals in the face of the economic and political issues facing the United States and the world should more than offset any weakness in fabrication demand for the metal in coming quarters, however.

On the supply side, it will be years before the sharp gains in prices seen in recent weeks and months will impact mine supply. Miners also have become more cautious about spending on expansions after the last bull market in these metals, given their build up of high debt levels and developing of low quality assets. So any positive impact of stronger prices on mine supply should not be expected for several years out. Secondary supply of these metals is typically more responsive to prices and economic conditions and should be expected to rise. This will be a headwind to prices but not a factor that can drive prices sharply lower.

            How to navigate around the marketing and beliefs

Investors need to be cautious. While the outside world is encouraging investors to stock up on silver, the reality is that large portions of the investor anxiety driving investors into silver can disappear quickly. While we say that the price levels are less important that those exogenous factors, high prices due and will have an effect on prices.

CPM’s view is that prices of gold and silver are likely to rise for years. We stated in 2000 that we saw a ‘golden renaissance’ that would bring more investors in more parts of the world into the market buying more gold for a longer period of time at higher prices than ever before. There was an upward shift in the investment demand curve for gold and silver on a semi-permanent basis.

We said that gold and silver were into a secular bull market that would last years if not decades. When prices peaked in the Global Financial Crisis and Great Recession of 2007 – 2011, we projected of a cyclical downward move in prices that could last 3 to 5 years within the context of that secular bull market, saying we expected prices to resume rising at some point after 2015 – 2017, because all of the economic and political issues that were driving investors to buy gold remained un-repaired, and in many cases had worsened and would worsen further.

All of this still seems a valid and rational outlook for silver and gold.

That said, there clearly are wildly unsupportable comments about silver and gold circulating the market by precious metals and mining marketing groups, believers in the faith that says the economic imbalances that have built up since the 1970s can only be resolved by a catastrophic failure of the global financial system, and others who seemingly have ignored silver and gold market fundamentals, including the enormous amount of silver and gold previously bought by investors that can be sold for massive profits during periods when the economic and political environment look a little better.

This is what happened from 2012 until around 2017, much to the chagrin of the believers and marketing agents. It should be expected to happen again.

This first part of this three-part series has covered silver’s relative outperformance to gold and CPM’s expectation that this outperformance is only beginning to play out in the current cycle. These sharp gains in prices come with additional risk, which is not every investor’s cup of tea. The risk inherent to silver is discussed in greater detail in Part Two of this three-part series on The Nuanced Silver and Gold Relationship.