It is often said where gold goes, silver will follow and for the most part this is generally true, but no-one is ever quite sure why! For two commodities of such contrast, it seems strange that one follows the other, since the fundamentals of supply and demand are so very different. Gold is used as jewellery, particularly in India which consumes around 58% of worldwide production, and as a monetary reserve by central banks and the IMF. Gold as I’m sure you know, does not get consumed, but is merely added to the stockpile around the world. Silver on the other hand is mainly an industrial metal, and no central banks hold it as a reserve. It is therefore consumed in a variety of consumer products year after year, and is generally the by-product of base metal mining such as copper, lead and zinc. Increased demand for silver does not lead to economically significant increases in its output, whilst increases in the supply of copper, lead, and zinc do lead to increased supplies of silver.
Silver is a bit of a different animal, but does tend to ride on gold’s coat tails – but in a far more volatile manner given its production patterns and industrial usage.  If gold does surge upwards, then silver may do even better in percentage terms, and conversely if gold falls then there is the distinct possibility silver may do even worse. Whilst this relationship certainly exists, silver is being used increasingly in industrial production, and is therefore more likely to suffer and benefit from changes in the economic climate, and perhaps interestingly its perception may change from one of precious metal, to industrial raw material. Demand from industrial consumers has been patchy with a downward bias throughout 2008 following the early recession, with silver mining supply having increased from previous years. This is likely to have a negative effect on prices as the market has to digest higher silver supply, amid a much slower industrial growth rate throughout 2009. So as we can see, whilst the two metals do correlate there are very different pressures on each, which can and does make correlation comparison more of an art than a science for this relationship.

One of the key technical’s that traders and investors use to try to analyse this relationship is that of the gold/silver ratio. This is a simple ratio of the price of gold in US dollars per ounce, divided by the price of silver in US dollars per ounce, so if gold is $1000 per ounce and silver is $10 per ounce the ratio is 100:1. For most of the 19th century this ratio was fixed at just over 15, but since relaxation of this fixing mechanism has risen as high as 98, and currently stands at around 78 in early 2009. In simple terms the higher the figure then the stronger the gold price and the weaker the silver price, with a falling ratio indicating strength in silver and weakness in gold. Alternatively it could mean that both are rising but that silver is rising faster! As with any ratio, whilst this is of interest, it should only form part of a broader analysis, as it is impossible to say what this ratio should be! This relationship has only ever been upset on two occasions, the first of these was the Hunt Brothers attempt to corner the silver market, with silver prices surging to new highs even though the markets in general were more positive on gold than silver at the time, and secondly as result of Warren Buffet’s large purchase of silver bullion during the late 1990’s, which again surged on the buying. Buffet later sold all his silver quietly back into the market and was out of silver completely by mid 2003.

As I have said earlier, this ratio currently stands at around 78:1 with gold at $825 per ounce and silver at around $10.50 per ounce. Now any geologist will tell you that silver exists naturally in the earth’s crust at a ratio of 14 times that of gold, which was one of the reasons that the original ratio was fixed at 15:1, but whilst many analysts are forecasting a return to this ratio, based on the available resources, this simplistic view does ignore some of the other more fundamental facts.  Firstly, silver is primarily an industrial metal, and as we have seen the bulk is consumed, and therefore its price is dictated by world and economic events, rather than any investment potential. Secondly silver is consumed, gold is not, therefore at some point one could argue that silver could become more valuable than gold since at some stage there will be none left – in other worlds gold would increase in value, but silver would increase faster. Thirdly, gold is classified as a precious metal, whilst silver is classified as an industrial metal, and finally gold will always have the Veblen goods aspect to its ownership, where higher prices attract increased sales, simply by virtue of its history and the statement of wealth that ownership bestows.

Having said all that, my own personal view is that this relationship is high at the moment, and I would expect it to fall, once the current economic turmoil calms ( which may take a few years) and markets return to more normal trading conditions. Some analysts are suggesting that this ratio could return 15 or even 10, such that if gold were $2000 per ounce then silver would be $200 per ounce. Personally I don’t see it going to that level, more realistically to something like 30:1 ( which is the mean for the last 350 years), but I do see silver as a good long term investment, whatever the ratio with gold may be.