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Silver vs Oil

Many economists and industry experts suggest that there is a strong correlation between the spot price of gold and oil, and typically this analysis relies on data covering a long period of time, which tends to flatten out any inconsistencies in the theory. In general these theories suggest that when the price of oil increases so does gold, and when the oil price falls, then gold prices will follow. If we assume that gold and silver have a relatively consistent and direct correlation also, then it is logical to assume that silver and oil must have the same relationship as gold and oil, in other words as oil prices fall, silver prices will also fall, and as they rise so will oil.

If we go back to the 1970’s and the long bull run, the correlation between the two commodities was around 0.80, so that prices generally moved in the same direction, a relationship which remained in place throughout the huge rise in commodity prices in the early 1980’s, falling only marginally to around 0.75 until the early 1990’s at which point the two diverged. Since 200o and onwards the correlation has been closer again varying between 0.60 and 0.70. It is important to realise that in trying to establish any correlation or relationship between the two, in effect what we are trying to do is to price oil in silver, and not in gold or dollars, and herein lies the problem. Put simply, gold is money, whereas silver is not, and despite what many contrarians and bankers say, this is a fact of life. Now some will argue that silver is money, and it is this dichotomy of views, and indeed of the commodity itself, that causes the problems in arriving at any meaningful view. Silver in a sense cannot decide whether it is a precious metal, or an industrial commodity. So is the relationship to other base commodities more important, such as copper, or zinc, or does it trade as a precious metal, and relate to gold?

On one level, this could be argued in a very simple way, in the sense that mining is an extremely energy intensive business, and therefore as oil prices rise, then the price of metals should rise as a result, since the costs of extraction and purifying are also rising. Similarly as prices fall, then the costs should also fall, making it cheaper. This however is an over-simplification, since it ignores some of the other factors which affect the price of silver of which oil is one, such as supply and demand, government stockpiling and industrial consumption. One could also argue that silver and oil should correlate more closely than gold and oil, for the simple reason that the two are industrial commodities, whereas gold is simply a precious metal. Silver, like oil is consumed, never to be replaced, and whilst it may not have the same global implications, it has more significant commercial and industrial applications than many may realise. Thirty years ago, there was much more silver available, and yet in relative terms silver is 10 times cheaper today and according the the Federal Reserve would have to reach $130 an ounce in order to equate to the price in 1980 in today’s terms.

My own view is that as traders and investors we often look for relationships to confirm our decisions, and sometimes these are just not there. In this case I think this is a case in point. My personal view is that whilst oil prices undoubtedly are a factor, they are only one of several, and probably play a greater part indirectly in their effect on the value of silver related stocks, rather than directly on the spot silver price itself. We can often find relationships when back testing – whether these relationships hold good for the longer term is the key. Personally I do not believe that the silver oil correlation provides anything meaningful for us as traders, but I am always happy to be proved wrong! Fundamental data is always hard to find when analysing silver and silver prices, but since 70% to 80% of production comes from gold, copper, lead and zinc mining, it is not unreasonable to assume that changes in these and other related industries will have a far greater impact on silver prices, than that of an indirectly related commodity such as oil.