Silver Is Leading

2008-FEB-10

The price of gold and silver rarely move at the same rate. The reason for this outcome is that their respective demand is fundamentally different. To put it into economic terms, the demand for gold is inelastic, while that for silver is elastic. In other words, the demand for silver is very sensitive to changes in its price, while in contrast, the demand for gold is relatively insensitive to changes in its price.

The result is that in precious metal bull markets, the price of silver typically rises faster than the price of gold, and vice versa in precious metal bear markets. This relationship is made clear by the following chart of the gold/silver ratio, which shows how many ounces of silver it takes to purchase one ounce of gold.

As precious metal prices peaked in January 1980, it took only 16.7 ounces of silver to buy one ounce of gold. Thereafter as precious metal prices fell, the ratio began climbing. In February 1991 it took 101.8 ounces of silver to buy one ounce of gold, at which point the ratio reversed course. Since then the ratio has been falling, indicating that the precious metals are in a bull market. The ratio is now 53.8, and I expect will in the years ahead eventually fall to the January 1980 level. In other words, silver is leading.

Since 1991 its price has been rising faster than that of gold. Silver has risen 4.9 times compared to gold's 2.6 times. However, for nearly a year, gold has been rising faster than silver. This short-term uptrend in the ratio can be seen on the above chart, with the ratio climbing and then staying above its 40-week moving average. But this trend is about to change in favour of silver.

The ratio looks ready to fall below its 40-week moving average and resume its major downtrend. This event would bode well for silver, which is an outcome consistent with the following chart.

Silver continues to follow the same pattern from the first pennant. If history continues to repeat, silver will soon exceed $20.

Importantly, silver is also looking very good in terms of other currencies. The following charts present silver in terms of the Euro and British pound.

In summary, it looks like the short-term trend in the gold/silver ratio will soon be in harmony with its long-term trend, with both trends falling. This event combined with the strength silver is displaying against various currencies could mean that a powerful rally in silver is just around the corner.