Is Silver Ready to Move Higher?

2010-AUG-07

It is gold - and not silver - that gets all of the attention being given to the precious metals these days, and why shouldn't it? After all, gold has risen nine years in a row against the US dollar and appreciated during this period at an impressive average annual rate of 17.1%. In a continuation of this trend, gold is up 9.9% year-to-date, making it one of this decade's best performing asset classes. But don't overlook silver.

Though it has risen only seven of the past nine years, silver's 17.6% average annual rate of appreciation during this period is actually higher than that achieved by gold. This year silver has risen 9.7%, approximately the same as gold.

The implication of these similar rates of appreciation is that the gold/silver ratio, which is the number of ounces of silver that equals the value of an ounce of gold, is little changed this decade. This result though masks silver's characteristic volatility.

Though the gold/silver ratio is little changed from the beginning of the decade to the present, it has been in a broad trading range that actually extends for nearly two decades, bound between 46 and 84 ounces of silver to equal one ounce of gold. This trading range is delineated by the horizontal red dotted lines in the following chart.

There are three clear conclusions from this chart. Given the fluctuations in their ratio, silver is a lot more volatile than gold. Just look at how the ratio rose in the 1980s from 17 at the beginning of the decade to 100. That level of volatility means that silver is not for everyone.

The second conclusion is that compared to gold, silver is still relatively cheap. In other words, their ratio remains relatively high compared to historical experience.

Third, note the downward sloping red lines on the above chart. The gold/silver ratio is in a downtrend, meaning that from 1990 to the present, silver has outperformed gold.

So should you own some silver in your precious metal portfolio? The fact that it is still relatively cheap compared to gold is only one compelling reason to answer this question in the affirmative. There are other reasons too.

Ignoring for the moment their different price, owning an ounce of physical silver is like owning an ounce of physical gold. Both accomplish the same thing. Both are tangible assets, and that means they do not have counterparty risk because physical metal is not a financial asset. The value of gold and silver does not depend upon anyone's promise. But there is another important factor to consider.

Silver has never been confiscated by any government. This characteristic alone makes it worthwhile to seriously consider owning some physical silver.

Another factor to keep in mind is that the following chart is very bullish.

Silver has been an accumulation pattern for more than three years. It is now near the neckline of that pattern, which itself is drawing to a conclusion. If silver completes this pattern in a way that one would normally expect by breaking higher and as a result hurdles above $20.50 or so, silver would likely be starting another leg higher. The target for this next leg would be $30, using normal technical analysis measurements.

So there are several compelling reasons to consider adding physical silver to your precious metal portfolio, but why isn't silver receiving the same attention as gold? Silver is still in stage one of its bull market, while gold is already in stage two.

Bull market first stages are always marked by apathy, if not downright neglect, and disbelief that any uptrend is sustainable. Those conditions explain what happened to gold, for example, when it was under $1,000 an ounce. Only when it hurdled that psychological barrier did gold start receiving widespread attention of its attributes and upside potential. It is the same kind of attention silver will be receiving when it enters its second stage, which is when it clears $50 per ounce - its record high price going all the way back to January 1980. That achievement would definitely put silver at centre stage.

So if you can handle the volatility, silver makes sense for your precious metal portfolio. A mix of 70% gold and 30% silver gives a portfolio the opportunity to take advantage of silver if it outperforms, but without subjecting it to too much volatility. And of course, if you do decide to add some silver, the prudent choice is to make sure it is physical silver and not any of the paper-silver varieties that have become so prevalent.