Gold/silver ratio hits lowest level since December 2006

2011-FEB-15

The global economic recovery is gaining traction. Several leading indicators, such as business and consumer confidence, are pointing towards a solid recovery of services and manufacturing activity in Germany and the United States. In spite of a slow recovery in the West of give or take 1.5 to 3%, Asia is still growing at a 6 to 8% annual rate. More importantly, the global economy is growing at 4% annually, which is quite a healthy backdrop. Companies with a global foothold, such as Caterpillar and UPS, which are good indicators of economic health as they are major suppliers of capital goods and services across the globe, are in good shape, and that buttresses our view that economic growth is not decelerating.



Gold has been consolidating for some time. Silver has also corrected quite sharply, which is normal after an 80% rise in 2010. Silver needs a breather right now. Interestingly, the gold/silver ratio has hit the lowest level since December 2006. Although inflation worries have not abated, investors are less worried than a few months ago, which has lowered gold demand as it is a purely monetary asset. Silver on the other hand is a metal with industrial and monetary components. If the global economic recovery continues, silver is set to outperform. An ounce of gold buys 44.5 ounces of silver today. This corresponds with a gold price of 1361.5 USD and a silver price of 30.6 USD per ounce. Although the downward potential of gold is likely to be rather limited, silver has greater upward potential, as it is a leveraged play on a global economic recovery.

The analysts that have proven to be the most accurate predictors of silver prices in the past, according to Bloomberg, reckon the white metal will rise more than 23% by the end of the year. Gold will rise 20% by the end of 2011, they believe. This is the median. We should heed their advice, because they have a strong track record and knowhow in predicting silver prices. UBS expects industrial demand for silver to hit its highest level since 1990 and silver-backed exchange traded funds are expected to boom as well.

Silver is not an obsolete metal, as many used to think a couple of years ago. The decline of analogue photography has significantly lowered silver demand in this area. But silver is an indispensable component of solar panels and flat screens.

Although hedge fund managers have cut their long bets on silver by 42% since October, they continue to hold net long positions, i.e. they remain bullish on silver going forward. We remain bullish too, because central banks are expected to raise their gold reserves for the third year in a row. The last time this happened was in the late 1970s, and we all know what happened back then. The sale of Silver Eagles by the US Mint has never been stronger and rose to record levels last month.

Be a savvy investor and keep accumulating physical gold and silver.