Watch The Gold/Silver Ratio As The Gold Price Rallies

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Includes: AAAU, AGQ, BAR, DBS, DGL, DGLD, DGP, DGZ, DSLV, DZZ, GDXJ, GLD, GLDI, GLDM, GLDW, GLL, IAU, IAUF, OUNZ, PHYS, PSLV, QGLDX, SGOL, SHNY, SIVR, SLV, SLVO, UBG, UGL, UGLD, USLV, USV, ZSL
by: Geoffrey Caveney
Summary

It's no secret that the gold price is enjoying a strong rally right now.

But silver has been less impressive, and the gold/silver ratio has soared to all the way above 90:1 this month.

In fact, the gold/silver ratio has been rising smoothly and steadily for the past three years, ever since the summer of 2016.

Silver may well enjoy a corrective rally in the short term, compressing the overextended gold/silver ratio somewhat.

But in the medium and long term, the global economic and industrial slowdown and the long-term gold/silver ratio uptrend do not favor silver over gold.

It's no secret that the gold price (GLD) (PHYS) is enjoying a strong rally right now. Gold finally broke above $1,300/ounce again at the end of May, it has continued to rally in June, and it broke above $1,350/ounce on Friday morning, so it is getting more and more attention in the financial news media. Bloomberg's interview with billionaire investor Paul Tudor Jones called gold his favorite trade for the next 12 to 24 months and said the gold price could run all the way up to $1,700/ounce, and he was widely published and quoted last week.

(Source: goldprice.org)

But at the same time, it is striking that the silver price (SLV) (PSLV) has not done anything all that special while gold has had its big rally. Sure, the silver price has gone up, but it's still barely touching $15/ounce, which is nothing to write home about:

(Source: silverprice.org)

As a result, the gold/silver ratio has rather shockingly continued to rise steadily, and this month it has even broken above 90:1. That means 1 ounce of gold is now worth 90 ounces of silver.

Zooming out a bit, the consistency of the trend in the gold/silver ratio chart for the past three years is even more striking: Ever since the early-2016 precious-metals rally peaked and ended in the summer of 2016, gold has outperformed silver so steadily and consistently that the gold/silver ratio chart is almost perfectly smooth in its ascent:

Now, that is a strong chart. No one can deny it.

I note here for the record that I did warn readers to be cautious about the silver price rally in summer 2016, right at its peak in early July, in my article "Why Silver Is Not A Sure Thing".

Short-Term Perspective on Silver vs. Gold

In the short term, with a precious-metals rally in full swing and the gold/silver ratio looking rather overextended, there may be a tradable bounce back for silver. It would basically be a corrective rally that compresses the gold/silver ratio back to its 50-day or 200-day moving average, which are respectively at 87.5:1 and 85:1 right now. (See chart above.)

However, the timing of such a trade is fraught with risk. As you can see in the chart above, the trend has been running against such a trade for three years now. There is no guarantee that gold will not continue to outperform silver for the next month or more, and the gold/silver ratio could continue to rise and get even more overextended. Who knows? It might not be until the ratio gets close to or touches the psychologically significant 100:1 ratio that we finally get the bounce back corrective rally in silver.

My investing and trading focus is not on such short-term trades on corrective rallies, but that is my perspective and my thoughts about it for those who are interested. (My own investing focus is much more about junior gold miners who can benefit both from the rising gold price and from their own exploration discoveries.)

Long-Term Perspective on Silver vs. Gold

But in the medium and long term, the global economic and industrial slowdown and the long-term gold/silver ratio uptrend do not favor silver over gold.

Investors should never forget that silver is more of an industrial metal than gold is. As such, silver has an unusual dynamic, being part precious metal, part industrial metal. Silver is most valuable in periods when there is inflation along with healthy or growing global industrial activity. For example, historically the silver price has soared in times of large-scale global military conflict, such as during World Wars I and II.

But this also means that silver is not purely a "safe haven" precious metal asset in the same way that gold is. Demand for silver declines when global economic and industrial activity are slowing down rather than growing. In the Great Depression, gold held its value but silver did not. The gold/silver ratio soared up to as high as 100:1 back then as well.

I also pointed to the distinction in this dynamic between silver and gold in another article from the summer of 2016, "When Stocks Crash, Gold Gains More Than Silver".

Right now the global economy, the U.S. economy, and stock markets are up in the air. We are not yet heading immediately into recession, especially not in the U.S., but more and more signs of economic slowdown are showing up all around us. For just one example, yesterday the Morgan Stanley Business Conditions Index collapsed from 45 to 13 in a single month.

So the sentiment of global investors and financial markets already embodies fears an approaching economic downturn and recession around the corner over the next 12 to 24 months. This kind of an environment is not conducive to a booming industrial market demand for silver.

Silver will be more likely to perform better in the aftermath and recovery from the next recession, when interest rates are still low and central bank policy is still very accommodative, but when global economic activity is picking up again. That is the time period to look at silver, along with copper and other industrial base metals.

In the Very Long Term, Gold Outperforms Silver and Everything Else

For a long-term historical perspective that informs my current understanding, I like to look at extremely long-term charts that go back as far as 100 years or more. These trends are not decisive in determining short- or medium-term market moves. Still, they offer a perspective that can inform us about reasonable expectations for the performance of, for example, the silver price or the gold/silver ratio.

Whether our perspective is one year, three years, or 10 years, these very long-term historical trends can tell us what is or is not a likely or reasonable expectation for where the gold/silver ratio will head.

Here is the extreme long-term chart of the silver price relative to the gold price:

(Source: pricedingold.com)

Yes, there were a couple spikes in silver relative to gold in the 20th century. The first spike represents World War I, and the second spike represents World War II, followed by the period of a fixed artificially low gold price in the 1950s and 1960s.

But outside of those exceptional periods, the trend for the past 150 years has been for silver's value to decline relative to gold's value.

It is going to take a lot to overcome a trend that has lasted for the past 150 years. That is why I am rather skeptical of those who have the perspective that the gold:silver ratio will return to ancient or classical 19th century levels like 10:1 or 15:1. The very long-term trend is clearly headed in the opposite direction.

I also rather doubt that the next big silver price rally, whenever it takes place, will even bring the gold/silver ratio down near 30:1, like we saw in 2011. Here is a chart of the silver price relative to the gold price from 1968 to the present:

(Source: pricedingold.com)

And here is a chart expressed in terms of the gold/silver ratio, from 1990 to the present:

I suspect it is much more likely that future silver rallies will peak and top out around a gold/silver ratio in the range of 50:1, or maybe temporarily 45:1, as we saw in the late 1990s or the mid-2000s. See the chart above.

In terms of a long-term average, given the prevailing extremely long-term trends, I expect that the typical long-term average for the gold/silver ratio will reset to around 75:1 or so, while oscillating in a range from 50:1 to 100:1.

This, I think, is a more realistic long-term perspective for gold and silver investors.

By the way, it is not only silver that exhibits this very long-term underperformance relative to gold. Almost all other metals and commodities exhibit the same dynamic. Here are a few representative examples:

(Source: pricedingold.com)

Conclusion

My main point is this word of caution to readers: Do not to expect some kind of automatic reversion of the gold/silver ratio down to dramatically lower levels in favor of silver just because the current ratio of 90:1 seems very high.

First of all, global economic trends will likely work against silver relative to gold, at least until the end of the next recession.

Second, even when such a silver rally finally arrives, it may not bring the long-term gold/silver ratio any lower than 75:1, although of course temporary spikes and oscillations in both directions are always possible.

In other words, if gold rallies to $1,700/ounce over the next year or two, I think the silver price is more likely to remain in the $17-$25/ounce range, rather than soaring to the $30-$50/ounce range.

In my perspective, if you are looking for a leveraged way to play the gold price rally, junior gold miners (GDXJ) are a much better bet than silver.

Disclosure: I am/we are long PHYS. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: I am long many junior gold miner stocks. Further details are available to subscribers of the Stock & Gold Market Report.