SLV Vs. GLD: The 'Expected' Silver Rally May Not Come This Time

Summary

• Gold prices have historically strongly co-moved with silver prices in the past 50 years.
• However, there is no clear evidence that bullish trends in gold tend to be followed by sharp moves in silver.
• SLV got sold aggressively during the February/March selloff, bringing the Gold-Silver ratio to new all-time highs.
• The divergence between GLD and SLV may continue in the short to medium term.

Introduction

In his essay The Fate of Empires and Search for Survival, which studies the dynamics of the human race and empires over a period of 4,000 years, Sir John Glubb finds that empires generally last for about 250 years or 10 generations, from the early age of pioneers to the final conspicuous consumers who become a burden on the heavily indebted state. Interestingly, the final stage of each empire is marked by the significant debasement of the currency. Hence, two popular commodities that have historically resisted each devaluation period are gold and silver, that some historians have also referred to as the ‘Ultimate Money.’ It is important to know that the US first began with a bimetallic standard in which the US dollar was defined in terms of both gold and silver between 1792 and 1862. The first coin act was signed in April 1792 under the recommendation Treasury Secretary Hamilton and the ratio of silver to gold was 15 to 1.

Even though we ended the Gold standard a long time ago (True Gold Standard was ended in 1933 and the ‘Quasi-Gold’ Standard ended in 1973 following the ‘Smithsonian Agreement’), investors have been questioning if the massive liquidity injections from major central banks to support markets and governments spending will eventually lead to a sudden unexpected rise in inflation and therefore a sharp appreciation in the two precious metals.

We saw in our previous article on GLD that gold has already been rising against all currencies since the summer of 2018 and is trading at all-time highs to the exception of USD and CHF. On the other hand, silver prices have remained flat. Figure 1 shows the value of silver against the G8 most liquid currencies; we can notice that the uncertainty over Brexit has led to a little rise in silver against all currencies in 2016, but we cannot observe any positive trend in the past two years as we do for gold.

Will silver soon follow gold’s lead? In this article, we challenge the conventional wisdom that says that ‘silver prices generally lag gold prices’ and show that there is no clear evidence of a statistical relationship between the two precious metals. In addition, we argue that the gold-silver ratio will become less relevant in the future and that silver prices may actually remain at depressed levels while gold keeps rising against all currencies.

Figure 1

Source: Eikon Reuters, RR Calculations

Gold and silver performances in volatile periods

If we look at the long-term dynamics between gold, silver and price volatility, we find an interesting result when we compute the average performance of gold and silver when the VIX rises. In figure 2, we compute the average monthly performance of gold, silver, US equities (SP500) and the USD index when VIX has been trading above 20 in the past 30 years:

• The left frame shows the performance of each asset when VIX > 20 at time t
• The right frame shows the performance of each asset when VIX > 20 at time t-2 (in order to see if assets recover quickly two months after a highly volatile month)

Left frame results: As expected, we can notice that equities perform poorly during periods of high VIX, averaging -24bs in monthly returns. Gold is the big winner and has historically averaged nearly 80bps when the VIX was trading above 20, followed far away by silver with 45bps in monthly returns. The US dollar (NYSEARCA:UUP) remains stable averaging 8bps in monthly returns.

Right frame results: Repeating the same analysis using a 2M lag for VIX indicates how persistent the volatility is in the market. We can notice that US equities rebound sharply and have averaged 36bps 2 months after the VIX was trading above 20; this was largely expected as we know that ‘Buy the Dip’ has been a winning strategy in the past 30 years to the exception of the year 2002 and 2008. More importantly, we notice the strong outperformance of silver over gold, implying that a gold rally during periods of market stress tends to be followed by a silver rally 2 months later. Figure 2 (right frame) shows that silver has averaged 84bps two months after the VIX > 20, whereas gold has averaged 68bps.

Figure 2

Source: Eikon Reuters, RR Calculations

Evidence of a statistical relationship is not clear

In this part, we check the existence of an evidence of gold’s leadership in the early stages of bull markets in precious metals, notably silver. Using monthly data since 1990, we first regress changes in gold prices on changes in silver prices, lagged from 1 month to 1 year. We use the following regression:

Where i = (1…12), gold and silver are expressed in log terms and e represents a white noise.

Results are shown in figure 3. We can notice that none of the coefficients are statistically significant; hence, the statistical evidence is not verified in the long run.

Figure 3

Source: Eikon Reuters, RR Calculations

However, we find interesting results when we look at a shorter period; sharp moves in gold (GLD) tend to be followed by similar moves in silver (NYSEARCA:SLV) two to four weeks later. Figure 4 shows the relationship between weekly GLD price and SLV prices (lagged by 3 weeks) in the past 5 years (excluding the recent COVID-19 events). For instance, gold price started to increase sharply in early 2016 amid rising uncertainty over Brexit, levitating GLD from 102 to 130, and was quickly followed by a significant move on silver three weeks later with SLV rising from 13 to 19.5.

On the right frame, we can also notice that the myth that silver is a leverage play on gold in bull markets is actually false: the rally in SLV may have outperformed the GLD one during Brexit in 2016, but it was not the case in late 2017 nor in the middle of 2019.

Figure 4

Source: Eikon Reuters

The COVID-19 effect and SLV risks in the short run

As a result of this analysis, some metals traders have been charmed by this tempting relationship and have been generating trade ideas on SLV following sharp moves on GLD, regardless of the supply/demand dynamics on the silver market. However, the recent health crisis broke the relationship between GLD and SLV; while gold received strong bids in the first quarter of this year, silver did not and therefore the gold-silver ratio hit new all-time highs. Figure 5 (left frame) shows that the gold-silver ratio broke through its LT resistance at 100 to hit 120 on March 23^rd (the day equities reached their bottom). Some analysts expect the ratio to consolidate back to its LT range; however, we argue that this ratio will have little relevance going forward and that the ‘expected’ rally in silver may not come this time.

Figure 5 (right frame) shows that SLV was significantly correlated to equities during the February/March selloff; even though silver prices have strongly co-moved with gold prices over time, the evidence of silver being a zero-beta asset is less clear. We know from our previous research that inertia – how well an asset has performed in the past – is an important characteristic when defining a safe haven asset.

Figure 5

Source: Eikon Reuters

Outlook on SLV

We are confident that the massive liquidity injections from central banks to support the titanic governments spending in 2020 will generate a long-term bullish trend on all precious metals as we strongly believe that a sudden rise in inflation expectations could surprise many market participants.

However, we could see a persistent divergence between GLD and SLV in the near to medium term. The fact that SLV was sold aggressively during the February/March selloff does not indicate a good sign for the near future. Investors who are already long equities may not find additional value in being long SLV as the precious metal could experience another sharp selloff if equities suddenly drop in this current environment.

Figure 6 shows that after reaching a low of 10.88 on March 23^rd, SLV pulled back to the 50% Fibo retracement of the yearly 10.85–17.67 high-low range. It did not manage to break through its 50D SMA resistance and seems on its way to retest its 13.45 support in the short run. We could see SLV trading higher if the bullish momentum in equities continues in May, but we do not expect SLV to outperform GLD in the coming weeks. In fact, we think that the ratio will become less relevant if the divergence persists between the two precious metals in the medium term.

Figure 6

Source: Eikon Reuters

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Analyst’s Disclosure: I am/we are long USDJPY. 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.