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The tightening of Silver prices and Gold prices – a short analysis

|Includes: Randgold Resources Limited (GOLD)

 As 2010 is winding down, it is time to examine some of the market paradigms that are considered reliable for investors and traders when trying to examine the market. One of these paradigms is that Gold prices are heavily correlated to Silver prices. In this short analysis I will review the nature of this relationship between these precious metals throughout the years 1998-2010.

 

First, consider that even though Silver and Gold are two precious metals, their demand mixture by industries is different: in 2009, nearly 40% of the Silver demand was for industrial applications, the highest share, while the industrial applications market share for Gold in 2009 was only 10.7%. The industry with the highest market share in Gold was, as you might have guest, jewelry – over 50%. For Silver this market share was only 17.6%.

If their demand mixture isn't similar it means they don't have to be necessarily correlated at face value, as they serve different industries with different needs and price sensitivity.

 

Nevertheless, the market sees these precious metals as very similar products. Also, silver and gold are also considered reliable investments to fall back on, which became truer since the recession broke in 2008.  

 

In the following graph I review the Gold prices and Silver prices for the years 1998-2010, average monthly prices, in which Jan 1998=100 so that it will be easy to compare these two commodities.


The chart shows that there seems to be a very strong correlation between Silver prices and Gold prices. Further, since the end of 2005 these prices started to pick up, and from the end of 2008 after a market correction a year earlier, the prices of Gold and Silver started to increase on a higher trend. The last steep inclination is obviously related to the fall back of investors on Gold and Silver, as I have already referred to before.

 

In the last chart, there is an examination of the level of correlation between the Month to Month percent changes of Silver prices and Gold prices. I have broken down this examination for the entire period and then for each two years.

 

 

This chart shows that while the level of correlation for the entire period is 0.68, a very strong and positive correlation, it also shows that there is a yearly inclination for the level of correlation between these two precious metals; it starts off at a low positive correlation of 0.29 in 1998-1999 and rises to 0.85, a very strong and positive correlation in 2008-2009. In 2010 it seems that this correlation has weaken a bit, however since there are fewer samples (only 10 months worth), it doesn’t mean the relationship strength diminished.

 

To speculate, I think this tightening of the correlation of these two precious metals in the last five years could be because Silver prices and Gold prices were not necessarily affected by their supply and demand forces, but more by their demand as investments to fall back on them. Since it could be that traders and investors consider these metals similar investments, their price behavior has become more in sync (no reference to the sucky boy band).

 

Finally, if people will continue investing in these metals as they did in the past several years, we will probably continue seeing these two metals' relation further tightening. 

 

 For further reading:

 

The Gold Rush – is there a bubble in the Gold Market? – A short analysis (in this site)

Silver and Gold Markets Review– weekly recap Dec 18th (in this site)

Ecstasy for the Gold – the diminishing relations of gold and USD – A short analysis (in this site)

 



Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.