Why buy silver when prices are rising?

By Greg Canavan

Last week the silver price hit a 30-year record. Does that make it a buy or a sell?

-- Dr Alex Cowie of Diggers and Drillers firmly believes it’s a buy. He lays out a case here, alongside his latest silver stock recommendation.

-- Certainly, a mixture of inflationary and geopolitical jitters might be viewed as sound reasons to be a silver buyer right now. But you can also be rightly dubious about an asset that’s risen 790% in 10 years. Examination of the gold/silver ratio might shed some light where silver is heading. Dan Denning wrote about the subject back in 2008, the last time silver prices were heating up...

-- “Before the modern era of floating currency exchange rates – where the relationship between currencies varies based on their respective strengths and weaknesses – the world was on a gold and silver standard. Precious metals were money, and the ratio between the gold price and silver price historically was around 15:1.”

-- “Gold has always been more valuable than silver, at least as money. Gold is harder to find and mine. Silver is relatively more abundant and can be consumed in industrial processes. Gold is more durable.”

-- “But in the last thirty years, the gold silver ratio has exhibited quite a bit of volatility. A higher ratio shows both gold strength and silver weakness. When the ratio declines – as it appears to be doing right now – it means silver is getting stronger. It should be noted that a declining ratio doesn't mean the gold price is falling. It could mean that both metals are rising, but that silver is rising faster than gold.”

-- Three years on, that seems to be exactly what’s happening now, only at a much more aggressive pace...

The gold/silver ratio has been declining rapidly over the last six weeks. Back in late 2008, when silver hit its last low, it took nearly 90 ounces of silver to buy one gold ounce. On this Labor Day it takes just 40. The last time the ratio hit this level was February 1998. Silver had just soared 33% in five weeks. Gold only went up just 4% over the same period...
In previous years when silver started to gain strength against gold, the ratio would near the 40 level, then retreat backwards. Last Monday it breached this point for the first time in 13 years. Certainly the technical analyst would say this is a very bullish signal for silver.

-- But, as mentioned, silver is already in the middle of a very mature bull market. Just how much more can possibly be left in the tank?

-- There are a few reasons why silver is – and may well keep on – outperforming gold in 2011.


-- One is that there is a thriving industrial demand for silver that is just not there for gold. 45% of the demand for silver comes from the electronics industry alone.

-- But the main reason silver is outstripping gold at the moment is the fact that retail investors – particularly the Chinese – want silver like never before.

-- Geopolitical issues will ensure precious metals remain an attractive option for the rest of the year. But the relatively smaller unit cost of silver compared to gold means smaller-scale investors looking for some kind of crisis hedge to inflationary worries or more unrest in the Middle East can get some peace of mind. Industrial demand for silver is pretty much the same level as it was back in 1998, the last time the ratio was this low. This time its retail demand that’s the real difference.

-- You can’t find a silver bullion bar for love or money in China right now. Sustained retail demand for silver is soaring there. China used to be a net exporter of silver. Last year it gobbled 14% of the global silver market. Says Chris Berry, founder of Mountain House Partners: “I know that the Chinese are buying huge blocks of the SLV silver ETF and then selling it to try and get their hands on the physical metal. You have the Chinese sitting on a store of $2.5 trillion US of which they know is completely useless, so I think they are looking at gold, but also at silver as a store of value and a way to hedge against the decline of the US dollar.”

-- What you’re getting with silver is cut-price wealth insurance in comparison to gold. That’s an attractive proposition for nervy investors in the current environment. And that’s why the gold/silver ratio is trading at a 13 year low.

-- Now it’s broken the key resistance level of 40, it’s very possible you could see a gold/silver ratio edging closer to where it should be historically – around the 15 to 20 mark. It might not happen next week or next month...but could it happen this year?

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