Silver to benefit from renewed gold strength

Ole Hansen

Head of Commodity Strategy

Summary:  Gold and silver has already rallied strongly after the US Federal Reserve on Monday rolled out some of its heaviest artillery to announce open ended QE. It was a reminder of the moves they made in March 2009 which started a strong rally in precious metals over the following years. Given silver's historic cheapness, both against the dollar and especially against gold we see the potential for a strong recovery.


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The global spreading of the coronavirus will have a negative impact on global growth over the coming quarters. In response to this development we have seen pro-cyclical commodities led by crude oil suffer a major blow while industrial metals have dropped to levels last seen in 2016. The biggest casualty however has been silver which derives half its demand from investors and half from the use in industrial applications.

Being categorised as semi-precious, silver tend to follow gold closer than any other metal. During the past few weeks, however it collapsed by almost 40% while the gold-silver ratio spiked to 127 ounces of silver to one ounce of gold. Some 70% above the average ratio of 77 seen during the previous five years. 

Source: Saxo Bank

Silver tends to perform like a high beta gold, meaning that it rallies faster but also drops faster. The combination of recession worries and the recent dash-for-cash phenomenon helped tip silver over the edge. Once the near twenty-year uptrend from 2002 was broken the floodgates opened and silver was left exposed to another problem that can occur when markets get out control. Namely its lack of liquidity which also helps to explain why the recent sell-off in both platinum and palladium ended up being so aggressive.

What we are left with is a metal, which like the Norwegian Kroner, has come symbol of the extreme risk adversity currently sweeping through the markets. The chart below shows a remarkable similar behavior between these two unrelated markets against their peers: gold and the euro.

Source: Saxo Bank

However, as mentioned, the main driver behind gold’s recent weakness has been the “dash for cash”. A move that was strengthened by the elevated leveraged positions that had been built up in gold during the past few months. In my latest COT report covering the week to March 10 I highlighted how deleveraging had become the overriding theme with both long and short positions being reduced. The biggest long reductions were seen in crude oil, gold, sugar, cocoa and cotton while short-covering was seen in natural gas, soybeans and corn.

The open interest in COMEX gold futures has dropped to 573,00 lots, the lowest since last July. A sign that positions, both long and short have now seen a significant reduction from the January peak at 800,000 lots.

The difficulty in fully understanding the sudden weakness and temporary loss of safe haven status have raised some concerns that the link between cash and paper is under pressure. While paper gold has seen a significant amount of selling the cash market has reacted to developments across the different regions. Discounts have been offered in Asia and India while dealers in Dubai have noticed a premium in recent days. Overall we conclude that the Covid19 has triggered a significant disruption to supply chains and logistics. Major buyers have temporary close down their borders while others have witnessed a slump in demand. Against these developments the supply chain is also severely stressed with shipments being held back and not reaching their destination, in this case Dubai.

The outlook for silver looks supportive in our opinion and the following tables highlight why that is. Silver is mostly mined as a by-product of other major metals such as zinc, lead, copper and gold. In fact only around 30% of mined silver comes from pure silver mines. The 20% drop in the LME London Metals Index since January and the current recessionary outlook may inadvertently lead to a supply crunch for silver as production slows.

Source: CPM Group via visualcapitalist.com

Silver’s industrial demand going forward is increasingly going to come from the alternative energy sector, especially towards its growing use in photovoltaic solar cells. Apart from that silver is also the best natural conductor of electricity and heat. It’s generally being used in electronics, batteries, LED chips, semiconductors and electric vehicles.

Source: Silver Institute via visualcapitalist.com

Once the world begin to normalise investors will start looking for relative value and based on our assumption that supply may slow and given its elevated discount relative to gold we see renewed upside for silver.

Gold and silver has already rallied strongly after the US Federal Reserve on Monday rolled out some of its heaviest artillery to announce ‘open ended’ QE. It was a reminder of the moves they made in March 2009 which finally succeeded in stabilizing the markets. The actions back then also raised inflationary and debasement concerns, both of which started a strong rally in precious metals over the following years.

From a technical perspective silver has already made it back above $14/oz thereby sending a signal that the recent breakout to the downside was a false one. The XAUXAG ratio has come down to 113 but remains very elevated compared with its recent past.

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