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IPMI and Industry News: Silver Market News

Silver Outshines Gold As Long As Gold Maintains Its Bull Run

Wednesday, August 26, 2020   (0 Comments)
Posted by: Matt Watson
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Silver Outshines Gold As Long As Gold Maintains Its Bull Run



  • Silver has been outperforming gold in recent months.
  • The news of the EU's plan to allocate a part of its recovery fund towards green energy helped revise up market expectations of the demand for silver.
  • I show that such news on changes in physical demand for silver don't tend to have a lasting effect and gold will remain the main driver behind silver's rally.
  • Therefore, as long as gold remains a crowded trade, silver investors will continue to purchase silver and keep silver outshining gold.

Gold and silver prices have been on a tear this year on the back of the Federal Reserve’s stimulative monetary policy and the rise in demand for a haven as the Covid-19 pandemic rages on. The Fed’s actions helped lower long-term bond yields, stoke fear among bullion investors of possible higher inflation (although there is nary evidence of rising inflation), and depreciate the U.S. dollar. In recent weeks, silver has been outperforming gold. While gold has been among the main drivers for lifting silver, other factors – besides those related to monetary policy - may have raised the price of silver. So, what is behind silver’s recent bull run? And is it sustainable?

First, let's quantify the impact of gold and the direct effect of the Fed's stimulative monetary policy on silver prices. A simple regression analysis of the past eight months of the changes in silver price demonstrates that gold, 10-year bond yield, and the U.S. dollar (Trade Weighted U.S. Dollar Index: Broad, Goods, and Services) can explain fairly well silver’s daily variance (about 37% of it). And even after controlling for gold, 10-year treasury bond yield and the U.S. dollar - which are mostly affected by the Fed's momentary policy - still contribute to the development in silver prices and explain roughly 13% of its variance (based on a separate silver price regression of only these two explanatory variables). However, a big part of the silver rally this year has been gold, which accounts for 24% of silver's variance (based on a silver price regression of only gold price as an explanatory variable).

Source: Author’s calculations

Even though gold may have been partly responsible to silver's bull run, in recent months, silver has outperformed gold. To illustrate this, I use the gold to silver ratio (see the chart below). This ratio has been falling since March 17th – around the time precious metals started to rally after the Federal Reserve started to provide monetary stimulus. Since then, the ratio has reached its lowest level since 2017.

Source: FRED and Author’s calculation

However, by late July, the ratio took another leg down as the silver price rose more so than the gold price. The following chart also demonstrates this noticeable shift in the volatility indexes of gold and silver.

Source: FRED

Moreover, the linear correlation between the two precious metals’ prices has also fallen since late July.

100-days moving correlation

Source: FRED and Author’s calculation

Some attribute silver’s latest bull run to the European Union’s plan to allocate almost a third of its €750 billion recovery fund to green projects. Since silver is used in green energy, mainly in solar panels, silver investors bet this news could provide another boost to future physical demand for silver.

However, how much more demand could this news mean for silver? A simple back of the envelope calculation reveals that if the EU allocates a third of the 225 billion euros green projects budget towards solar (the EU aims to have solar energy account for 36% of renewable electricity capacity by 2030), the budget for solar projects will reach €81 billion or $95.6 billion. If the funds were to be distributed equally over the next decade, the annual budget for solar energy would come to €9.5 billion. However, this annual budget won’t be allocated solely towards silver. Hardware materials account for about 25% of the cost of solar panels and silver is a small portion of it. According to one source, an average solar panel starts at $6,000. Even if such a panel includes one ounce of silver, the cost of silver in such a panel comes to $26 or less than 0.5% of the total cost.

So even if we assume that 10% of the solar energy budget were to be allocated to silver (a very generous assumption), the annual demand for silver could rise by 37 million ounces (for the silver price of $26). As such, the annual demand for silver in photovoltaics could rise by 38% (the Silver Institute projects the demand for silver in photovoltaics would reach 96 million ounces in 2020 or 10% of total demand), and the total demand would rise by only 4%.

So, this news could have revised market expectations of silver’s future demand and, by doing so, contributing to silver’s recent bull run. But I suspect it won’t be enough to keep silver outpacing gold, because the EU’s green energy initiative isn’t likely to change much total demand for silver. Moreover, in the past, the physical demand for silver hasn’t been the main driver of the silver price. For example, back in 2016, the demand for silver in photovoltaics nearly doubled (see chart below), but it didn’t lead to a sustainable rise in the silver price.

Source: FRED and Silver Institute

The gold to silver ratio chart above shows that while silver has outperformed gold in the first half of 2016 – as both metal prices increased – by the second half of the year, the gold/silver ratio began climbing back as their prices started to fall again. In other words, the shift in expectations over higher physical demand for silver in 2016 didn’t maintain silver’s outperformance over gold. Besides, back in 2016, the silver rally was fueled by gold’s recovery, and as the Federal Reserve held back from raising interest rates again until the end of the year.

Therefore, I think changes in physical demand for silver tend to take the back seat for changes in demand for silver as an investment. So perhaps, silver tends to outperform gold whenever gold becomes a crowded trade, as in 2011 and early 2016. But for now, gold isn’t expected to crash as the Fed remains ready to provide more stimulus to the markets if economic conditions deteriorate further.

Silver has been outperforming gold in recent months, and it could continue to do so as long as the demand for gold remains high, and the Federal Reserve maintains interest rates low. News of green energy provided a short-term boost to silver as it revises expectations. But such news won’t have a sustainable impact on silver price if the gold bull run comes to a halt.

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