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Gold vs Silver

It is often said where gold goes, silver will follow and for the most part this is generally true, but no-one is ever quite sure why! For two commodities of such contrast, it seems strange that one should follow the other, since the fundamentals of supply and demand are so very different.  Gold is used as jewellery, particularly in India which uses around 58% of worldwide production, and as a monetary reserve by central banks and the IMF.  Gold, as we have seen, does not get consumed, but is merely added to the stockpile around the world. Silver on the other hand, is mainly an industrial metal, and no central banks holding it as a reserve. It is therefore consumed in a variety of consumer products year after year, and is generally the by-product of base metal mining such as copper, lead and zinc. Increased demand for silver does not necassarily lead to economically significant increases in its output, whilst increases in the supply of copper, lead, and zinc do lead to increased supplies of silver.

Silver is a very different commodity, but it does tend to follow the price of gold – but in a far more volatile manner, given its production patterns and industrial usage.  If gold does surge upwards, then silver may do even better in percentage terms, and conversely if gold falls then there is the distinct possibility silver may do even worse. Whilst this relationship certainly exists, silver is being used increasingly in industrial production, and is therefore more likely to suffer and benefit from changes in the economic climate, and perhaps interestingly its perception may change from one of precious metal, to industrial raw material. Demand from industrial consumers has been patchy with a downward bias throughout 2008 following the early recession, with silver mining supply having increased from previous years. This is likely to have a negative effect on prices as the market will have to digest higher silver supply amid a much slower industrial growth rate throughout 2009. So as we can see, whilst the two metals do correlate there are very different pressures on the two metals, which can and do make correlation comparison more of an art than a science for this relationship.

One of the key technical indicators that traders and investors use to try to analyse this relationship is that of the gold/silver ratio. This is a simple ratio of the price of gold in US dollars per ounce, divided by the price of silver in US dollars per ounce. For most of the 19th century this ratio was fixed at just over 15, and subsequently throughout the last century and this has risen as high as 98, and currently stands at around 78 in early 2009. In simple terms the higher the figure then the stronger the gold price and the weaker the silver price, with a falling ratio indicating strength in silver and weakness in gold. Alternatively it could mean that both are rising but that silver is rising faster! As with any ratio, whilst this is of interest, it should only form part of a broader analysis, as it is impossible to say what this ratio should be!