Despite Higher Demand For Silver, SLV Remains Down

Even though the discussion in the U.S. continues to revolve around the timing of the Fed’s next rate, which could still move the price of the iShares Silver Trust (NYSEARCA:SLV), the physical silver continues to tighten on account of rising demand. But does a deficit in the physical silver market push higher the price of SLV? Also, will the high gold-to-silver ratio – currently at 77 – suggest that silver is undervalued relative to gold and may suggest a buying opportunity?

Demand for silver as an investment remains robust

Despite the weakness in the silver market, the demand for silver for investment purposes hasn’t tumbled: According to the silver institute, up to July, global silver ETFs have increased their silver holdings by 4.7 million ounces. Conversely, the silver holdings of SLV have only slightly declined since the beginning of the year.

Source: SLV’s website

But the silver holdings have actually increased in the past few months, despite the drop in the price of SLV. Perhaps traders are stocking up silver, as they believe it’s undervalued; the gold-to-silver ratio could suggest that silver is undervalued relative to gold – as stated by the Silver Institute.

Gold-to-silver ratio

It’s no surprise that gold and silver are strongly correlated with gold tends to lead the way. When gold rises, silver tends to follow and when gold falls – silver declines. But does this relationship always hold? Well, no. Over the past three years, on a month-to-month basis, silver didn’t move in line with gold (e.g. when the price of gold rose in a certain month, while silver fell) 26% of the time. Nonetheless, silver is still strongly linked to gold, as presented in the chart below.

Source: Bloomberg and Author’s calculations

The main takeaway from this chart, besides the strong relation, is that when gold rises, silver tends to rise higher and vice versa. Therefore, now that gold isn’t doing well and mostly falls in the past three years, silver tends to decrease faster – hence the sharp rise in the gold-to-silver ratio. And even if silver is undervalued against gold, for the coming year gold’s outlook isn’t optimistic. As such, the price of silver is also expected to head down. But perhaps silver has a silver lining from the vice versa demand?

Rising deficit

The demand for silver in the industrial sector, which accounts for 60% of the total demand, is expected to rise this year, for example in the renewable energy industry, by 8%. Thus, the balance between physical demand and supply is expected to reach a deficit of 57.7 million ounces – a third consecutive year in which there was a deficit.

Source: Silver Institute and Bloomberg

But the chart above also shows little connection between the changes in the physical silver balance and the price of silver. Even when the deficit reached 171 million ounces back in 2008, the annual price of silver didn’t rise the following year and only slightly picked up from the previous year.

The silver market continues to struggle. The market conditions aren’t favorable. The gold-to-silver ratio is rising and could keep so, but I remain skeptical whether this could suggest SLV is undervalued and whether this entails a possible comeback for silver. The demand for silver is still rising and for now, it doesn’t translate to higher prices. Down the line, if the demand continues to rise, it could break the downward trend of SLV. But it could be a while before we will see any long-term recovery for SLV. Source