Is Silver A Better Buying Opportunity Over Gold?

By Lior Cohen

Looking back, Silver and iShares Silver Trust ETF (NYSEARCA:SLV) resumed its downward trend falling by 0.5% in the last week of October 2014. Considering the ratio between Gold and SPDR Gold Trust ETF (NYSEARCA:GLD) and Silver and SLV has picked up in the past few weeks, does this make Silver a better buying opportunity over Gold? Also, what is next for Silver?

This week, the FOMC will convene again for its penultimate meeting of the year. The current expectations are for the FOMC to end QE3, which could impact Silver. In the past FOMC meeting, Silver tumbled down by 3.3%. Will Silver fall again?

In a recent interview, James Bullard, president of the St. Louis Federal Reserve Bank, opened the door for the possibility that the FOMC won’t end QE3. Any change from the current expectations could result in Silver bouncing back. This possibility, however, is unlikely. It’s hard to see Bullard changing the opinion of other FOMC members. Also, Janet Yellen stated in the past meeting that QE3 will end in the October meeting. So any change from the current guidance could rock the financial markets and reduce the reliability of the FOMC.

Also, if the FOMC keeps the wording of the statement unchanged this includes keeping the phrase “considerable time”, then Silver is likely to resume its downward trend.

Despite the weakness in the silver market, SLV’s silver holdings didn’t fall much in the past few weeks. The chart below presents the changes in this ETF’s silver holdings during the past year and the price of SLV.

Source of data: iShare Silver Trust ETF and Google Finance

The Silver ETF sells silver “to cover expenses and liabilities and any losses that may have occurred.” But the movement in its silver holding also stem from the changes in the demand for this ETF. In the past few weeks the amount of silver holdings only slipped by 0.7%, while the leading gold ETF, GLD, recorded a sharp fall in its gold holdings; GLD’s gold hoards declined by 2% in the past week and by 3.5% during October. As stated before, the changes in holdings aren’t only related to the shifts in the demand for an ETF. But at face value this finding suggests a sharper fall in the demand for Gold than Silver. This comes even though gold has outperformed silver in the past few months. This is also indicated in the changes in the ratio between Gold than Silver.

Source of data: Google Finance

As you can see, the ratio between Gold than Silver spiked to over 7 – its highest level in recent years. Some analysts use this high ratio as a reason to prefer Silver over Gold by claiming: Since Silver is similar to Gold (under the heading of a precious metal investment) and since Silver is (relatively) less pricey, then it’s high time to choose Silver.

Moreover, in the past few weeks the linear correlation between Gold than Silver picked up and reached around 0.8, which is a strong and positive correlation.

Source of data: Google Finance

So this linear correlation indicates that if Gold keeps picking up, Silver will follow. Right? Well, yes and no.

First, remember that the relation between the two assets isn’t reliable — as seen above, back in September the correlation between the two assets was very low.

Second, the ratio between the two may suggest that Silver is less pricey than Gold but it doesn’t mean the ratio should come back down to its “steady state” ratio (what ever that ratio you think should be). This ratio could remain very high for a long time. If anything, since silver follows gold, a weaker gold could only drag further down silver by a higher margin (remember that silver is also more volatile than gold).

Source of data: Perthmint’s website

So even though the gold to silver ratio tends to revolve around 60 (that’s the median and mean for the past 14 years), the ratio is very erratic and could vary significantly as you can see in the chart above. The same, obviously, goes for the GLD/SLV ratio.

Third, SLV follows silver. This precious metal isn’t only impacted by the changes in gold, but other factors such as global demand for the metal. This metal has more industrial applications; so while this factor plays, in my opinion, a smaller role in the direction of silver. It’s still an important factor to consider.

This higher ratio may steer more investors towards Silver over Gold, but based on the above, I don’t think that using the gold to silver ratio or GLD/SLV ratio offer an indication for the direction of Silver.

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