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Market Brief: Silver-Gold Ratio Widens, Disconnect Between Gold Price and Money Supply

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The following is a market update as it related to precious metals prepared by SchiffGold intern commodities analyst Jason Mezhibovsky.

Silver/Gold Ratio Continues to Diverge

The silver/gold ratio continues to diverge, favoring silver as relatively cheap compared to gold at the moment. This presents an attractive opportunity for silver. The white metal could benefit, along with gold, as a “safe haven” asset in a weakening economy with plenty of uncertainty surrounding the trade war and Brexit.

The silver/gold ratio was over 89:1 on May 29. That means it takes 89 ounces of silver to buy 1 ounce of gold. The modern average over the last century is around 40:1.

Recently, the silver price fell to its lowest level of 2019, in part due to speculators increasing their net short positions. But speculators tend to be wrong more often when there is a turning point compared to commercial institutions. Interestingly, commercial institutions are currently beginning to cover their net short positions. This could be a signal that if a turning point for silver is on the horizon, it would be favored for an upward movement.

The relatively cheap price of silver compared to gold, coupled with speculator/commercial sentiment, and silver’s role as a safe storage of wealth in troubled economic times, point to the possibility that an upward rally could be expected soon.

Supply/demand dynamics also favor silver. Silver demand was up 4% and hit a three-year high in 2018, according to a report by the Silver Institute. Meanwhile, silver mine production fell for the third straight year, dropping 2% in 2018 to 855.7 million ounces.

Another point to keep in mind is that the price of silver, unlike gold or most other commodities, is mostly driven by investor sentiment because is primarily mined as a byproduct of production from other metals. With silvers low price and high utility as a safe haven asset, we could see investors buying in soon.

Gold Prices and Fiat Money Supply

Gold has not appreciated in value nearly as much in dollar terms as it has relative to other currencies. This seems a bit unusual given the fact that fiat money supply has been increasing in volume all around the world.

Fundamentally, the value of the USD and its strength are negatively correlated with the price of gold. Dollar strength has been creating headwinds for gold for months. But a key factor in that equation that is consistently overlooked is the actual supply of the fiat money (USD).

Basic economics tells us that as supply goes up, prices go down. As more dollars enter the system, this should push their value down and drive a correlating upward trend prices. But we’ve not seen this principle operating in gold and precious metals markets of late.

In some currencies, including the Nigerian naira, Russian ruble, and Argentinian peso, gold prices have been appreciating relatively strongly. However, even in these countries, gold is still considered undervalued due to the weak condition of these emerging economies, the economic burdens they face, and the impact it has had on their currencies.

Part of this undervaluation is linked to the failure of gold to rise with the overall fiat money supply.

Unlike gold and other precious metals, fiat money can be created out of thin air, virtually into infinity. As this new money works its way through the economy, prices tend to rise (inflation). However, this has not been the case with gold in recent years. We can see that since the Great Recession, the fiat money supply (not value) has risen almost 70%, while the price of gold has fallen almost 45%.

What we can take away from this is that gold is inherently undervalued in all markets, and this adds a major reason to why it can be seen as an attractive investment at the moment. Without other factors taken into consideration including the global political climate and potential for a downturn, gold might be the best bet.

Supply of M2 (M2 = hard currency in circulation + savings + CDs) money

(Source: fred.stlouisfed.org)

Other Developments

Trade war tensions are on the rise again. Trump ratcheted up tensions on Monday in Japan, saying that he is not yet ready to make a deal with China. This adds new tensions to the negotiations and the timeline seems even more uncertain. Meanwhile, the Chinese have threatened to cut off US access to rare earth metals.

Theresa May resigned and this led to uncertainty about potential Brexit developments. Her successors are considered to have even more harsh terms in regards to the Brexit, with little desire to settle with the EU at all.

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