Silver and Gold

As long time readers will know, I have a particular fondness for Silver. I was fortunate enough to buy a small stack of one ounce silver bars as a kid just before the Hunt brothers tried to corner the market. The story even has a happy ending as I managed to sell most of my stash very near the top at $42-45 an ounce (my average price was around $12).

So, it did not take too much encouragement from the feverish doomsayers to get me to dabble in Silver once again last year. Rather than loading up on coins or bars, I decided to participate in the shiny metal this time by buying the SLV ETF.

For those of you who do not spend too much time on the internet researching investment ideas, SLV has been at the center of an email, newsletter and pundit campaign which sees dark forces (JP Morgan was assumed to have been over-exposed on the short side of the futures market) surrounding the market for silver. I remember reading several reports from otherwise credible websites that cast doubt on whether there was actually much silver backing the ETF.

So how did it work out and why?

Obviously, Silver went up alot last year. SLV closed 2009 at $16.54 and finished 2010 at $30.18. I did not pick up until about halfway through the rally (I was using the discipline of the System) but that still left me with a smile on my face. If you check out SLV on the Steam Gauge, it is still ranking pretty highly. The question one should ask is why?

Relationship with Gold

Both Gold and Silver have served as money and store of value for thousands of years. Their value as precious metals for jewelry goes back even further. And, often Silver is found as a bi-product of Gold mining (as well as copper, lead and zinc mining). However, there are also important differences. The first is that gold is nearly indestructible despite its industrial applications. Almost all of the gold ever mined in human history can still be accounted for. Silver, while much of it is recycled over the centuries, has many industrial uses that cause it to be used up.

For investors the question is: what is the “fair” or “proper” relationship between Gold and Silver? While most of the research that I have read argues persuasively for a 30:1 price relationship, the fact is that over the last 100 years, the ratio has fluctuated between 100:1 and 15:1. Whatever the proper relationship, there is no question that most of the performance last year came from a rerating of Silver vs. Gold. In the chart below, we have charted the price of GLD divided by SLV over the last two years. Remember that GLD is meant to represent 1/10th of an ounce of Gold vs. a full ounce of Silver for SLV.

Will it continue?

There is probably a bit more left in Silver because it has two drivers. The stronger driver is the relationship to Gold (which will rise in conjunction with general investor anxiety and fall if confidence in economies and currencies returns). If Gold goes up, Silver will follow. Silver may close the “valuation gap” a bit more this year but most of the revaluation is history now. The lesser but still significant driver is Silver’s role as an important industrial metal. Like Aluminum, Copper and Zinc (which one can gain exposure to through DBB), it may rise in line with general inflationary pressures.

Read more at Fund-King.com