Metal rush at fever pitch

Gold has climbed to an all-time high of $1,370 per ounce and silver to a new 30-year high of $24. But there is much talk of both metals having further to run as the loss of faith in the ability of central banks to prop up the global economy grows.

The dollar has fallen to its lowest level since January on speculation that the Federal Reserve will continue to ease monetary policy to stimulate the US economy. This could propel gold prices up by a further 3%, according to a Bank of America Merrill Lynch report.

Participants at the London Bullion Market Association conference at the end of September were even more bullish on precious metals, correctly forecasting silver's rise to $24 and predicting that gold would rise to $1,450 next year.

One view is that gold will, at the least, forge ahead until its ratio to silver pushes 70 times. Gold's price ratio is 57%, a tad below its historical average of 60%, but whenever that important threshold is breached, gold tends to push up further.

However, silver also trends towards the benchmark ratio, although sometimes after a delay. For example, in 2003, when the ratio was near 80%, silver prices jumped from $4 to $8, and in 2009, when the ratio was around 79%, silver rose from $10 to $16. The same thing happened in June, when the ratio came close to 71% and silver again played catch-up.

Ultimately, when these dislocations happen, silver breaks the pattern and gradually cools, because it is constrained by different factors.

Although silver has long been regarded as a precious metal with historical connections to currencies, coins, medals and the jewellery market, these sources account for less than 30% of demand, compared with 80% for gold.

The supply side is less transparent with silver, as 70% of the silver produced in the world is a by-product of mining activity focused on other metals.

Industrial uses

Silver has industrial uses in mobile phones, batteries, solar power, spectacles, medicines, mirrors and paint, and demand from these sources has increased over the decade.

For example, silver's anti-bacterial properties are crucial in parts of the water purification industry, and demand for clean water in emerging economies is escalating.

Consequently, while gold prices have risen for 10 consecutive years – the longest rally since 1920 – silver prices are more volatile: they more than halved in 2008 as industry and consumer spending declined during the financial crisis.

In contrast, gold always spikes in recessions, as it is seen as a store of value in difficult markets. Silver is subject to two contrary forces, making it hard to know which way its price will go.

This is why one of the best times to buy silver is when large economies are emerging from recession – during the very earliest stages of growth. For those who are bullish about the long-term outlook and think that now is the time to buy, exchange traded commodities such as the dollar-denominated DB Physical Silver and ETFS Physical Silver, (which has a sterling class), are available.

Gold's spectacular rally will collapse if the global economy recovers and there is a sustained rally in the US S&P 500 index, but silver might not be so comprehensively routed because demand is increasing for almost every product that uses silver in its production process, with the exception of photography.

Shorter-term movements are therefore difficult to call, but some investors may reason that the grey metal has temporarily been held back from soaring in price because of the short-term reluctance of companies to pay higher prices in an uncertain market and that this situation will inevitably change.

"For the first time in two years our clients overall are now short gold," says Angus Campbell, head of sales at Capital Spreads.

"Having been long, on the whole, throughout the past few years, they now believe the rally is over. However, bulls may have just taken their profits and are waiting for a correction before buying back in again.

"As regards silver, clients have taken the opposing view and are long overall. This would indicate that they think silver has a lot of catching up to do."

This article was originally published in Money Observer - Moneywise's sister publication - in November 2010