Gold (NYSE: GLD) has been one of the big winners of the coronavirus crisis, as central banks have cut interest rates aggressively all over the world. They are also providing support to various credit markets to ensure that liquidity is plentiful. Additionally, fiscal policy is being used to negate the economic damage from the shutdowns.
It's interesting to note that gold is less than 10% from its all-time highs. In contrast, silver (NYSE: SLV) is more than 70% off its all-time high just below $50 which was set in May 2011. Typically, both metals have a tight correlation, and it's unusual to see such a major divergence between the two.
Silver to Gold Ratio
The divergence between the two took off in the fall of 2018 when gold bottomed around $1,200. At the time, silver was just above $14. Since then, gold is up nearly 50%, while silver is up a measly 10%. This has resulted in the silver to gold ratio hitting record-low levels.
At today's prices, it takes 120 ounces of silver to buy one ounce of gold. Over the last decade, this ratio has fluctuated between 70 and 90, while it's historically been around 40.
Reasons for Silver's Weakness
The major reason for silver's weakness is its supply has been growing. Typically, commodities are subject to market forces, meaning that lower prices result in lower production. However, most silver is produced as a byproduct of copper and gold mining, so its supply continues to rise despite lower prices.
Another factor in silver's continued bear market is that it experienced a massive bull market and price appreciation which drew in several retail investors between October 2008 and May 2011. During this period, it went from $8 to $49. In contrast, gold went from $750 to $1900. This extreme move has created several sellers at higher price levels, and it takes longer for it to work through this excess especially as supply continues to grow.
Catalyst for a Turnaround
Given that silver's supply and production remain plentiful, the one catalyst to make silver prices catchup with gold would be an increase in investment demand. The last two periods of silver outperforming gold for a lengthy period was the recovery following the Great Recession and the 1970s.
Both periods coincided with an increase in inflation expectations. Following the Fed's implementation of QE, the consensus was that inflation was going to roar out of control with many even speculating that hyperinflation was around the corner. These concerns resulted in people flocking into precious metals as a store of safety. Of course, these concerns didn't materialize, and prices collapsed.
The 70s also saw a spike in inflation expectations as Nixon took the US dollar off the gold standard. That time, inflation did materialize especially as the economy was much more industrial-based and resource-constrained at the time. During that decade, silver went from $1.50 per ounce in 1971 to $36 in 1979.
So far, inflation expectations have remained muted despite the Fed's and government's efforts. The difference this time is that fiscal policy is being utilized much more aggressively which has a better chance of being transmitted into the economy. One lesson of inflation not materializing is that monetary policy can create inflation in the financial economy but not in the real economy especially if risk appetites are depressed.