GOLD ANALYSIS

Silver could be pointing the way higher for gold?

Speculators often take advantage of silver’s volatility to gear up their gold exposure when looking for a move in the sector. Is such a move underway again?

Author: Rhona O’Connell
Posted: Thursday , 23 Oct 2008

LONDON - 

Silver is a notoriously wayward metal.  If there is one thing that is consistent about it, however, it is the fact that it is regularly more volatile than gold; as a result it will often be the leader when it comes to changes in investment or speculative patterns as market players look to play up their expectations for price performance.  It does not always work successfully (no rule is incontrovertible), but the history is long enough for investors and speculators to give it a try from time to time and it rather looks as if it is happening again.  As the credit markets work their tentative way towards a thaw (over-night LIBOR has dropped below 1.3% from its recent spike to more than 6%, and is actually at its lowest since mid-2004), gold has been subject to regular bouts of weakness as a result of the strength of the dollar.

This strength is partly due to the demand for US T-Bills as a safe haven, and the size of some of the recent falls means that since the start of October the gold price has easily outstripped the international strengthening of the dollar. Gold prices have fallen in dollar terms by 12%, in euros by 6%, in rupees by 7% and in yen by a massive 17%.  In major producer currencies, though, the story is generally brighter with prices steady in Canadian dollar terms, up by 3% in Australian dollar terms and a generous 10% on South African rand.  In renminbi terms, though, gold has fallen by 12%.  There is a cynical adage in the City of London, which runs as follows: "The bad news is that the price is down.  The good news is that it fell in low volume".   Recent falls in gold's price have generally been in low volume, exacerbated by technical selling orders and a clear reluctance on the part of would-be investors, at least at the professional level, but this is of cold comfort to some speculative holders, who are now becoming somewhat disenchanted with the metal, and on the expectation of more short-term strength in the dollar, sentiment in the market has been cautious to say the least.

On the other hand, however, the medium term view is generally more positive, as the market looks at potential consequences of the Fed's flooding the market with dollars, especially when coupled with the persistence of the twin deficits.  There is, therefore a sense that there is strong buying interest beneath the market - the question, of course, is "how far is ‘beneath'?".

The answer almost certainly is that the buyers will return when prices have stabilised - after all it is better to miss the first 5% of a move than to try and call the bottom and miss it completely.  To this end the market needs help from external signals.  The natural gold buyers in the world, notably those concentrated in India and the Middle East, are showing interest in the market, but at muted levels by comparison with August and September.  This is despite the fact that we are in the wedding season and important festivals, notably Diwali (or the Festival of Lights) fall at the end of this month; some natural buying of these festivals was done in August and September and some buyers are looking to alternatives to gold because of the high local price - even though it has fallen sharply recently and is expected to recover.  So for the time being at least there is little bullish leadership from this quarter.

There is not much enthusiasm at the other end of the market; holdings in the gold Exchange Traded Funds have been edging lower - but not by much.  The SPDR® Gold Shares fund has slipped slightly from its recent 768 tonne-high (14^th and 15^th October), losing 12 tonnes in four days, while there has been some very slight attrition in the London and Australian fund - although these are so small as to be likely to be tracking errors.  Interest has been sustained in the iShares fund in New York, which has added almost three tonnes this week while the ZKB fund in Zurich has bounded up by almost 20 tonnes or 28% in the past fortnight.  It is also interesting to see the Swiss Bank Julius Baer launching a physical gold fund on October 24^th, to be listed on the SWX Swiss Exchange.

So where does silver fit in?  The logical answer is, probably, that it doesn't, much, since it has, even by silver's own standards, been oversold against gold in the mid-part of October, with the ratio recently widening to more than 82, the widest since March 1995, and that a move such as this should be expected to unwind.  Demand from industrial consumers has been patchy, but jewellery and coin has been strong, with Indian market premia expanding enormously amid calls both for silver jewellery in favour of gold, along with gold-plated silver jewellery.  The silver Exchange Traded Funds are mixed.  In the US the metal in the iShares silver fund continues to increase, as it does in the ETC in London, although there has been some withdrawal in from the Zurich fund.  The net reduction in the funds is has only been twenty tonnes since early October, which when set against holdings of over 8,200 tonnes is negligible.

In day-to-day trading, however, there have been several reports of fresh buying interest in silver, concentrated particularly in the United States.  More than once this year silver has been bought ahead of gold as speculators have anticipated price increases across the sector and looked for silver to gain more than gold.  This has not always been a successful venture, but it is a useful pointer to shifts in sentiment and silver's current outperformance may be signalling revived interest in gold.