Despite the decline of silver prices in recent months, a key leading indicator is suggesting that silver prices might skyrocket in the months ahead. Silver investors who bought the precious metal the last time this metric peaked made an astonishing 420% return.
You won’t get rich overnight. But with a little patience and a well-timed buy, you could catch silver on its upswing. Most investors tend to prefer gold as their hedge against inflation, but there is evidence to suggest silver is underpriced right now.
For instance, it currently takes 74 ounces of silver to buy one ounce of gold. In 2011, that same ounce of gold could get you only 32 ounces of silver. Did gold become more valuable relative to silver? What’s the story here?
Well, silver prices peaked near $50.00 in mid-2011, before crashing to their current value of $14.98. The crash reflected, in part, a renewed enthusiasm for stocks. Investors poured money in American equities, boosting the NASDAQ 86.6% over the same time frame. The Down Jones and the S&P 500 advanced 48.9% and 62.1%, respectively.
The stock market rally can be traced back to the Federal Reserve’s quantitative easing program. The central bank actively purchased low quality assets from troubled financial firms using newly-printed money. By acting as the “buyer of last resort,” the Fed was artificially pumping the price of financial assets.
All that makes sense, but what confuses me is why the retreat in gold prices was half the size of silver’s sell-off. The yellow metal declined by 35%, far below silver’s nearly 70% drop. Why?
The Last Time This Happened, Silver Prices Soared 420%
To answer this question, we need to look at the silver-to-gold ratio. Prices for silver and gold tend to move in tandem. A rise in gold prices is usually mimicked by silver and vice versa. That’s what we see from the long run historical average of the ratio. The mean ratio for the previous 40 years is approximately 42.8 ounces of silver to every ounce of gold.
However, reality isn’t as clear cut as the math implies. There are moments where the ratio deviates unusually far from the mean, distorting the true value of one (or both) of the precious metals.
A persistently elevated silver-to-gold ratio means the grey metal is undervalued. For some reason, investors got too bearish and pulled too much money out of that commodity – which is an incredible opportunity for those who pay attention to this valuable metric.
(Source: Stockcharts.com, June 25th, 20152015/06/25)
Whenever the ratio topped 70, investors stood to make huge returns. The last three occurrences were in 1995, 2003, and 2011. The respective gains were 70%, 200%, and 420%.
What’s the likelihood it happens again?
Actually, that’s the good news. It’s quite probable that silver will rise to record heights again. The silver-to-gold price ratio is currently hovering between 73 and 76, hinting at an upcoming bull run for silver. Like I said, 70 is the proven breaking point. The last time relative prices drifted past that magical number, investors made 420%!
Another tailwind for silver is the physical abundance of the precious metal. If you add up the actual deposits of gold and measure them against silver deposits, the ratio pans out to 17.0. This physical relationship is what should govern the relationship between gold and silver, but investor sentiment can distort the market.
If you hold gold steady at its current price of $1,138.80, and use the natural ratio of silver-to-gold deposits as the valuation method, silver should sit at $67.00. I don’t think the market will reset all the way down to the natural ratio, but just by dropping down to 22 or 23, silver prices could hit $50.00.