Making an accurate silver price forecast is never easy. So to understand where silver prices are going next, let’s go back to where silver has been and why it was there.
As the Great Recession hit the U.S. economy in 2008, the U.S. Federal Reserve adopted extraordinary measures—printing money to buy assets. The scale and length of the quantitative easing program was never seen before. After the Fed spent trillions of dollars to buy assets, the U.S. ended up with a bloated asset market: both the stock market and the bond market soared to all-time highs.
The return in the stock market has been astronomical; since March 2009, the S&P 500 has climbed more than 200%! High returns in these markets made precious metals a lot less attractive in the eyes of investors. During the bull market run in stocks, precious metals prices plunged dramatically.
The interesting thing is, during this tumble, silver crashed particularly hard. Since its peak at close to $50.00 in April 2011, the price of the grey metal has plunged more than 70%! Gold price also plunged. But at 40%, the extent was much smaller compared to silver.
To give you some perspective on the divergence in gold and silver price movements, let’s look at the gold to silver price ratio. As we can see from the chart below, since mid 2011, the ratio has more than doubled from 33 to 74. As it stands right now, you can get 74 ounces of silver for one ounce of gold.
You might think that the yellow metal is a lot scarcer than the grey metal and therefore commands a much higher price. But take a closer look and you’ll see that the ratio of 74 is hard to justify. Comparing the actual deposits of silver and gold in the earth, the natural multiple is 17.0.
Now let’s take a look at what happens when the gold to silver price ratio reaches relative peak levels.
(Chart Courtesy of Stockcharts.com)
As you can see from the chart, when the ratio deviates far from the trend, it always comes back.
In the past twenty years, there were significant deviations in the gold to silver price ratio. The first peaked in 1996, and the subsequent gain for silver price was 200%. The second deviation peaked in 2003, leading to a 70% increase in the price of silver. The third time was in 2011, and the subsequent gain for silver price was 420%!
So, what would happen to the price of silver?
Well, given the high gold to silver price ratio today, the upward trend is due for a reversal. Holding the gold price as fixed, if the ratio were to go down to 35 (which is still much higher than the natural deposit ratio of 17), the price of silver would increase to $31.00 per ounce.
Other than looking at the price ratios, fundamentals of the grey metal should provide some hint as to where its price will go. At today’s silver prices, silver mining companies are getting killed, so production from silver mines is going to decline. Moreover, output of silver as a by-product of other mines is declining too, due to the low prices of other precious metals. That is, supply is shrinking.
On the demand side, things look solid. Unlike gold, silver is used extensively in industries. Its excellent electrical conductivity makes it an essential part of all kinds of electronics. The rise of solar energy also puts significant demand on the grey metal as it is used in solar panels to conduct electricity out of solar cells. Investors have also started to hoard silver bullion. The U.S. Mint recently announced that 2015 silver bullion coins are sold out due to a significant amount of demand. (Source: Reuters, July 7, 2015.)
Whether you look at silver from a technical perspective or a fundamental one, a big squeeze could be coming. My silver outlook for 2016 is definitely bullish.