Gold to silver ratio could be set to decline again

India may be the world’s top consumer of gold, with 66% increase in demand in 2010 to 963.1 tonnes, but analysts are urging investors to shore up on the white metal, expecting the gold to silver ratio to drop.

Author: Shivom Seth
Posted: Friday , 14 Oct 2011

MUMBAI – It is a buying opportunity for silver. The white metal, which rose at more than twice the rate of gold last year, should continue to outperform its more lustrous peer, say analysts. In the process, it has narrowed its long term gap with gold, known as the gold-silver ratio, although this is currently well above the level it fell to earlier in the year.

The gold to silver ratio measures the relative value of the two precious metals. The higher the ratio, the more expensive gold is relative to silver. On the other hand, the lower the ratio, the more expensive silver is relative to gold.

Analysts say the ratio, which was at 80 a year ago, had come down below half of this level with some experts suggesting it could come down further, implying one may be better off buying silver than gold.

“On a year-to-date basis, gold prices in the international markets have given returns to the tune of more than 16% while silver has slipped more than 3% during the same period. The white metal had delivered phenomenal performance in the January to May period this year, as it had jumped a whopping 22%. Gold, on the other hand, rose only around 8% in the same period,” said Reena Walia, research analyst with Angel Commodities, a broking firm in Mumbai.

Gains in silver were not only backed by its safe-haven appeal, but also because it is a cheaper alternative amongst the precious metals pack and still has many of the same characteristics.

However, the rally in silver has been cut short sharply in the month of September when compared to gold, as apart from being a precious metal, silver also finds industrial applications.

“There was a lot of speculation. Fundamentals played a big role,” said R Prasad, bullion analyst at investment, broking firm, Karvy Consulting. “Silver rose 7% in August, a performance which looks subdued in comparison with gold, but is not, considering it had risen 21% in April 2011,” he said.

Walia added: “In February this year, the value of silver was the highest in five years since the gold to silver ratio fell to just above 45:1. It then went for a toss declining sharply during the year. It touched a low of 31.53 on April 28, much below the level of 34.89 that it had touched in 1980.”

In this case, the ratio indicates that an ounce of gold could buy only around 31 ounces of silver as opposed to around 70 ounces in early June 2010.

Walia noted that during the year, silver prices increased sharply and had tested a high close to $50 per ounce. “The gold to silver ratio has been witnessing a decline since the end of January 2011 from an average of 47.80 witnessed in January 2011, to 41.72, witnessed in June 2011, even touching an average low of 35.25 in April 2011,” she added.

Currently, the ratio has risen back above the 50 level. In September, it averaged 47, indicating that prices have taken a hit. The trend has been reversed exactly when the ratio hit a low of 31.53, she pointed out.

For many Indian investors though, gold continues to be the mainstay. Traders said that investment demand for gold in India jumped 78% to 108.5 tonnes in the three months ended June 30, marking the second highest quarterly increase on record.

They added that out of 55% of global jewellery demand, India accounted for 32%, while China contributed 23% for global bar and coin investment. India is presently the world’s top consumer of gold, with a 66% increase in demand in 2010 to 963.1 tonnes.

Rajesh Jain, precious metals analyst with another investment firm said, “We have stepped into the fourth and the final quarter of this year. There is a lot of uncertainty and confusion over the state of global economic affairs and investors cannot take a logical decision.”

Adding that precious metals, which are largely considered as the safest form of investment, “have taken a beating as investors not only shunned riskier investments but also sold off their holdings in their most preferred investments, which is gold. This has created havoc in the global markets as all asset classes have given a negative performance,” Jain added.

At the current level, Walia notes that the ratio indicates that prices could witness a reversal again, “as it has hit a high of 56.75 and one could say that at these lower levels, buying could emerge.”

SILVER HOT

However, the current scenario is not supportive of a rise in silver prices as market sentiment remains choppy and with the downside in base metals, silver too is feeling the heat.

At the current ratio, one ounce of gold can buy around 53 ounces of silver. The broking firm has advised their clients that the gold to silver ratio will be in the range of 40 to 50 during the year.

Walia noted that spot gold prices declined almost 12% in September and in the same period, spot silver lost 33%, taking its cues from copper which on the LME fell 28%. “Since global economic growth forecasts have been downgraded, demand for base metals has become a major concern and this factor has influenced silver prices to a large extent,” she added.

While the ratio is an indicator of how prices have moved over time, analysts maintain that it is only one of the several factors that should be considered while taking an investment decision. “There is still a lot of interest in silver here,” said Raj Venkateshia of ScotiaMocatta, a division of Scotiabank, the largest seller of precious metals among banks in India.

Analysts are of the opinion that governments in many places are rapidly embracing gold as a security mechanism, especially since the value of the US dollar foreign reserves has drastically fallen over the past decade. Rising physical demand from Asia, especially from India has also supported the yellow metal prices, Angel Broking has said in a note to its clients.

Gold touched an intra-day high of $1691 and closed at $1676 on Wednesday. On the MCX (Multi Commodity Exchange), Gold December contract rose around 0.8% and touched an intra-day high of $549.85 per 10 grams on Thursday.

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