Back in biblical times gold and silver prices were at parity although by the Roman era the ratio had widened to between 15 and 16. Silver backed major currencies right the way through to the nineteenth century although as economies evolved it tended to become the norm that silver was used for intra-national payments while gold was used for international transactions. India and China were among the last countries to remove the silver backing from their currencies, which is the reason why there have been substantial government sales of the metal from these two nations in particular although these sales have dwindled somewhat over the past two years or so. It is also the primary reason why the markets are uncertain as to the level of silver stocks, private or public, that lie in countries such as these.Net government sales into the market reached a recent peak of 2,743 tonnes in 2003 (GFMS figures), but had halved by 2007 and it looks as if they halved again in 2008, with further reductions looking likely in the future, although since these sales currently comprise less than 5% of silver supply their further erosion is unlikely to make much of a difference to silver prices per se.What has been making something of a difference recently is the rejuvenation of gold: silver ratio trading. Technical analysts have been looking favourably on silver since the start of the year and the gold: silver ratio has come increasingly onto the radar screens. Technically-driven trading of the ratio has also been important, with the ten-day and twenty-day moving averages defining the upper boundary of the ratio's path. Once the ratio had severed support at 72 this trading gained considerable traction and within two days we were at 69, en route for a test of 67, the lowest since late September, when gold was at $740 and silver at just less than $11.This time the activity in the market brought silver up to $13 while gold was easing from $920 to just below $900 and since then gold has taken up the reins to test $950 while silver has approached $14 then retreated towards $13.40. and the ratio has settled at around 70.Obviously the ratio, of itself, does not drive markets. It is normally a result of the inter-related moves of both gold and silver, but every now and then it does have an impact on the metals' prices - much more so on silver than on gold. What has lain behind the changes in the ratio this time? Certainly not the silver market's fundamentals in terms of marginal costs of production against the balance between industrial supply and demand (and this includes jewellery demand but not investor interest), which are not looking favourable. Silver may often be regarded as a precious metal by virtue of its historic connection with currencies and its lingering jewellery market but jewellery, silverware and coins+medals between them comprise less than 30% of silver demand as against more like 80% in the gold market); on a purely fundamental basis, therefore, silver belongs in the industrial camp.Sentiment and perception are important market elements, however and silver's long-standing relationship with gold is a vital influence on prices and investment activity. Essentially, because of silver's intrinsically higher volatility than gold, some speculators and investors use exposure to silver as a means of gearing up their exposure to the latter. If gold is going up, silver typically goes up further, so a combination of the two is a stronger performer than gold on its own. This does not work for the whole time, obviously, but it is a well-entrenched mechanism and has been playing an important part in silver's price performance over the past two months since the gold: silver ratio briefly exceeded 80.This has been no more evident than in the exchange traded funds and the London ETC. When the gold:silver ratio reached its maximum in mid-December 2008, these funds harboured 7,661 tonnes of silver in their coffers. In the two months since then this has shot up to 8,734 tonnes, an increase of 1,073 tonnes and on annualised basis this is the equivalent of 6,096 tonnes per annum (196 million ounces) or almost 25% of global industrial demand. Over this period the silver price has increased by 21%, from just over $11 to just less than $13.40. Gold has risen by 13% and copper, 12% over the same period.With this degree of uptake it is not surprising that silver has outshone gold recently and left copper some way behind. Although gold and copper have improved by similar amounts, silver's correlation coefficient with gold over the period has been a healthy 90%, while that with copper, although still impressive, has been lower at 63%.Speculative exposure on COMEX over the same period has also been increasing, although it is important to remember that this does not involve physical metal - but it can be very important in terms of price discovery. The net long speculative position rose from 3,849 tonnes on 9th December to 5,158 tonnes on 3rd February (latest available figures), with a goodly size of fresh longs entering the market, and only a small degree of short covering.There is an old adage in the market that the gold:silver ratio only really counts in two places; the COMEX floor and the Indian market. In India it is by no means unusual for jewellery and investment holders to switch between gold and silver when they perceive that the prices are out of line. Certainly recently there has been a very healthy market in old gold scrap, but silver demand has remained slack in response both to high outright prices and the economic environment. Silver's outright fundamentals do not justify prices at these levels, but for as long as the market retains its bullish stance and investors keep coming for the metal then any industrial surplus this year stands a good chance of being absorbed and when investors like the look of gold, some of them will like the look of silver even more. This metal is, however, flying almost as high as Icarus and when that ratio starts to rise, then silver speculators had better be watching very closely.
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