3 Reasons To Pump The Brakes On This Silver Rally

David Dierking

Since mid-March, the price of silver is up more than 90%, making it one of the top-performing asset classes since the bear market low earlier this year. It's also up more than 22% just during the month of July alone.

The rapid decline in the dollar, negative real yields, ballooning deficits and additional government stimulus likely on the way are all fueling the current precious metals rally. All of these factors support a further rally in commodities, but it's also becoming one of the more crowded trades in the financial markets.

The current rise in silver prices especially warrants some caution. Violent bullish rallies like the one we're seeing here are prime candidates for pullbacks, but there are other fundamental factors at play here that investors should consider before piling into silver.

Here are three reasons why investors should pump the brakes on this silver rally.

Silver Is An Industrial Metal

While gold is considered a store of value and inflation hedge in many circles, silver has many industrial uses. Its high electric conductivity make it a useful component in everything from electronics to solar panels to batteries.

As such, silver is more heavily tied to the global economy. While many countries around the world are slowing getting back to business, GDP growth expectations are negative, industrial production is contracting and it could take years for manufacturing to return to pre-COVID levels.

In this chart, we can see that nearly 60% of global silver demand comes from industrial applications.

Screen Shot 2020-07-27 at 8.22.12 AM

If the coronavirus pandemic continues to spread throughout the latter half of 2020, it could result in lower demand for silver.

Silver Disconnects From Gold During Down Markets

As precious metals, gold and silver are inextricably tied to each other. Many assume that prices generally move together, but that's not always the case. In fact, silver often loses its link when silver prices are falling. In other words, they may not keep up with gold.

We can see in this chart that in many cases, gold and silver are highly correlated, as indicated in the line at the bottom on this chart. But situations where gold and silver become nearly uncorrelated occurs most frequently when silver prices are falling.

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With gold getting so much attention as the Fed floods the market with cheap dollars and inflation expectations start rising, don't assume that silver will come along for the ride.

The Value Opportunity In Silver Has Somewhat Disappeared

Earlier this year, the gold-to-silver ratio reached heights never before seen in the past 100 years, reaching nearly 120 at its peak. To put that in perspective, the only times in history where this ratio managed to even near the 100 level were in 1991 and 1940.

gold-to-silver-ratio-2020-07-27-macrotrends

That created an unprecedented value opportunity in silver, but the recent rally has eliminated a lot of that opportunity. The current ratio is back down to 83, which still makes silver undervalued by historical standards, but no longer makes it the ultra-cheap asset it once was.

Conclusion

I still believe that silver is a longer-term buy here. Earlier this year, I said that silver could reach $25 an ounce by the end of 2020, a 9-10% premium from current prices.

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The current macroeconomic environment provides enough opportunity for silver, and gold for that matter, to continue rising, but there are a few factors to consider that don't necessarily make it a slam dunk pick.

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