Gold and Silver Breakout – What Next?

I have been asked these three questions many times: 1) What is my target price for gold?; 2) Do I think silver will follow gold and break out of its declining trend?; and 3) What are my thoughts on the gold-to-silver ratio?

Until a few months ago, all I had was an underlying faith and conviction that, at some point, gold would finally break through resistance to above $1,350/ounce after attempting this feat multiple times since 2016. It did just that after the June 18-19 FOMC (Federal Open Market Committee) meeting. Until a few days ago, I wasn’t sure what the catalyst would be, or the timing, for silver to have its day in the sun. I knew that investor attention would, one day, return to silver, which has been largely shunned in recent years in favor of cryptocurrencies and cannabis. On July 16, silver bullion finally broke its downtrend, sending the gold-to-silver ratio lower and sparking a rally in silver equities.  YTD, through the Friday, July 19 close, gold bullion is up 11.14% and silver bullion has gained 4.58%. 

Figure 1. Gold and Silver Breakout Ignites in May

A comparison of the XAU, XAG, DXY and SPX Indices from April 1, 2019, to July 17, 2019, normalized. 

Source: Bloomberg.

Where to From Here?

To sum up my current views, I am borrowing a quote from a technical analyst who has called for a gold breakout for a long time:

“I have no real price objective for gold or silver, other than "higher". Which is to say, the bet is that we’re witnessing a structural change taking place for the first time in years, in which precious metals outperform (general) equities… and trade much higher than where they are trading at present. May it be so!” — Carter Worth, Cornerstone Macro

2019: We Predicted a Year of Change

We at Sprott have been gold and silver bulls for years and have written about the various economic and political imbalances building up in the global financial system. This past January, we held a webcast for our clients in which we discussed 2019 as a year of change and argued that a number of factors presented a positive environment for gold, silver and the underlying equities.

We predicted that 2019 could surprise to the upside because of:

(1) A deteriorating global macro-economic environment;

(2) Trade tensions between the U.S. and the rest of the world; and

(3) Global geopolitical tensions.

All three reasons to be bullish still stand and are even more pronounced right now.

Most importantly, the macro outlook has softened further, with signs of economic slowdown in the U.S., Europe and China. 64% of the world has PMIs (purchasing manager indices)¹ that are negative or <50, including the Eurozone, China, Japan, Korea, Malaysia, Taiwan, Mexico and Canada. U.S. PMIs have been declining as well. The Fed is widely expected to begin lowering its target interest rate at its July 30-31 FOMC meeting, while the ECB (European Central Bank) is planning to roll out its own monetary easing measures. As the ECB rate is already <0%, the Bank will likely restart QE (quantitative easing), which it phased out in December. These central bank U-turns have happened rather rapidly and are the main driver behind the precious metals rally.

Trade tensions also appear to be intensifying. While we read about a supposed truce between China and the U.S. at the G20 summit in Japan, there was no real resolution at the meeting last month, and it seems that the talks are not progressing. There are also signs of growing tensions with Europe: The Office of the U.S. Trade Representative said on July 1 that it is considering tariffs on an additional 89 items against the European Union. This would bring the trade value of items under consideration for tariffs to $21 billion a year.² There are also U.S. threats of tariffs against Mexico if it does not hold up its end of the recently signed immigration agreement.

Geopolitical risks are also playing a role in the recent rally, with Iran making news headlines. It was reported on July 7 that Iran would breach the 2015 nuclear agreement for the second time by enriching uranium above the agreed-upon 3.67%. Breaking the nuclear agreement is an attempt to put pressure on Europe, China and Russia to do more to offset U.S. economic sanctions. To this, President Trump said: “Iran better be careful,” and Secretary of State Mike Pompeo threatened further steps against Iran in response to its plans to accelerate uranium enrichment.

The Wind is at Our Back, Particularly for Silver

The wind is now at our backs and we believe that both gold and silver will climb higher.

Silver, in particular, has the potential to outperform gold significantly. For example, in the wake of the global financial crisis, the gold-to-silver ratio plummeted from 80:1 bottoming at 32:1, with the silver price topping out at ~$50/ounce. Recently the ratio hit a record 93:1, while the price is sitting at around $16/ounce. Yesterday, the ratio stood at 89:1 as shown in Figure 2. 

This leaves significant room for silver to run. The annual silver market is only about $15 billion of value, and it does not take much to move silver’s price. Silver demand is already making a stealth comeback with the U.S. mint reporting a 43% increase in silver coin sales year-to-date as of June 30 and with ETFs gathering steam. If this investor interest continues, it will definitely push the silver price higher.

In Sprott’s active equities portfolios, we are looking for mining companies that have good financial leverage to the prices of gold and silver — companies that will have greater upside potential if both metals prices continue to rise.

Figure 2. The Case for Silver

The gold/silver ratio has averaged 67:1 from 1988-2019, but currently stands at 89:1 as of July 17, 2019. This means that silver is significantly cheaper than gold, based on the historical averages.

Source: Thomson Reuters Eikon. Data as of 06/30/19.

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Sprott Physical Silver Trust (NYSE Arca: PSLV) 
Sprott Physical Gold and Silver Trust (NYSE Arca: CEF)

1	The Purchasing Managers Index (PMI) is a measure of the prevailing direction of economic trends in manufacturing. The purpose of the PMI is to provide information about current and future business conditions to company decision makers, analysts, and investors.
2	WSJ: U.S. Proposes More European Tariffs Pending Airbus Case.