Gold and Silver: A Correlated Duo

While gold and silver often move in tandem, their relationship can sometimes be complicated. Despite sharing similar characteristics and applications, differences in underlying demand and supply dynamics can lead to occasional divergences. Octa broker discovers the nuances behind the gold-silver correlation and explores potential trading opportunities with the gold-silver ratio.

Over the past 40 years, gold and silver have exhibited a strong positive correlation.

● Both commodities are precious metals and are often regarded as substitutes.

● Both commodities have similar demand structures, but there are also significant differences in demand composition.

● There were times when the correlation between gold and silver was negative, but this does not happen very often.

● The supply of silver is five times greater than that of gold.

● The gold-silver ratio is the oldest continuously tracked exchange rate in history.

● Traders monitor the gold-silver ratio to find anomalies in the precious metals’ valuation.

● Asian countries are among the largest importers of gold globally.

The positive correlation between gold and silver may appear to be regarded as a totally natural phenomenon. Both commodities share related applications, possess very similar characteristics, and are even often found and extracted in the same geological locations. Therefore, it is perfectly intuitive to consider them close substitutes and expect their prices to correlate closely. However, if we delve deeper into the subject, we find important nuances and complexities in the price movements of gold and silver.

Correlation coefficient between gold and silver

In statistics, a correlation coefficient measures the strength and direction of the relationship between the two variables. When it equals 1, the correlation is perfectly positive—as the price of one commodity increases, the price of another also increases (and vice versa). In the case of gold and silver, the correlation is strongly positive and is almost perfect, meaning that the prices of both commodities tend to increase and fall in tandem. Octa broker has studied the daily closing prices of gold and silver from July 1982 to October 2024 and found that the correlation coefficient between the two commodities is around 0.92.

Why the correlation is positive

A very close statistical relationship between gold and silver is mirrored by their similar application in the physical world. Both commodities are precious metals and are often bought and sold for similar reasons. Indeed, according to the World Gold Council and Silver Institute, jewellery accounts for 49% of gold demand and 27% of silver demand. In addition, both commodities are often regarded as ‘safe-haven assets’ or ‘stores of value’. People would often buy gold and silver to protect their capital from inflation. Thus, private investment accounts for another 30% of the gold demand and 15% of silver.

Furthermore, both metals have industrial applications—but unlike gold, silver is used primarily for manufacturing and industrial purposes. Industrial usage accounts for 58% of silver demand and just 11% of gold. Another important difference is that central banks continue to regard gold as pure money and remain active buyers of the bullion to this day. Octa broker calculated that global central banks have bought over 1,000 tons of gold in the past four years. According to the World Gold Council, central bank purchases accounted for almost 20% of total gold demand in Q2 2024.

‘Although both metals share a very similar demand structure, which basically consists of just three sources—jewellery, investment, and industry—the relative share of these sources is rather different. Silver is a sort of quasi-industrial precious metal, while gold still has an important monetary function’, says Kar Yong Ang, a financial market analyst at Octa broker.

These subtle but important differences explain why, at times, the correlation between gold and silver prices had broken down. The global economic recession in 2020, induced by the coronavirus epidemic, led to a sharp decline in industrial demand for silver—but, at the same time, contributed to higher interest in gold as a protective asset during times of uncertainty. Kar Yong Ang, the financial market analyst at Octa broker, says: ‘Silver is much more sensitive to economic cycles than gold because silver’s investment thesis is less pronounced while its industrial usage is more widespread’.

Why silver is cheaper than gold

There is also one huge difference between gold and silver in terms of supply—gold is much scarcer than silver. According to the World Bureau of Metal Statistics, around 3,100 tons of gold were produced in 2023, whereas silver production amounted to 25,200 tons. This is why silver has always been cheaper than gold on a dollar per troy-ounce (oz) basis. As of 4 October, the price of silver on COMEX was $32.17 per oz, whereas gold closed at $2,652.25 per oz.

What the gold-to-silver ratio is

The gold-silver ratio is a popular way to look at the price difference between gold and silver. It is the longest-standing exchange rate that has been consistently monitored throughout history. This ratio shows how many units of silver are needed to buy one unit of gold—and existed long before gold futures started to trade on COMEX in 1982. In ancient Egypt, King Menes established the gold-to-silver ratio of 2.5:1. Subsequently, in 210 B.C., the Roman Empire officially set the ratio at 8:1. The ratio has evolved considerably since then but has generally tended to increase—partly due to governments’ manipulation with money supply and also thanks to the discovery of large silver deposits in South America.

To calculate the gold-silver ratio, one needs to divide the current market price of gold by the current market price of silver. As of 4 October, the gold-silver ratio stood at 82.44, which means that one troy ounce of gold can buy 82 ounces of silver—or that 82 ounces of silver are needed to buy one troy ounce of gold.

Traders usually monitor the gold-silver ratio to find anomalies in the relative valuations of precious metals. A high ratio relative to historical norms suggests that silver is undervalued compared to gold, while a low ratio indicates the opposite. In other words, when the ratio deviates substantially from its historical norm or a long-term average, traders would bet that it will return back to normality.

Kar Yong Ang, the financial market analyst at Octa broker, provides the following example: ‘In March 2020, the gold-silver ratio rose above 120, more than 40% above its long-term average, indicating that silver was extremely cheap relative to gold, and that gold was extremely expensive relative to silver. In this situation, a trader could either sell gold or buy silver. The smartest decision, however, is to do both. This way, a trader gets exposure to the ratio itself and is essentially placing a bet that the ratio will return to normal with a relatively low risk’.

Gold in South and Southeast Asia

Gold plays a vital role in the traditions and culture of South and Southeast Asian nations. Apart from being a safe-haven asset, it is viewed as the symbol of prosperity and is often used to underpin status and wealth. Owning gold jewellery or ornaments has been a traditional way to display affluence. Besides, gold has an important religious significance—especially in India, where it is closely linked to Hindu mythology and is often associated with sacred rituals. Overall, Asian countries are among the largest importers of gold worldwide. In fact, just four Asian countries—China, India, Singapore and Thailand—account for over a third of all global gold imports, around 39%.

About Octa

Octa is an international broker that has been providing online trading services worldwide since 2011. It offers commission-free access to financial markets and a variety of services used by clients from 180 countries who have opened more than 52 million trading accounts. To help its clients reach their investment goals, Octa offers free educational webinars, articles, and analytical tools.

The company is involved in a comprehensive network of charitable and humanitarian initiatives, including the improvement of educational infrastructure and short-notice relief projects supporting local communities.

Since its foundation, Octa has won more than 70 awards, including the ‘Best Forex Broker 2023’ award from AllForexRating and the ‘Best Mobile Trading Platform 2024’ award from Global Brand Magazine.

This article was written by FL Contributors at www.forexlive.com.