Gold and silver both started surging in January, but silver less so. Silver has also dropped in late February, while gold has held near its 2016 high. This is called divergence. There are a couple reasons for divergence between the movement of gold and silver prices. One is the gold/silver ratio, a method traders use to assess the value of one metal to the other. Another reason for the divergence may be more fundamental, involving the demand and applications of the metals of themselves.

Divergence and Gold/Silver Ratio

Gold and silver are thought to move together, and often they do, as can be seen on figure 1. Figure 1 also shows periods where the Gold Trust (GLD) and Silver Trust (SLV) move in opposite directions, and periods where one metal outperforms the other.

Figure 1. Gold Trust (blue) Versus Silver Trust (red), Percentage Scale (right)

Gold versus silver, percentage performance

Gold is currently outperforming silver, surging higher, and staying higher, while silver has surged less and has fallen off its recent highs. Such discrepancies occur, and are monitored by the gold/silver ratio. The gold/silver ratio shows how many ounces of silver it takes to buy an ounce of gold. Since 1975 the average is near 60; right now it stands near 83 ($1258 divided by $15.17).

Figure 2. Gold and Silver Price Ratio

Gold and silver price ratio

While gold out-performance--or silver's under-performance relative to gold--is very noticeable in early 2016, this has actually been going on for a long time. Figure 2 shows that gold prices have risen relative to silver prices quite steadily for years. This is mainly due to silver price weakness since peaking near $50 in 2011 (when silver outperformed gold).

Going back to 1995 the ratio has typically topped out near 80 and then reversed. This indicates silver may start to see greater strength (relative to gold) in the coming months, possibly catching up to and overtaking gold in terms of percentage performance.

Gold and silver do diverge, but why is it so pronounced right now?

Metal Uses, Demand and Supply

Gold and silver are traded markets. There is a multi-year trend where gold has outperformed silver. As with any market, sometimes extremes need to be reached before a reversal. The gold/silver ratio near 80 is reaching one of those extremes now.

Traders are emotional; they pile into what looks good and avoid what isn't performing as well. Eventually though what is forgotten (silver) is bought up, and what was favored (gold) eventually falls out of favor. What is occurring in gold and silver is a pattern that plays out over and over in all markets.

Supply and demand also play a role though. One key driver of gold's strength has been central bank bank buying, which in 2015 was near its highest levels in decades. Silver is missing that key demand group, and could be part of the reason it's slumped relative to gold over the last several years (aside from the ebb and flow of the gold/silver ratio).

Figure 4. Central Bank Gold Buying in Metric Tonnes

Supply and demand for gold and silver are also related to economic and industrial output. Gold is primarily esthetic, as 50% of the gold purchased in 2015 was for jewelry. Approximately 38% was bought as investment or by central banks. Only 8% of gold is used in industrial processes, according to the World Gold Council's 2015 Gold Demand Trends report.

For silver, industrial fabrication consumes more than 50% of silver supply, jewelry uses up 28% and investment consumes about 20%, according to the Silver Institute's 2015 report.

The chart and numbers show that investors and central banks tend to favor gold over silver right now. That could change though if investment in silver starts to creep up. A lot of industries require silver, and but have much less need for gold. When investor demand for silver creeps up that squeezes the supply, and the big industrial players are forced to buy at higher prices, helping to fuel more people into the silver investment as prices rise. This sort of process increases silver demand relative to gold, and the gold/silver ratios starts its multi-year trek back the other way.

The Bottom Line

The divergence in gold and silver prices are not anything new. The fluctuations between the two metals are tracked using the gold/silver ratio, which is currently near extreme levels. Near extremes, and possible reversal points, market participants often see the wildest swings. This could be why the spread between gold and silver performance is so pronounced in 2016.

Right now, investment in silver is steady, but not high. Since silver is used so much in industrial processes, any increase in investment demand has a magnified impact since the large industrial players have to buy no matter what. It all comes down to supply and demand. Right now demand favors gold, but if the gold/silver starts to slip lower market participants are showing that silver is becoming more favorable again.

Want to learn how to invest?

Get a free 10 week email series that will teach you how to start investing.

Delivered twice a week, straight to your inbox.