The price of silver has soared to its highest level in two years. Silver is the best performing monetary metal – metals that trade in currency markets – this year, outshining its better-known sibling, gold, which has also risen strongly.
So far this year (to 18 July) silver is up 43 per cent in US dollar terms, while gold is up 25 per cent. By comparison, the S&P 500 is up 6 per cent, and the FTSE 100 up 7 per cent.
Performance of indices in 2016
Source: FE Analytics
The two metals are, of course, different, chemically and economically.
Silver is much cheaper per ounce, and has a wider industrial use than the rarer and more precious gold. More than half of world demand for silver comes from industry.
The two metals are also, like siblings, linked. You can study this linkage by examining the gold/silver ratio (see chart). The gold/silver ratio is the gold price, currently $1,328, divided by the silver price, currently $20 (1,328/20 = 66).
Source: Bloomberg
When the gold/silver ratio wanders far from its historical average, there will be a pressure for it to revert to the mean. When we launched the Old Mutual Gold & Silver fund in March, the gold/silver ratio was very high, around 82.
Since then the ratio has fallen to 66 (as of 18 July), which has driven a brisk tailwind behind the portfolio. A fall in the ratio means that silver is becoming more highly valued compared to gold. As can be seen from the graph, the general trend of the ratio over the last five years has been upwards.
The centre cannot hold
In April an important structural change was seen in gold and silver, with the Chinese starting a new overnight ‘fixing’ process denominated in Yuan, pivoting off their 1kg standard weight physical gold market at the Shanghai Gold Exchange (SGE). 
This physical market is huge compared to physical buying in the West and potentially has real and dynamic implications for price discovery (the market’s determination of fair price).
The ‘London’ market, which has only a wafer-thin physical backing relative to paper trading flows, has for decades driven price discovery in a way that bears little relation to underlying physical metal demand.
As a result market participants and observers have been waiting to see if a more physically-driven overnight market can create a change in dynamics. It is early days still, but I am watching with interest to see how volumes and overnight trading evolve and what effect this has on price discovery over the coming months.
Why are both metals rallying so strongly?
Everyone knows the story of the emperor who wore no clothes. None of his subjects dared point this obvious fact out, except a little child. It is the same today with central banks and quantitative easing.
The central banks have been printing money hand over fist for years, and yet we are invited to applaud this and think it OK. Well, it is not OK. Most investors know perfectly well that it is not OK, but, like the emperor’s subjects, they are nervous about saying so aloud.
Those who acknowledge the crisis in the world’s current monetary system are seeking to hedge their portfolios, and an excellent way to do this is with monetary metals.
Though sold in US dollars (and that is how, following convention, I have quoted its prices here) gold in particular should really be seen as a global trade-weighted currency, not a commodity.
The central banks, ironically, seem to be privately well aware of the true situation. The central banks of G20 nations currently hold 18 per cent on average of their reserve position in gold bars.
By contrast, and despite the recent rally, asset allocators and individuals still have record low positions in gold, silver, and precious metal mining shares. In the long-term, I believe there is plenty of upside to the rally.
Ned Naylor-Leyland is manager of the Old Mutual Gold & Silver fund. All the views expressed above are his own and should not be taken as investment advice.
