Will deflation crush the silver price? Investors are particularly worried about this because silver is seen to be predominantly an industrial metal and are concerned that the silver price will drop substantially if deflation occurs.

Defining deflation

Let’s start by defining deflation, which can mean different things to different people. A common definition is a fall in the prices of goods and services and this would be indicated by a negative Consumer Price Index (CPI). That can either occur due to increased efficiency, productivity and technical advances which is a good form of deflation. Alternatively, a bad form of deflation may occur where there is a decline in consumer demand.

Others refer to deflation as a decrease in the money supply or a decrease in available credit.

Some may also be referring to asset deflation such as deflation in the stock market. Note that it is possible for the stock market to deflate while other goods inflate. Also note that that deflation is different from disinflation. Disinflation just means less inflation (i.e. prices are still rising but by smaller amounts). 

History of inflation and deflation

Annual inflation rate 1786-2019 (Source: Incrementum)

This chart shows the history of the consumer price index over 233 years in USA. Between 1785 and the early 1900’s the US currency was convertible to gold and silver. During this period there were huge swings between inflation and deflation, and these swings were by large amounts, ranging from +38% to -22%. Forty three percent of years were spent in deflation while the currency was under a gold standard. From the early 1900’s to the mid to late 1960s the swings were much less severe and occurred less frequently, with only 19% of years being spent in deflation. Interestingly during the fiat era there has not really been any deflation to speak of. Indeed, is deflation likely to occur in the fiat era?

Effects of deflation on silver

The effect of deflation on gold, silver, and commodities (Source: Incrementum)

Let’s compare how silver fared compared to gold and commodities when there was significant deflation. From 1814 to 1830, both gold and silver did well, while commodities did pretty badly. The episode from 1864 to 1897 is the civil war greenback story discussed previously. The precious metals held up pretty well while the commodities suffered. Note that during both these times the currency was convertible for gold and silver. In the Great Depression of course, the currency was under a gold standard and the gold price was fixed and raised by the government. However silver prices did drop a bit and commodities again did very badly in comparison. We do not have any examples of any deflation to speak of in the USA during the fiat era.

Sources of silver demand

Silver demand in 2017 (Source: Free bullion investment guide)

Looking at where the demand for silver comes from might help us. Around 60% is industrial demand for use in products such as solar panels, electronics, batteries, and photography. Twenty percent is used to make jewelry. Investment in coins and bars makes up 15% of demand. It is therefore fair to say that currently silver is predominantly used as an industrial metal.

Composition of silver demand 2013 (Source: Smaulgld)

How has silver demand evolved over the last thirty years? This chart dates from 1976 to 2013. Silver usage in photography has declined since the late 1990s. Silver use for jewelry and silverware had increased from the 1980s up until the late 1990s but since then demand has remained flat. The demand for silver in electronics and batteries increased from the late 1990s. Interestingly, silver coin demand was quite low up until around the year 2000 and increased significantly after 2006.  

Global demand for silver coins and bars (Source: SRSrocco Report)

If we look more closely at the investment demand, the demand for coins and bars from 2008 to 2015 was four times that of the preceding seven-year period and we know that the demand hasn’t dropped off recently. Indeed in recent months we know that bullion dealers have had record sales of silver and many had sold out.  

Silver ETF holdings (Source: Silver institute)

Silver demand also comes from exchange-traded products (e.g. silver ETFs) and this chart shows that as with coins, the demand increased sharply in 2008 and remained high. The demand for silver ETFs soared in the late 2000s. Even as the silver price dropped off, exchange-traded product demand remained high.

Although not shown on the chart, the figure for silver ETP demand in 2020 is actually off the chart at 896 million ounces. Indeed in the last six months alone silver ETPs saw inflows of 167 million ounces which is the highest ever inflow. This is particularly significant if you consider that the second-largest inflow for a whole year was 149 million ounces during 2009. This shows that investment demand for silver is increasing and if it continues, it suggests that this is something that is different to what occurred in the Great Depression. Although recent events may mean a decrease in industrial and jewelry demand, there has also been a drop in silver supply with about a third of the world silver production being shut down temporarily in 2020.

 Silver price during asset deflation

Silver, gold and stock performance in deflation

Let’s move on and take a look at the link between stock market deflation and the silver price. This chart covers 1929 to 1935 and all prices are indexed to 100 in 1929. The red bars represent gold, the grey bars represent the Dow Jones index, and the cream bars represent silver. The silver price initially dropped with the stock market but the drop became less pronounced while the stock market continued to decline. Silver ended up outperforming the stock market significantly and so silver rose while the stock market continued to decline.  

Industrial metals and silver ratio to stock market

Another way of looking at the relationship between the stock market and commodities is to look at the price of the commodity divided by the stock index. Does the price of silver behave like the price of an industrial metal? This is a chart of the S&P GSCI industrial metals index divided by the S&P 500 over the last 40 years. A low value means that the commodity is cheap relative to the stock market and a high value means that the commodity is expensive. It is very easy to see that the commodities behave very cyclically and we are currently at or near the lows of the cycle. How does this compare with how silver behaves relative to the stock market? The lower half of the chart shows that silver behaves very differently from commodities. This suggests that the silver price probably doesn’t behave like an industrial metal, certainly as far as the stock market relationship goes.

Correlation between silver and commodities

This chart goes from 1992 to present, showing the silver price (grey line) and the Bloomberg industrial metals index (red line) which consists of aluminum, copper, nickel, and zinc. Both are expressed as a percentage change from 1992. The lower section of the chart shows a plot of the correlation coefficient. A correlation coefficient value of +1 means that both indices move in the same direction whereas a coefficient value of -1 manes that the indices always move in the opposite direction. A value of zero means there is no directional relationship between the two variables.

For most of the last two decades the correlation between silver and the industrial metals has been positive and close to one a lot of the time. However, if we go back to before the year 2000, the relationship was actually negative for half of the time and more recently we have seen episodes where the correlation has been negative. This calls into question the idea that the silver price always behaves like an industrial metal. Perhaps the silver price responds more to trading and investment and is therefore behaves more like gold. 

Correlation between silver and gold

To test this idea we can have a look at the correlation between the gold and silver price. Apart from two short periods, the correlation has been positive for the majority of the time and most often has been close to +1. This shows that in terms of the direction of movement, silver behaves more like gold than it does an industrial metal. It should also be noted that silver has a high beta to gold, meaning that when gold moves in a certain direction, then silver tends to move by a greater amount in the same direction. 

Correlation between silver and the stock market

Finally, how does the silver price relate to the stock market? The silver price (grey line) and the Dow Jones index (blue line). It is clear that there is no real relationship between the two. The correlation swings between positive and negative.


Will deflation crush the silver price? No.

This answer may be surprising. The reason that people think that deflation affects the silver price is because silver is seen as an is an industrial metal. According to the data presented here, although silver is mainly used as an industrial metal, the silver price does not behave like an industrial metal. It behaves more as an investment and trading instrument and therefore it seems to be more closely related to the price of gold. Paper contracts probably do have a significant influence, overwhelming the effects of industrial demand.