Wednesday, 4 November 2009

Silver-Gold ratio seen from a different perspective

You read a 2009 article. The present situation bears little resemblence with those circumstances prevailing several years ago. Tendencies observed have broken down.
The US-dollar strength being negatively correlated to commodity and precious metal prices, its influence on both silver and gold prices is similar, therefore the silver-gold ratio is largely dollar independent.

Whenever the silver-gold ratio is being discussed, its value is set in a time perspective. Analysts deduct all information possible from the mere evolution of the silver-gold ratio.

The actual and recent average values of the Ag/Au ratio are being used to forecast future values: especially future silver spikes making the metal outperform gold spook the contrarian investors interested in silver. Recent extreme values are seen as resistance and support levels for the Ag/Au ratio. The significant slide of the silver price in the heat of last years financial crisis has inspired the eminent analyst A. Hamiltion (1,2) to study in detail the Ag/Au ratio evolution in this stressful time span.

The factor time being so crucial in all analysis, it never occurred to anyone to eliminate time from the Ag/Au analysis and just plot the silver price against the gold price on the horizontal axis. Constant Silver-Gold ratios are then differently sloped lines in this diagram.

The time independent analysis is shown in the graph below. Observations were quite startling. Not only we observe an (expected) non-linear dependency with the silver price sloping more upward at high gold prices, proving an expected overperformance of silver versus gold in an upleg: we observe two such curves. (click to enlarge)

The top one (red) contains all observations from early summer 2007 (when we had a modest $655 for gold against $12.5 for silver) until mid August 2008.

The bottom one (blue) contains all weekly observations from mid September 2008 until now (last week’s observation on 27 Oct 2009).

The four points in between (magenta colour) is what I call the Lehman Brothers bankruptcy transition from 20 August 2008 till 17 Sept 2008. During this period it became clear that the proclaimed statement that the credit crises was contained to the financial sector and would not affect the ‘real economy’ was just overly bullish wishful thinking.

Silver demand, being a key metal in many industrial processes, was expected to be more affected in a prolonged industrial downturn than gold. This drove down the silver price far more than the gold price with the Ag/Au curve transiting to the bottom (blue) one.

The clearcut distinction between both curves and the excellent correlation of both sets of Ag/Au price observations were better than expected. Moreover all observations added recently continue to obey the bottom blue curve, with silver indeed outperforming gold in the recent upleg. Since the Ag/Au ratio is resulting from collective positions of all traders and speculators, it fairly well follows the general investor sentiment.

If the Ag/Au ratio were to revert to the top curve, silver would have been over $22 at the 20 Oct gold price of $1062. But can we revert to the top curve? In my opinion the main reason why silver has been beaten up first needs being removed. When the proclaimed ‘green shoots’ materialize rather than being just some more bullish wishful thinking aimed at propping up investor confidence, we may, or rather we will revert to the top curve. Bright skies are ahead for silver, but not just right now.

1: Silver-gold ratio reversion (2) (Adam Hamilton – Zeal Essays : 19 June 2009)
2: Silver/Gold Ratio Reversion (Adam Hamiltion – Zeal Essays :6 February 2009)

1 comment:

  1. Current Gold:Silver Ratio Screams:
    Buy All Things Silver!
    Lorimer Wilson

    An accumulation of historic data and bullish forecasts, especially on silver. It lacks sound argumentation however.