Gold and silver prices had a rough summer season. After trading to a high of $1,365.40 on the continuous futures contract in April, selling in the gold market took the price of just over the $1,160 level in mid-August when the dollar index reached its most recent peak at 96.865. Gold dropped to its lowest level since early 2017.
The price of silver fell to a new low for 2018 in July along with gold, but silver waited until September to reach what now stands as a bottom at $13.91 per ounce, the lowest price since early 2016 for the precious metal. After probing below the $14 per ounce level, the price of silver recovered. However, gold and silver are still trading a lot closer to their lows that their highs for 2018 as we move towards the end of the year.
In 2015, 2016 and 2017, the precious metals had experienced selling pressure during the final month of the year. Fed rate hikes in December had weighed on the prices of the precious metals, and the Fed plans to hike the short-term Fed Funds rate at their December meeting. By the end of 2018, the Fed Funds rate which was at zero before December 2015 will stand at 2.25–2.50%.
Meanwhile, silver has been a lot weaker than gold since June which could mean that investment and speculative interest in the precious metals arena have declined dramatically as prices moved to the downside.
The ratio has been around for thousands of years
Sometime around 3,000 BC, the first Egyptian Pharaoh Menes declared that two and one-half parts silver equal one-part gold. The Pharaoh’s declaration was the first recorded comment on the relationship between the two precious metals and their roles as a means of exchange.
Gold and silver have had long histories as money. The Spanish Empire rose to the top of the heap in Europe after the discovery of massive reserves of silver in Peru. One of the primary issues that voters faced during the 1896 Presidential election in the U.S. was which metal would serve as a backing for the U.S. dollar. The winner, William McKinley favored gold, while his challenger William Jennings Bryan wanted silver to be the metal that provided the value for the U.S. currency.
These days, gold and silver have slipped to the background when it comes to their respective roles as money. While central banks still hold gold all over the world as part of their foreign exchange reserves, silver has not survived to the same extent. Governments continue to issue gold and silver coins that are legal tender, but these days fiat currencies derive their value from the full faith and credit of the countries that print paper money and mint coins. Many other metals have replaced silver in coinage as the value of the metal is higher than the coin values these days.
The relationship between gold and silver continues to be a subject of contention for many who follow the precious metals markets.
As the quarterly chart dating back to 1974 highlights, over the past 44 years, the median of the relationship is around the 55:1 level or 55 ounces of silver value in each ounce of gold value. The high came in 1990 at 93.18 and the low in 1979 at 15.47. The average of the high and low is at 54.325:1.
I like to look at the ratio as a guide to value. When it moves above the 55:1 level, silver is historically cheap compared to gold since the mid-1970s. When it falls below the average level, either silver is too expensive, or gold is too cheap, on a historical basis.
The quarterly chart in the ratio shows that the price relationship between gold and silver has increased to its highest level in a quarter-of-a-century at almost 84:1. The last time we saw this level was back in 1993, and this year the ratio rose to a higher high on the long-term chart.
The argument for watching the ratio
I like to watch the ratio because it is a barometer of speculative interest in the precious metals sector. Gold tends to be a more stable metal when it comes to its price compared to silver.
The quarterly measure of price variance in the gold market is around the 11.62% level.
In silver, the quarterly historical volatility is around 16.80%. Silver volatility tends to run around 50% higher than gold volatility over the long term.
Silver typically attracts much more speculative interest than gold because of its higher price variance. Therefore, buyers and sellers who come to the market to make profits from trends that take the metals higher or lower have a history of achieving better results on a percentage basis in the silver compared to the gold market. Since investment demand is one of the most significant factors when it comes to the path of least resistance for the prices of both metals, when the herd is buying silver investment interest in both metals tends to be higher than when the herd is selling silver or sitting on the sidelines. The ratio between the metals tends to move lower during bull market periods and higher when the trend is lower. In late 1979 when the ratio hit a low below 16:1, gold was on its way to $875 and silver to $50.16 on the highs. In 2011, when gold hit $1,920.70, and silver found a top at $49.82 per ounce, the ratio fell to a low of around 38.5:1. Conversely, in 1993 when the ratio hit its high t over 93:1, both gold and silver were at lows and mired in bear markets.
While I do not believe that history repeats itself perfectly, it does rhyme over time, and the silver-gold relationship is a tool that can reveal value and tells us if one metal is historically cheap, in modern times, compared to the other.
The argument against watching the price relationship between gold and silver
While some market participants continue to watch the silver-gold ratio, others dismiss the connection as a barbarous relic of the past. With silver removed from the global monetary system, its role as a currency or means of exchange has declined, and silver has become more industrial than precious in its role as a commodity.
Silver suffered in the 1990s when digital photography reduced the demand for the metal, but its applications in technology, solar panels, and other industries have replaced the photographic demand, and the proof is that the price of silver is much higher today than it was back then.
Moreover, a segment of the market argues that a cabal of banks and governments work together to depress the price of silver. J.P. Morgan is often mentioned as a primary seller of the metal, and some opine that the bank holds a massive short position in the silver market. However, I view these opinions as marketing fodder for those pushing silver as a retail investment. If the price of silver appreciates in the future, it will not be because J.P. Morgan is covering their nonexistent short position. It will be because the fundamentals of the silver market and a herd of buyers decide that the equilibrium price for the metal is higher.
Meanwhile, the role of the ratio has changed as silver’s value has tarnished compared to gold since the 2011 high and the ratio has been making higher highs. If history continues to rhyme, the higher ratio is a bearish sign for the two precious metals so long as the relationship remains near the highest level in twenty-five years.
Extensions in markets can lead to volatility
In the world of commodities, extensions from long-term means can lead to increased volatility. Other than the new digital currency asset class, commodities tend to exhibit the highest levels of price variance when compared to stocks, bonds, and other financial assets. The supply and demand fundamentals of raw material prices cause them to double, triple or halve over relatively short periods. When the price of a raw material hits the top or bottom of its pricing cycle, we often witness significant price appreciation or corrections. Most recently, we watched as lumber rallied to an unsustainable all-time peak at $659 per 1,000 board feet in May. This month, the price of wood futures has traded to lows of $316, less than one-half the value just five months ago. On the other side of the coin, extensions in the coffee and sugar markets led to the lowest prices in a decade in September, just last month. After trading to a low of 9.83 cents, sugar rallied to over 14 cents per pound this month. Coffee found a low of 92 cents last month and moved to over $1.20 per pound this month. Extensions to the up and downside ignited price volatility in these three markets, and the current level of the silver-gold ratio could be telling us that a significant move and wider price variance is in the cards for the silver market in the days and weeks ahead.
Leveraged ETN products in silver turbocharge results but do not sit on them for too long
In September, the price action in silver was a lot like what we witnessed in sugar and coffee futures markets. Silver fell to its lowest level since early 2016 as the price traded to a low of $13.91 on the nearby COMEX futures contract. The price came within 27.5 cents of the level of critical support for the silver market at the December 2015 bottom at $16.635 per ounce. Meanwhile, gold fell to a low of just over the $1,160 level in August, which is nowhere near its December 2014 bottom at $1,046.20 per ounce.
Silver has been the weak link between the two precious metals. At the current level of 84:1, either the price of silver is too low on a historical basis, or gold is too high. Given the role of gold in the world, the metric that has been a guide for the precious metals sector for almost one half-century is telling us that it may only be a matter of time before the price of silver corrects. A herd of buyers looking for a significant percentage gain could soon return on the long side of the market. If the ratio is meaningless, as some market participants argue, silver will continue to divorce itself from the yellow metal. I am not willing to argue with 44 years of history or a relationship that dates back thousands of years.
If gold holds above its low for 2018 at just over the $1,160 level, and it is trading at over $1,237 as of October 26, silver should have its day in the sun, perhaps sooner rather than later.
The Velocity Shares 3X Long Silver ETN product (USLV) is a short-term trading tool that can turbocharge returns in the silver market if the price is getting ready to correct to the upside. The fund summary states:
The investment seeks to replicate, net of expenses, three times the S&P GSCI Silver index ER. The index comprises futures contracts on a single commodity. The fluctuations in the values of it are intended generally to correlate with changes in the price of silver in global markets.
The use of leverages futures and options to create a triple return on a short-term basis in the USLV product makes it susceptible to time decay and reverse splits. The product recently underwent a 1-10 reverse split. USLV has net assets of $306.15 million and trades an average of over 335,000 shares each day making it a highly liquid tool for short-term trades.
USLV was trading at $65.63 per share on October 26, in 2012 the price hit a high of $65.13 on a split-adjusted basis. The time decay is a warning sign that USLV is not an instrument that should sit in your portfolio for long.
However, when used as a short-term instrument, USLV offers market participants a highly useful tool for those who time the silver market. On September 11 the price of nearby COMEX silver futures hit their low at $13.91 per ounce and on October 26, it was trading at $14.71, a rise of 5.8%. Over the same period, USLV moved from a low of $56.50 to the $65.63 per share level last Friday, a gain of 16.2% over the period. A reason that USLV has not represented triple the value is time decay as silver hit a high at $14.95 on October 2 which was a gain of 7.5%. On that day, USLV traded to a high of $68.90 which was an increase of 22% from the low.
The complimentary short-term product to USLV for bears in the silver market is the Velocity Shares 3X inverse ETN product (DSLV), which has net assets of $13.92 million and trades an average of 147,673 shares each day. Just like USLV, DSLV turbocharges the results on moves to the downside in the silver market, but it is only appropriate for short-term forays into the silver market on the short side.
When commodities markets extend on the up or the downside, volatility tends to increase, and many times prices reverse. The silver-gold ratio is at a quarter-of-a-century high, and silver recently tested a level that was dangerously close to the December 2015 and critical level of support. We could be in for a significant move in the silver market over the coming days and weeks. On the upside, $15.07 stands as a critical technical resistance level, and the price seems to be working its way towards a test of the upside. USLV and DSLV are products that could magnify results but do not hold them too long, or they will become dust collectors in your portfolio.
- The ratio has been around for thousands of years.
- The argument for watching the ratio.
- The argument against watching the price relationship between gold and silver.
- Extensions in markets can lead to volatility.
- Leveraged ETN products in silver turbocharge results but do not sit on them for too long.