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Silver’s historical relation with gold has changed character dramatically throughout 2011. There are technical signs that December will close with both returned to their more traditional relation with potential upside for silver investors.
“Together Again”
As in the title of the Ray Charles tune, gold and silver are thankfully “together again.” 2011 has weathered both the highs and lows of their stormy relation including a complete breakup in July. Gold, the usual cool head of the quarrelsome couple, became more volatile than silver following their separation from mid-August through mid-September. By my Oct. 6 IBTimes commentary, What is Up (or Down) with Silver and Gold? , the two were showing signs of reconciliation. As this year closes, they may yet ride into a golden sunset rally.
A close relation historically
The October commentary explained silver’s historical relation with gold as typically having high-correlation, high-volatility and high-beta. These three attributes reveal much about silver but also about gold; when they are behaving normally as a pair – and when they are not.
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Typically, as gold price goes; so goes silver. Since gold and silver are both precious metals, it is reasonable to expect silver to have a high positive price correlation with its lustrous companion (i.e. a correlation close to + 1.0). However, the price volatility of silver can be quite exaggerated compared to more stable gold.
Beta measures the price sensitivity of silver relative to gold. Silver is often characterized as a “high-beta” metal because its price sensitivity is usually greater than 1.0 – a gold-silver beta of 4.0 implies one can expect a 4% change in silver price for a 1% change in gold price. This makes silver a “higher percentage-gainer” than a bet on bullion in a rising market. Unfortunately, the opposite is true when fortunes reverse and price declines in silver become dramatic when compared to more steadfast gold.
High-beta is a consequence of silver’s high-volatility and high-correlation. The three metrics for silver performance are related – beta (β) is simply the product of correlation (ρ) and volatility (VOL):
β (Au, Ag) = ρ (Au, Ag) x VOL(Au, Ag)
A positive correlation close to unity combined with high relative volatility results in high-beta performance for the white metal.
Long lonely nights
Here is an updated one-year chart of the price volatility and beta for silver relative to gold* through Friday’s close:
(*Both volatility and beta are computed over a moving 3-month window. Volatility is defined as the ratio of the 3-month standard price deviation of silver to the 3-month standard deviation of gold. The standard deviations are normalized by their respective means)
