One can only be impressed by the ascendancy of silver price lately. Buoyed by increasing tensions in the Persian Gulf region, gold prices have found new vigor and gold’s white metal companion has declared, “Whither thou goest, I will go…”
Figure 1 is a 6-month chart of the closely watched gold-to-silver price ratio (GSR) from August, 2011 to last Friday’s close, Feb. 24, 2012. It demonstrates not only silver’s recent commitment to follow but perhaps to lead:
*Ratio of most active COMEX contract prices
Figure 1 – 3-Month Gold-to-Silver Ratio
The bullish compression of the late-2011 GSR (gray triangles) to present levels (yellow diamonds) bodes well for silver price going forward with the 3-month moving average (gray line) just starting to nudge down in the same direction. A falling ratio denotes silver gaining strength relative to gold.
The GSR has been hovering about a Nov. 26, 2010 level of 51 (dotted line) for roughly month before bullishly gaping down to 50.27 at Friday’s close. By contrast, the ratio peaked at a bearish 57.02 last year when COMEX gold recorded a new high Sept. 6, 2011. The November date is used for a norm because it marks a period when not only gold-to-silver but gold-to-copper and –oil ratios returned to near historical norms after the extreme volatility of the 2008-2009 financial crisis.
A less noticed but even more startling metric of silver performance is the stability of the ratio itself. Commodity Ratio Stability© (CRS©) analysis is a simple technique for assessing the stability of commodity ratios and future trends. For any commodity pair, CRS is defined as the standard deviation of their ratio divided by the ratio mean over a specified period of time – a measure of how much variation there is compared to the average. Figure 2 shows the 1-month gold-to-silver CRS for the past six months:
Figure 2 – Six-Month Gold-to-Silver Ratio Stability
A CRS variation (blue curve) less than 3% is considered “very stable” and greater than 4% to be “divergent.” The above chart shows an improving trend in stability (dotted narrowing channel) from the extreme GSR divergence of 9.53% on Oct. 4, 2011 to a very stable 0.85% at Friday’s close. The October date marked the 2010 bottoms for both the DOW and S&P 500; a volatile period for precious metals following the record COMEX gold in early September (Figure 1).
The present stability of the GSR is even more remarkable considering that last Thursday’s CRS of 0.67% is the lowest (i.e. most stable) 1-month level since the onset of the Great Recession in December, 2007. What does this condition mean for silver price going forward? As the CRS© approaches zero, the price sensitivity of one commodity relative to another (commonly referred to as “beta”) approaches the inverse of their commodity ratio. For the case of silver relative to gold:
As gold-to-silver CRS© => 0, beta (Ag, Au) => (1/GSR)
This important property implies that silver price will rise (or fall) with gold with unusual fidelity given the present market environment: a bullish uptrend for gold should be bullish for silver without the usual volatility. As markets teach us daily, the forces creating these environments can change quickly and dramatically. In October when then CRS© showed high divergence, silver price was 2.5-to-3.2 times more volatile than gold on a 1-month basis; at the Friday close, the relative volatility was a much calmer 1.4 times.
The stability trend since last fall is the silver investor/trader’s friend; like Biblical Ruth, the white metal has chosen to stray not far from gold’s tent, “where thou lodgest, I will lodge.”
By Richard Baker, CP Value Analytics