Silver’s historical relation with gold has changed character dramatically since its late April record highs. Some traders see opportunity in this anomaly but it may portend more ominous things to come in the marketplace.

Silver and Gold - Three attributes of a close relation

Silver’s historical relation with gold can be characterized by the “three-highs”: 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.

Since gold and silver are precious metals it is reasonable to expect silver to have a high positive price correlation with its lustrous cousin (i.e. a correlation close to + 1.0). Typically, as gold price goes; so goes silver.

However, the price volatility of silver can be quite exaggerated compared to more stable gold. The market for silver is smaller and easily influenced by speculative enthusiasm in up-markets and asset liquidations in down-markets. Late April was a good example of the former when spot silver topped the 1980 high of the Hunt brothers’ speculation bubble and COMEX silver touched $49.880/oz on April, 25. During the 2008-2009 financial crisis, silver was often the first treasure thrown overboard by hedge fund captains of sinking ships and silver dipped into $9/oz territory. In either case, silver exhibited high price volatility with respect to gold.

Silver is both a precious and industrial metal that now competes with gold for investment as well as a hedge against fiat currencies. This has tempered some of the characteristic volatility in recent times and many believe emerging hi-tech applications for the white metal will reduce it further as demand and the market grow with time.

The last “high” is actually a consequence of silver’s high-volatility and high-correlation. Beta measures the price sensitivity of silver relative to gold. Some refer to silver as a “high-beta” metal because its price sensitivity is usually greater than 1.0 - during the April highs, the gold-silver beta was close to 4.0. This implies one can expect a 4% change in silver price for a 1% change in gold price making silver a “higher percentage-gainer” than a bet on bullion. Unfortunately, the same is true when fortunes reverse and price declines in silver are often calamitous compared to more steadfast gold.

The three metrics for silver performance are thereby related – beta (β) is 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 a high-beta performance for the white metal.

When silver and gold drift apart

Here is a one-year chart of the price volatility and beta for silver relative to gold*:

(*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)

From last fall until the April 25, 2011 high for silver, the two precious metals behaved normally in relation to each other. Silver VOL (blue line) was greater than 1.0 (dashed black line) and ramped to a peak of nearly 5.0 by the end of 2010. It fell back to 1.5 in mid-February and then shot up to the 4.0- level during the highs of late April. The beta curve (red line) tracked volatility fairly closely over this time since silver-gold correlation was positive and in a range of 0.64 to 0.98 – overall, an example for the text books.

The period after the April highs until the present demonstrates a very different character for silver and gold. Early May witnessed a violent reversal for silver price falling from its near $50/oz April high to mid-$30/oz territory marking the beginning of the May-June malaise for metals and mining equities. By June the silver beta was not only less than 1.0 but approached zero by the end of the month. Volatility, on the other hand, soared to 4.8 as beta flirted with nil; beta recovered to 0.5 and VOL peaked to an alarming 6.9 by mid-July. In stark contrast, gold made a very orderly and uneventful transition higher in July from the low- $1,500/oz to the low-$1,600/oz level.

By August it was time for gold to act a little crazy as it took off on a parabolic trajectory to its Aug. 23 COMEX high of $1.917.9/oz followed by a $166/oz intraday plunge the next day. That record was replaced Sept. 6 when COMEX gold touched $1,923.7/oz but then fell to an intraday low of $1,793.8/oz on September 7; a high-to-low swing of nearly $130/oz.

Gold price had become more volatile than silver. On Aug. 12, silver beta dipped below 1.0 again soon to be followed by a less-than-unity volatility ratio (dotted circle). Rolling into September, silver abandoned two of its traditional “high” attributes and reunited with gold only in high-price correlation. Currently on Oct. 5, silver volatility is back above unity at 1.637 and beta is moving closer to unity at 0.868.


Some commodity traders sensed opportunity in the present anomaly between silver and gold. Dennis Gartman, respected editor and publisher of the Gartman Letter, announced in mid-Sept. that he may return to the silver market, one he traditionally avoids because of silver’s high price volatility. Now that silver volatility is down relative to gold, Gartman contemplated selling silver short as he saw a bearish trend developing in the white metal’s chart.

There are two other important pieces to this puzzle. Gold has been until just recently more volatile than either copper or oil, both reliable proxies for global growth. The copper crash and fall in oil prices has reversed that trend although the present copper:gold and oil:gold ratios remain elevated at recessionary levels.

Two scenarios come to mind: one bullish on markets moving forward; the second, less sanguine – perhaps ominous.

Scenario One

The startling increase in gold volatility is just more evidence that gold has reached a near-term peak. There has been much technical talk about the “double-top reversal” pattern of the August 23 and September 6 highs. Accordingly, gold and silver prices will trend down as the worries about Europe ease, the Western economies muddle along in slow but not contractive growth and the East continues a moderate appetite for oil and base metals. Broad-based global supply restrictions will provide a floor to prices providing an overdue compression of key gold-referenced commodity ratios from elevated recessionary levels.

Scenario Two

A rare change of character between gold and silver and other key commodities signals trouble ahead for a fragile global recovery. Gold-referenced commodity ratios at recessionary levels are just that with a double-dip confirmation or worse coming after say, the first European bank failure makes the headlines. Precious metal prices remain at elevated levels as key commodity prices, such as oil and copper, fall on diminishing demand.

Always hopeful, I prefer the first scenario. As a harbinger of better times to come, it would be reassuring to witness silver fully rejoin with gold in their historically close relation.
By Richard Baker, CP Value Analytics