Large swings in gold’s price have been more the rule than the exception lately. The record gold price set on Aug. 23 was followed by a $166/oz intraday plunge the next day. That record was replaced Sept. 6 when COMEX gold touched $1,923.70/oz but then fell to an intraday low of $1,793.80/oz on Sept. 7; a high-to-low swing of nearly $130/oz.
Gold’s price has become more volatile than the price movements of copper, oil or silver. A check of records back to the first trading day of 2009 reveals no similar situation. That includes some of the worst days for markets including the S&P 500 bottom March 2009 during the later stages of the “Great Recession.”
Some commodity traders sense opportunity in this anomaly. A Kitco News Nugget (“Watching Silver For Price Break – Gartman”) reported on Sept. 15, “Although he says he tends not to trade silver because it is more volatile than gold, newsletter editor Dennis Gartman says that volatility has dropped recently and ‘that entices us to the market’.”
Are there also darker clouds on the horizon?
Copper, Oil and Silver Volatility Relative to Gold
Here is a one-year chart of the price volatility of copper, oil and silver relative to gold.
For this example, volatility is defined as the ratio of the 3-month standard price deviation of each commodity to the 3-month standard deviation of gold. The standard deviations are normalized by their respective means. If volatility (Ag, Au) equals 1.0, silver and gold experience the same fluctuation in price. If volatility is greater than 1.0, silver is more volatile than gold; if less than 1.0, less volatile.
The above chart shows that copper, oil and silver typically experience much greater price deviation than gold. To use a family analogy, gold is the stable parent and these commodities are the errant children running around the house. Silver (light gray line) reached seven-times the volatility relative to gold in mid-July. Copper (red line) and oil (dark gray line) have had peaks in the three to four times range. Copper volatility dropped below unity this spring but never have all three attained this state until COMEX gold reached its Aug. 23 high (dotted line & circle). Since that date copper, oil and silver volatilities are solidly less than 1.0 – the children behaving as adults? Has the parent lost its senses?
The Golden Rule
For those who consider gold to be the ultimate arbitrator of value in the commodity space, these are strange times indeed. My Aug. 8 Kitco Commentary introduced a Gold Value Index© (GVI) that computes the relative value of gold with respect to the commodities in the above comparison: copper, oil and silver. These three were chosen because copper and oil have proved to be reliable proxies of global growth and, silver is both a precious and industrial metal that now competes with gold for investment as well as a hedge against fiat currencies.
The GVI was assigned a value of 100 on June 7, 2010 when gold attained a high relative value on the day the Dow Jones Industrial Average closed below the “Flash Crash” low recorded a month earlier. During the 2010-2011 commodity inflation exacerbated by the Federal Reserve second round of quantitative easing and the oil spikes of “Arab Spring,” the GVI plumbed a low-value of 67.7
The U.S. debt ceiling debate, credit downgrade and deteriorating sovereign debt crisis in Europe returned the GVI (golden line) to high-value territory as shown in this plot over the same 1-year time period as the previous chart:
Since early August, gold has enjoyed a high-value relative to key commodities tempered by extraordinary high volatility (dashed range). The one-month moving average (black line) is presently at the center of these volatile swings showing some signs of topping out just below the 100-level.
To answer the question begged by the title of this commentary two scenarios come to mind: one bullish about markets moving forward; the second, less sanguine – perhaps ominous.
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 Aug. 23 and Sept. 6 highs. Accordingly, precious metal 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 such as the Grasberg copper mine strike in Indonesia will provide a floor to prices providing an overdue compression of gold-referenced commodity ratios which are presently at recessionary levels.
The lustrous patriarch is warning something while the children sleep - a rare change of character in the commodity household presages difficulty ahead for the fragile global recovery. Gold-referenced commodity ratios at recessionary levels may be just that with a double-dip confirmation or worse coming after say, the first European bank failure makes the headlines. Notably, a recovering economy is more able to absorb shocks. The “Flash Crash Redux” spike in gold value in 2010 was short-lived; the current volatile persistence at comparable levels in a much weaker economy may signal something more serious.
Always hopeful, I prefer the first scenario – thankfully, optimists are correct more often than pessimists. If the opposite were true, we’d still be living in caves except they would be more crowded with less food to eat and our neighbor, the pessimist, would be predicting worse things to come.
Nonetheless, the data are the data.
By Richard Baker, CP Value Analytics