A few weeks ago we wrote a blog on the GSR or Gold:Silver Ratio, and which you may recall is effectively the exchange rate of Gold expressed in Silver – much like the value of the Pound Sterling expressed in US Dollars or indeed the Euro. Regular readers may recall that we commented on the long term history of the relationship between the two principal precious metals but in turn drew their attention to more recent price action, which at the time suggested that a rally in both Gold and Silver was imminent. That article was published on the 11th March 2014. London spot Silver closed that day at $20.85 an ounce with the London Spot Gold contract ending the day at $1348.97.
Within a week of the articles publication spot Gold would print at $1392.22 and Silver would trade at $21.7925 .Representing gains of 4.32% and 3.10% respectively. Useful increments over the short term but the not kind move that we were looking for.
In the latter part of March, despite heightened geopolitical tensions in the aftermath of Russia annexation of Crimea, signs of a cooling Chinese economy and comments from New Fed chairman Janet Yelland, and which spooked equity markets, both Gold and silver have old off sharply. In fact, they are as oversold now as at the nadirs during the Xmas and New Year lull.
The GSR (Gold Silver Ratio) has, over this period, headed back towards recent historical peaks which range between 66.18, 66.43 & 67.20.
We can’t help but draw a comparison between the current move higher in the GSR and that seen in late June/early July 2013. When the Gold Silver ratio spiked to the aforementioned high points, before plunging to 57.54 by the end of August. During that period of volatility, Gold rallied by more than 11%. Silver, which is often seen as a geared play on Gold, appreciated by some 25%. The peak and subsequent sell off in the Gold Silver ratio can be seen clearly on the chart of the same below.
The reasons behind the recent sell off in precious metals are far from clear to us. Some commentators have pointed to a stronger USD in the wake of Fed tapering. But if one plots a Five year chart of Gold versus the Dollar Index (a trade weighted basket of currencies versus the US dollar) we find that the value of the dollar, in this measure at least, is only loosely correlated to the price of gold (see below).
The programs of Quantitative Easing, Asset Purchases and the almost open ended supply of liquidity that central banks have provided over the last five years have skewed many historical relationships within financial markets and instigated other new correlations. However, these changes are by their very nature artificial and likely to prove to be transient over the fullness of time. We believe that as, what we have often described as the narcotic drug of central bank intervention, is withdrawn (a process which his now underway) and interest rate rises loom large on the horizon, traditional relationships will return.
Gold and silver have historically been seen as stores of value and hedges against both inflation and its anti-matter cousin deflation. The former may well emerge strongly in Asian economies, whilst the latter is a distinct possibility in Europe, which in some lights is mirroring 1990’s Japan. That is to say efforts to stimulate its economy through loose monetary policy & low interest rates are having a negative feedback effect.
Our contention is that Gold and Silver will both be beneficiaries of the above over the longer term. But there is also potential for a near term rally based on the current valuations of the GSR.
Timing the turnaround, as ever, is the million dollar prize but with the technicals lining up on our side from an oversold perspective what with gold & silver being down 8 days out of 10 now and it slicing through both the “round number” support at $1300 this afternoon (27/03/14) and the 200 day moving average, together with renewed pessimism, we can smell a classic contrarian sharp rally recipe is being cooked up. We also see marked reluctance to buy the precious metals from fund managers again and so continued working through the capitulation that has been taking place for nearly a year now. The likes of the GDX & GDXJ have moved back into what we believe is extreme value territory.
As we write the price is looking to find a firmer footing around $1291 but we wouldn’t discount totally a move to $1272/74, in extremis, before bouncing.
Of course, we could be seeing a so called “paradigm shift” in the markets, in this instance in the relationship between Gold and Silver but we think this highly unlikely given the longevity of their relationship. Watch the GSR closely alongside the prices of both Gold & Silver for clear indications that the worm is turning.