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It is a
commonly held belief by many precious
metal investors and even a good percentage of market pundits that
silver always outperforms gold during the latter stages of a precious metals
rally. When the chart action goes parabolic — such as in January 1980
or May 2006 — silver is at its most profitable, or so the thinking
goes. The truth, however, is that silver outperforms gold only during orderly
and strong price advances that remain trend-bound. Once gold and silver prices achieve the
wildfire stage, the blond metal can outshine its albino sibling both on the
way up and especially on the way down (by falling less, of course). With
incorrect notions in hand about gold and silver price action, both pros and
amateurs can make fundamentally-mistaken allocation decisions in their
precious metals portfolios that can be painful in the short and long run.
We will employ a visual construction in this
analysis that essentially reconsiders the traditional market perception of
gold/silver prices and ratios. At first our approach may appear a bit
convoluted but even cursory study should reveal its utility. What we have
done is plot the gold and silver
price on the same chart, adjusting the silver price by a factor
that causes a confluence with the gold
price at each market top that we are attempting to analyze. For
example, the market top in January 1980 occurred near a ratio of gold to
silver prices of 20-to-1 so we multiplied the silver price by 20 on that
chart. The gold/silver ratio has also been plotted on the chart with red
arrows drawn to indicate the trend during each market phase.
Prices are COMEX daily highs for the futures
contract that was active during the market top. There are no contract rolls
or continuations using this method and therefore prices become sharper and
more focused as time passes. This is because the contract goes from lightly
traded in the outer months to heavily traded as it becomes the front month.
Furthermore, plotting only the daily high removes a lot of noise and
magnifies the trending characteristics of each rally. The net effect is
subtle but useful in a way that would take a long time to describe in words
so we’ll let the charts do most of the talking. Note that each
chart is also labeled with a graphic to indicate the phases when silver is in
a strong, sustained price advance. Interim price peaks and blow-offs are
visually separated to help isolate price action and gold/silver ratio changes
during these market events.
While it would be preferable to
use spot gold and silver prices for
our analysis, the lack of historical (and current) spot price granularity
would blur or even obliterate many of the relational features found in charts
constructed from active, exchange-based market data.
Let’s now look at the first chart, which
displays the classic 1979-1980 rally in gold and silver ending with the
ultimate blow-off high on January 21, 1980. The chart shows that, amazingly,
the vast majority of that historic price rise occurred during just two 45 day
periods. Moreover, almost the entirety of silver’s relative strength
was limited to these two short intervals of time as indicated by the vertical
arrows pointing down in the below chart. Note that our unique chart
construction makes silver look like a machine on a mission. It is actually
gold that appears to be careening out of control as the afterburners are lit
during the final few days of this historic move.
 
Link to
Chart: http://www.metalaugmentor.com/eforum/wp-content/uploads/2010/12/1979_1980_GS.gif
Note that the gold/silver ratio spent the vast
majority of its time during 1979-1980 drifting sideways or slightly up while silver
was not advancing strongly. Of particular note is that during the interim
price peak of early October 1979, the gold/silver ratio interrupted its
ultimate decline to under 20-to-1 and did not resume it until gold and silver
prices started to strongly advance again in late November. Moreover, most of
the relative gains in
silver were made while advancing into the interim peak in October and not the
final blow-off in January.
As the rally went parabolic in early January 1980,
the gold/silver ratio actually flattened out prior to turning up sharply in
March (not shown). Therefore, the time to profitably own silver over gold was
actually quite limited in duration and it certainly did not include the final
blow-off stage, especially given that silver was back to $10 by April 1980
(not shown).
The above chart obviously shows a peak
high for COMEX silver slightly over $40 whereas spot prices reached and even
exceeded $50 around January 21, 1980. While this is a valid point, it
doesn’t materially change the story told by the above chart. Gold at
$850 and silver at $50 results in a gold/silver ratio of 17-to-1 which is
exactly where the chart shows the ratio bottoming during the demarcated
blow-off stage. In other words, using spot prices would still result in the
same conclusion that silver did not outperform gold during
the January 1980 blow-off whereas gold did substantially better during the
subsequent price decline (not shown).
The only
logical conclusion to be drawn from the above chart is therefore that silver
should have been sold for gold at the start of January 1980 well before the
famous blow-off got to its spectacular final stage. If your newsletter
writer, broker, analyst or pundit doesn’t know this then how in
tarnation will he or she provide useful guidance much less advice the next
time such a blow-off takes place?
Let’s now move along and look at the next
chart, which shows the 2003-2006 period. Here was a long rising market with
at least two interim peaks and a very exciting blow-off that had both COMEX
silver and gold going parabolic. This particular stage of the precious metals
bull market was marked by long advances during which silver maintained a
relentless climb and the gold/silver ratio fell. Once again, the declines in
the ratio correspond directly with strong but trend-bound advances by silver.
As price peaks and the blow-off stage are approached, however, silver no
longer outperforms gold and in fact surrenders much of its relative gains
during the subsequent price decline. The May 2006 blow-off is particularly
interesting as it marks an obvious low in the gold/silver ratio prior to the
top in prices. In fact, gold continues to rally even as silver’s first
parabolic rise fails. Remember, we are looking at daily highs here and so it
is quite possible that other charting methods will not reveal this relative
price action in such obvious detail.
Link to
Chart: http://www.metalaugmentor.com/eforum/wp-content/uploads/2010/12/2003_2006_GS.gif
As the Q&A embedded in the chart suggests, there
is a fundamental difference between the behavior of prices and the
gold/silver ratio during the interim peaks compared to the final blow-off
stage. Interim peaks are marked by an almost inverse relationship between
gold and silver prices and the gold/silver ratio whereas the blow-off is
associated with a sudden correlation between the gold price and the
gold/silver ratio as a result of gold turning on the afterburners in a late
bid to outshine its monochromatic kin. If we look back at the 1979-1980
chart, we can make a similar observation with some caveats. Namely, the
October 1979 interim peak shows a sloppy inverse relationship whereas the
January 1980 blow-off suggests a sloppy direct correlation. Note also that it
is gold finally going vertical that seems to mark each blow-off, which of
course is consistent with the idea that silver literally loses its edge right
before the rally ends.
Another point that may be worth considering is that
interim peaks seem to be accompanied by more gradual rallies in the price of silver and steeper declines
in the gold/silver ratio. Blow-offs meanwhile appear to be preceded by
steeper advances in the silver price and more gradual declines in the ratio.
Let’s keep this in mind as we look at the final chart in this analysis,
the period from 2009 to today.
Link to
Chart: http://www.metalaugmentor.com/eforum/wp-content/uploads/2010/12/2009_2011_GS.gif
By now all of the relationships should be familiar:
strong but trend-bound advance in silver associated with declining
gold/silver ratio, interim peaks with stalling or reversal of the fall in the
ratio, no blow-off without gold going vertical. Note that the most recent
price advance was much stronger and steeper than during the preceding interim
peak but the ratio also declined more sharply in the Sep-Dec 2010 period.
This actually doesn’t look all that different from the period
immediately preceding the 2006 blow-off. The conditions apparently required
to fulfill such an outcome include gold going vertical while the gold/silver
ratio turns up.
Other possibilities outside an imminent blow-off
could include:
(1) Interim peak preceding 1979-1980
or 2006 style blow-off.
(2) Interim peak with no blow-off to follow (2003-2005 style).
(3) 2008 style topping (multiple peaks, high level consolidation).
The best comparative fit in our opinion is an
interim peak before a 1979-1980 or 2006 style blow-off because both the price
and gold/silver ratio exhibit similar geometry compared to those prior
events. For this thesis to hold, any pullback in the gold price should
ideally be shallow and immediately followed by basing action during which the
gold/silver ratio remains steady.
The following chart is basically the same as the
previous one but some of the markings have been removed and the confluence
factor has been recast to 35 under the assumption that the next blow-off will
happen near a 35-to-1 gold/silver ratio.
Link to
Chart: http://www.metalaugmentor.com/eforum/wp-content/uploads/2010/12/2009_2011_GS2.gif
In our opinion, the current price advance in the
above recast chart appears analogous to the interim peak in October 1979. The
hypothesis would be negated by a strong rise in the gold price accompanied by
an upturn in the gold/silver ratio.
In summary, the two favored scenarios in the
current precious metals market according
to our unique reconsideration analysis of gold/silver prices and ratios are
an interim peak or a blow-off. Further price evolution is required before
either theory gains credibility but it should be noted that the modeled
relationship between gold and silver prices and the gold/silver ratio
suggests silver will not outperform gold by a substantial margin in either
case. One may wish to consider the investment implications and portfolio
allocation factors resulting from such a conclusion derived from the
foregoing analysis — but not before also evaluating the possibility
that the strong recent advance in silver prices will simply resume in short
order and thereby provide impetus to a substantial further decline in the
gold/silver ratio. Trend-wise we are getting long in the tooth for resumption
in the price advance and therefore we will assume for now that failure to
achieve new highs in silver by mid-January brings into play the scenario
involving “interim peak preceding 1979-1980 or 2006 style
blow-off”.
There are a number of other obvious
conclusions that can be reached from this reconsideration analysis. We’ll
reserve our own interpretations and integration with other analyses (such as
the gold basis) for the benefit of Metal Augmentor
subscribers. The last
few Founding Memberships are going fast and we will probably never offer this
premium level of subscription after we close the sign-up window on January
12, 2011 — and certainly not at the ridiculously-low current price.
Founded
by Tom Szabo and David Zurbuchen, the Metal Augmentor is a subscription based
investment research, consulting and wealth management firm focused primarily
on analyzing the mining sector and broader gold and silver markets. Our services
offer investors with a wide variety of content from detailed fundamental
research reports to institutional-level technical analysis. Meanwhile, our
unique analysis of the gold and silver basis is a tool that others are
largely unaware of and unable to provide.
Tom Szabo
Silveraxis.com
Metal Augmentor services offer investors a
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Their analysis of the gold and
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