|
In our previous essays we often used the R-square coefficient to
measure particular gold or silver stocks’ exposure to the price of
respective metal. Some of the featured companies were both gold and silver
producers. The problem with this analysis was that it implied rising gold /
silver ratio. We said that we will research this topic further and here we
are. For details of this analysis please see articles available in the
Researchsection on our Website.
Gold to silver ratio is a topic often covered in various analyses and
essays. As you probably know, we strive to provide you with articles that
differ from all other essays you might find on the web. This is why we
decided to look at this matter from an unusual perspective. In this essay we
apply similar methods as we used when analyzing gold/silver’s influence
on the prices of precious metals stocks. We will therefore use a chart which
lets you see the whole structure of the correlation without using the time
axis. Please take a minute to understand the chart, used scales and the shape
of the trend lines.
 
Each point on the graph represents the combination of silver’s
and gold’s price at a particular date. Looking at this chart instead of
standard gold/silver and time axis does not give you clear idea about extreme
levels this ratio goes, but it’s clearer if you want to see general
tendencies. As we all know, looking at various things from different aspects
usually leads to making better decisions, especially the investment-related
ones.
All trend lines on the above chart are rising. That means that if we
took the first stage of the bull market, the second stage or even the whole
bull market (please refer to our previous essays to find out what we mean
under these terms), we would see that on average price of silver increases
along with the price of gold. Not much of a news, up to this point. What is
interesting is that in all these time frames this correlation is best
described using different trend lines. What is not that obvious is that all
these trend lines have different shape. First, we will focus on the long term
trend line and what implications it has on the current situation on the
metals market.
Data for the whole bull market is best represented by a linear trend
line, so the trend line is rising and the slope is constant. This suggests
that the gold / silver ratio could average around 43 level. If this trend
line is to be taken into account, silver is currently undervalued to gold and
therefore it might make sense to add to your silver positions by selling gold
(if you are inclined to trade this ratio) or making additional purchases of
metals by buying silver instead of gold. This trend line may change its shape
in the future as it will be calculated by using combination of more prices
than we currently can use. Although it is possible that this trend line will
be held, we expect that the slope of this trend line start
to decline at some point, consequently changing long term direction of the
gold/silver ratio in favor of the white metal. There are
numerous fundamental reasons, which were deeply covered in many essays, so we
won’t go into details here. Even according to current trend line with
gold at $900 the fair (not long-term under- or overvalued) price for silver
would be $19. Silver has definitely some catching up to do.
Term 'catching up' was not used by a coincidence. Silver, just like junior mining
companies, tends to 'take its time' before finally starting to rise
really significantly. However, when it finally does move, then it’s
'up, up and away' for silver and its relative performance to gold. Some
of our readers have already experienced these absolutely stupendous upswings
in the price of the white metal, for example in the first months of 2004 and
2006. We have seen this type of performance on very long term charts that go
back to the previous secular bull market in precious metals. Silver’s
catch up materialized mostly in the final stage of the bull market. Scale was
far greater than in more recent examples, but the fact remains that the most
of the rise took place in its last part.
The trend line for the first stage of this bull market (thin, dotted,
logarithmic line on the chart) seems to confirm our initial assumptions.
One of the main principles of the technical analysis is that history
repeats itself. Let’s say that it rhymes at least, so we might infer
that the second stage of this bull market will probably be characterized
by a huge 'silver catch up'.
Using the word 'will' is definitely accurate, as it was not the case
up to this moment of the second stage of this bull market. For now, the
second stage is best reflected by the exponential trend line, which means
that gold tends to outperform silver so far. If history is to repeat itself
once again (which we expect) silver might be in for a huge rise in the
future. As you may see, changing the trend line to logarithmic would require
the gold to silver ratio to decrease significantly. Please note that during
the first stage of the bull market the gold / silver ratio fell significantly
below the trend line during silver’s local peaks. Applying this to more
recent prices would cause us expect silver to rise above $19 with gold at
$900. Of course gold is in an uptrend itself, so the price of silver might
get a lot higher than $19 at its next peak. This would also cause the slope
of the long term trend line to decrease, and as we indicated above, we expect
that to take place.
The main point is that silver’s underperformance to gold is
nothing to worry about, as we are still in the early part of the second stage
of the bull market. On the contrary - we should expect it. In our view, this
situation will change but not necessarily right away. Current tendency has
influenced our leverage model for some gold / silver companies (see our
previous essays for details). It was based on data from the second stage of
the bull and did not take into account the fact that the change of the gold /
silver ratio is likely to decrease in the future. As you may see, using
pure numbers for your analysis and looking at the short term price swings
without relating to the bigger picture might lead to making wrong and costly
investment decisions. Therefore, we strongly advise you to understand the way
a particular number was calculated, before you decide to manage your money
taking into account a particular ratio or coefficient.
In summary, the Gold / Silver ratio is declining
along with the rise in the price of metals. Sometimes silver lags and
sometimes it laps gold. It tends to accelerate its rise in the last part of
particular upswing, rather than at the beginning. Since we are still early in
the second stage of the bull market, silver’s rather poor performance
in comparison with gold is pretty natural and we expect it to change in the
future. Stay alert for strong moves in the price of the
white metal, especially those connected with minor changes in the price of
gold. They may signal that we are on the brink of another spectacular,
parabolic rise.
On our website you can access tools dedicated to evaluating trend
lines and calculating leverage for most popular precious metals stocks. Register
today and you will gain access to all our Tools and much
more. We use the methodology described in this essay as well as many other
techniques to forecast market’s moves and discover unique opportunities
for profit. When you register, we will send you
occasional, brief market alerts, based on our research, whenever situation
requires it. Registration is FREE of charge and you may unregister anytime.
Przemyslaw Radomski
Editor, www.sunshineprofits.com
| 
