Commodities/Forex

Andy Hecht

Top 3 Ranking in Commodities, Metals & FX --SeekingAlpha

The Silver-Gold Ratio Reached A Record Level On The Quarterly Chart

•    Gold’s ascent does not take silver along for the ride
•    The ratio rises to a new peak- but there is room on the upside
•    Silver fundamentals are meaningless
•    It’s all about sentiment in the silver market
•    Silver may shock market participants if gold continues higher

Gold plays a prominent role in the global financial system, and it has for thousands of years. Silver also has a long history as a means of exchange and a store of value. While central banks, governments, and monetary authorities around the world continue to hold gold as part of foreign currency reserves today, silver has had a diminished role. However, for many, people gold continues to be hard money, and while the metal compares to the banknotes issued by countries, they consider silver the change. One of the earliest recollections of my grandfather was that he did not call the change in his pocket coins, but silver. In his day, dimes and quarters contained silver. 
The price relationship between gold and silver has been under siege over the past months as the yellow metal continues to outperform that change in my grandfather’s pockets. 

Gold’s ascent does not take silver along for the ride
Gold broke out to the upside in the aftermath of the June FOMC meeting. The prospects for lower interest rates lit a bullish fuse under the gold futures market. 

Source: CQG
As the monthly chart highlights, the price of the yellow metal moved above the 2018 and 2016 highs and above the top end of a $331.30 trading range that had been in place since 2014 in June. Gold traded to a high at $1441 per ounce, and as of Friday, July 5, the yellow metal settled at just over the $1400 level, which was still over $20 above the 2016 peak. At $1400 per ounce, gold is 1.6% above the 2016 high and 33.8% above its late 2015 bottom at $1046.20. 
While gold has shined, silver continues to tarnish. In 2015, when gold hit bottom, silver traded to a low at $13.635 per ounce. In 2016, when gold reached $1377.50 in the aftermath of the Brexit referendum, silver rose to a high at $21.095. At a settlement price of $14.918 per ounce on July 5, silver was 9.4% above its lows, but still 41.4% below its 2016 high. Silver’s miserable performance compared to gold sent the silver-gold ratio to a modern-day high on the quarterly chart. 

The ratio rises to a new peak- but there is room on the upside
In 1990, the silver-gold ratio hit a peak at 93.18 to one, or 93.18 ounces of silver value in each ounce of gold value. At the time, the price of gold was below $400 per ounce, and silver was under $4. The move in the ratio above the 1990 peak comes at a time when the prices of both precious metals are appreciably higher. 
The two most significant modern-day bull markets in gold and silver came in the late 1970s and 1980 and 2011. In 1979, the silver-gold ratio fell to a low at just under 15.5 ounces of silver value in each ounce of gold value. In 2011, the ratio fell to just under 43.3:1. 
The ratio dates back way past the 1970s. In around 3000 BC, the first Egyptian Pharaoh Menes proclaimed that two and one-half parts silver equal one-part gold. Recently, the ratio moved to a level that was above the 1990 high. 

Source: CQG
As the quarterly chart shows, the ratio at 93.73:1 level at the close of business on July 5 surpassed the 1990 high. However, a look at the monthly and weekly charts reveals that the price relationship could have more room on the upside as the trend continues to push gold higher at the expense of its precious cousin. 

Source: CQG
The monthly chart displays a high in 1990 at 98.72:1. 

Source: CQG
The weekly chart shows that in February 1991, it rose to 101.42:1. The silver change required to purchase an ounce of gold could still have more room on the upside when it comes to challenging historical peaks from the early 1990s. 

Silver fundamentals are meaningless
Producers all around the globe explore for and extract gold from the crust of the earth as their primary business. Therefore, the price can be sensitive to the overall production cost of the yellow metal. As the price of gold moves higher, miners can profit from extracting lower grade ores with higher output costs. However, silver is often an afterthought when it comes to production. Silver is a byproduct of gold, copper, lead, zinc, and other ores and primary producers of those metals and ores sell the silver pull out of mines regardless of the price. Therefore, fundamental analysis when it comes to silver is far more of a multilevel process when it comes to the supply side of the equation. Production cost for many producers of base and other precious metals is zero for silver as they would continue to produce the metal regardless of the market price making fundamentals a waste of time. 

It’s all about sentiment in the silver market
In 2004, James Surowiecki’s book, The Wisdom of Crowds: Why the Many Are Smarter Than the Few and How Collective Wisdom Shapes Business, Economies, Societies and Nations, argued that large groups of people are collectively smarter and make better decisions than individual experts. Markets are the embodiment of the wisdom of the crowd as the last price is always the “right price” because it is the level where buyers and sellers meet in a transparent marketplace. If the price is too low, buyers will overwhelm sellers and vice versa. Whenever I ran trading desks during my career, my mantra was that the market is always correct, and traders and analysts could only be wrong. 
When it comes to silver, the current price at under $15 per ounce, even with gold at over $1400 and the ratio at over 93:1, is the right price. In silver, the path of least resistance of the price of the metal is a function of market sentiment. As of last Friday, market sentiment is telling us that silver continues to depreciate against gold. However, that could change, on a dime, that is no longer made of silver these days. A shift in sentiment could launch the price of silver in a heartbeat if the wisdom of the crowd decides that silver is too cheap compared to gold and that risk-reward profile favors significant upside potential for the price of the metal. 

Silver may shock market participants if gold continues higher
I had thought that a break to the upside in gold above the 2016 peak would light an even more bullish fuse under the silver market, but so far, I have been wrong according to the market. The market is not wrong; I am. However, silver could attract a herd of buyers if the price of gold continues to move higher over the coming days, weeks, and months. And, if gold fails, and the price of the yellow metal suffers a significant correction, the price action in the silver market could become ugly. After all, the price of platinum, another underperformer in the precious metals sector, fell below the 2015/2016 low, so why can’t silver do the same? The answer is, it can. 
There are still plenty of market participants out there who view the world like my grandfather did and believe that silver is more than a metal that sits like a lump and tarnishes over time. 
I will continue to watch the crowd and the price of silver. One bullish signal would be rising price and increasing open interest in the futures market. 

Source: CQG
The semiannual chart shows that the total number of open long and short positions in the silver futures market was at the 222,392-contract level at the end of last week. The record high was at almost 244,000 level. Rising open interest and a break to the upside above the 2019 high at $16.20 per ounce could trigger a flood of buying in the silver market. The crowd will tell us if that type of move is in the cards for the silver market. 
I continue to believe that risk-reward favors the upside in the silver market, and the future price action will tell me if I am correct or suffering from a delusion. The most successful traders and investors respect the market and realize that they are long or short at the last price on the screen, and not their execution levels or because of historical relationships. Historical trends can bend, but a healthy respect for the past can sometimes predict human behavior which, in mass, forms that crowd that makes a decision or determines a price. 


 

Andy Hecht covers Commodities and Forex as one of the original contributing analysts at FATRADER. A former senior trader at one of the world’s leading commodities trading houses, Philipp Brothers (now part of Citigroup), Andy has worked and consulted for banks, hedge funds, and commodities producers and consumers around the world for over 35 years.
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