Silver’s
recent rallying action is starting to catch traders’ attention.
Since the end of its latest correction in early February, this white metal
has surged 23% higher. It has well outperformed gold, which only
climbed 9% over this same 9-week span. And based on silver’s
strong historical relationship with gold, odds are today’s silver rally
is only beginning. Silver’s gains should accelerate in the months
ahead.
The primary
reason is silver remains seriously undervalued relative to gold.
While it sounds strange to apply valuation concepts across metals, in the
case of silver and gold it is very appropriate. The gold action utterly
dominates silver traders’ sentiment and hence silver price
action. When gold rallies, they get excited and aggressively buy
silver. And when gold sells off, they get scared and swiftly dump
silver.
Over the decades
as silver traders watched gold for silver-trading cues, naturally
silver’s behavior converged to mimic gold’s ever more
closely. This became a self-fulfilling prophecy. The more that
silver traders watched gold and followed its lead, the closer tactical silver
action mirrored gold’s. This led even more silver traders to
monitor gold and elevated this yellow metal to the dominant driver of silver
sentiment.
Silver’s
ironclad relationship with gold is easily quantifiable through the
Silver/Gold Ratio. The SGR simply divides the silver price by the gold
price and charts the result over time. Thanks to late 2008’s epic
stock panic, the SGR today is still way out of whack compared to historical
precedent. While silver has already recovered greatly relative to the
gold price, it still remains nowhere close to rectifying the panic-driven gap.
This
persistent-yet-gradually-closing valuation anomaly of silver relative to gold
continues to create excellent opportunities for silver traders. As
silver continues to normalize with prevailing gold prices, its price will
rise driving all silver-related investments including silver stocks much
higher. To understand these SGR-reversion opportunities, we have to
first consider the stock panic’s impact.
This first chart
is not the SGR, but simply raw silver and gold prices over the last 5 years
or so. It establishes the usual historical relationship between these
two precious metals, how the apocalyptic fear generated by the stock panic
threw this relationship into chaos, and how silver has been recovering relative
to gold on balance ever since. This necessary reversion has yet to
fully run its course.
Prior to the
stock panic, silver’s very-tight correlation with gold is readily
apparent visually. Silver rallied when gold was strong and fell when
gold was weak. And this critical relationship is even stronger
mathematically than our eyeballs can perceive. On a day-by-day basis
between January 2005 and August 2008, silver had a stellar pre-panic correlation
r-square with gold of 94.7%!
This means almost
95% of silver’s daily trading action over this entire span was directly
explainable mathematically by gold’s own. Silver, as has always been
the case in history, was acting as a leveraged proxy
on gold itself. Silver has always mirrored, and usually amplified,
underlying moves in gold. Silver traders watch gold like hawks, hence
prevailing gold action at any given time creates silver psychology.
But during
2008’s once-in-a-century stock
panic, silver radically decoupled from gold. The silver traders were
watching gold as always, but it was the least of their concerns. They
got caught up in the unbelievably-intense general fear gushing from the
plunging stock markets. Silver has always been a highly-speculative
asset, and those overwhelming panic fears collapsed the universal appetite
for speculation in all risky assets. Silver was collateral
damage.
The heart of the
stock panic was an insane 21-trading-day span ending on October 27th, 2008
where the flagship S&P 500 stock index (SPX) plummeted 30.0%! Gold
didn’t fare as well through this fearstorm as its investors had long
hoped, falling 16.7%. Yet even though it held up much better than
general stocks, silver traders still freaked out. They drove a 32.6%
silver plunge over this 4-week span, brutal.
And provocatively
in October 2008, silver hit new lows on days the SPX did (and gold did not).
Silver followed the stock markets. The SPX fear temporarily
eclipsed gold as silver’s primary driver. During that 4-month
panic span (September to December 2008), silver’s correlation r-square
with gold plunged to a once-unthinkable 52.5%. Merely just over half of
silver’s daily action was statistically explainable by gold’s
own, a surreal anomaly without precedent.
When the dust
settled from this unparalleled panic period, silver had plunged 53.4% from
its July highs a few months earlier while gold lost 23.4%. Although
gold only fell to a 14-month low at its panic nadir, silver went much deeper
to a 34-month low. As I told our subscribers at the time in the heart
of the panic, it was very clear that silver was radically undervalued
relative to gold. So we aggressively bought and recommended elite
silver stocks in late 2008 to ride this anomaly’s unwinding.
And silver has
indeed recovered sharply as you can see in this chart. Whenever you see
a market anomaly driven by an extreme emotion, realize that once this emotion
abates the anomaly will not persist. Extreme fear crushed silver, so as
this fear evaporated silver bounced back. Between its panic low under
$9 in November 2008 and its latest interim high above $19 in early December
2009, silver has already rallied over 115% at best. Yet despite these
big gains, silver’s post-panic recovery is still far from over.
You can see why
in this silver and gold chart. Even though silver has rallied mightily
out of the depths of panic despair, it is now only nearing its pre-panic
levels. Meanwhile its primary driver, gold, has surged to new highs well
over its pre-panic levels. And silver’s joined-at-the-hip
day-to-day relationship with gold has been largely restored since the
panic. Since January 2009, its r-square has surged back to 88.5%.
In the post-panic timespan, 89% of all silver action has been mathematically
explainable by gold’s own.
With silver
mirroring and amplifying gold again on a daily basis, the odds are
overwhelming that silver will continue normalizing back to its historic price
relationship relative to gold. And even with this chart, it is readily
apparent silver tracked gold very well prior to the panic. If the blue silver
line was to mirror the red gold line again, silver would have to be trading
at new bull highs in the lower $20s. We aren’t even close yet.
And this is where
the Silver/Gold Ratio comes in. The SGR precisely quantifies the
relationship between the silver price and the gold price. This next
chart shows the SGR in blue, along with its key 50-day and 200-day moving
averages. Technically the SGR leads to difficult-to-understand
decimals, so I usually take the inverse of it (Gold/Silver Ratio) and invert
the axis so a rising blue line indicates silver strengthening relative to
gold and vice versa. The raw silver price is shown in red.
For many years prior
to the stock panic, the SGR averaged 54.9. An ounce of silver tended to
trade at 1/55th the price of an ounce of gold. This 55 ratio naturally
became widely accepted in the precious-metals mining industry. When
primary silver producers converted byproduct gold to silver-equivalent ounces
for their SEC financial reports, they used 55. Primary gold producers
used the same number for their byproduct silver. In today’s
silver bull, a 55 SGR was established normality prior to the stock panic.
And interestingly,
the SGR was actually in a secular uptrend before 2008’s stock
panic crushed silver traders’ resolve. As the silver bull marched
on, silver gradually gained ground relative to gold. This made a lot of
sense. As more investors learned of the secular gold bull, their
interest in deploying capital in it grew. And silver, since it is much
more affordable and leverages gold’s gains, is a perfect
precious-metals investment for the masses. As silver’s popularity
with investors grew, it rallied faster than gold.
But the stock
panic was a bullet to the skull of normality, and the resulting silver plunge
drove a massive SGR breakdown. Since silver fell much faster
than gold during the stock panic, the SGR naturally plummeted. This key
ratio ultimately fell to its lowest levels of this entire secular bull.
At the height of fear in the stock panic, you could by an ounce of silver for
just 1/84th the price of an ounce of gold! It was truly the silver
fire-sale of a lifetime, a fantastic opportunity I told our subscribers about
in real-time.
Over the entire
4-month panic span, the SGR averaged 75.8. Silver remained far too
cheap relative to gold based on historic precedent. After our
subscribers had had plenty of time to lay in their own silver-related
positions, I first wrote about this anomaly publicly in early February
2009 when silver had just climbed back over $12.
Since then as expected, silver has indeed regained much ground relative to
gold.
Today, the
SGR’s recovery uptrend is now well-established as you can see in this
chart. No one has to take it on faith anymore. Silver has been
rallying much faster than gold during the latter’s uplegs, regaining
lost ground. And as usual when gold corrects, silver falls faster than
its primary driver. But over time these flowings and ebbings have
clearly carved higher lows and higher highs in SGR terms, a textbook-perfect
recovery uptrend.
And there is no
reason not to expect this post-panic SGR-reversion normalization to
continue. Investors and speculators, terrified of silver’s
volatility during the panic, are gradually returning to this popular white
metal. As awareness of these powerful precious-metals bulls filters
from contrarians out into the mainstream, countless investors will add
positions in silver and silver stocks. Just as before the panic,
silver’s popularity profile will once again continue to grow among
investors.
For all kinds of
sentimental, technical, and even geological reasons, I fully expect silver to
eventually resume its historical relationship with gold. This means one
of two things. Either the SGR will return to its pre-panic average of
55, or this ratio will climb back into its secular uptrend where support is
now running near an SGR of 47 or so. And this recovery could accelerate
sharply from the pace we’ve seen so far when investors start really
getting excited about silver again. It is overdue, as we haven’t
seen serious silver excitement since early 2006.
If you start
plugging various gold prices into these fully-recovered SGRs, you quickly
understand why I am so bullish on silver today. At today’s
$1150ish gold and the pre-panic average 55 SGR, we are talking about almost
$21 which is considerably above today’s $18ish levels. If you
think the silver stocks you own or want to buy look stronger now, imagine
where they would trade with silver well over $20.
And at the 47 SGR
necessary to get this ratio back into its secular uptrend, and today’s
$1150 gold, this fully-recovered projection leaps to $24.50 or so!
Silver’s best price seen so far in this bull was only $20.77 in March
2008. New bull highs will spark widespread excitement in silver like
nothing else can. Last autumn after gold broke decisively above
$1000 for the first
time ever, investors got so excited they quickly
bid it up another 20%+ in just a couple months. New highs jumpstart
investment demand.
And for a variety
of reasons including its bullish fundamentals and seasonal
spring rally, gold itself is likely to power much
higher in the coming months and years. The higher gold goes, the higher
silver will ultimately go as well. When you plug higher gold prices
into the recovery SGRs, the potential of silver is even greater. At
$1200 and $1300, the 55 SGR yields about $21.75 and $23.50 while the 47 SGR
yields around $25.50 and $27.50. The “normal” silver
targets relative to gold quickly climb higher as gold rallies.
Each time
I’ve written publicly about the reversion of this panic-driven SGR
anomaly, I get hammered on my conservative assumptions. But that is the
whole point of this analysis. Sure, gold could and probably will go
much higher and the SGR could very well climb well above these baselines next
time traders really get excited about silver. So plug in whatever
numbers you want, conservative or aggressive. The core point here is
silver is undervalued relative to gold, regardless of one’s
assumptions, offering great opportunities for traders.
For years I read
financial newsletters, trying to get an edge in the markets and improve my
own trading. But I could never find one concentrating on what was
important to me. What is driving the markets today, and why? And
how can I position my capital to ride today’s prevailing trends over
the key 6-to-12-month time horizon that encompasses major uplegs and
corrections? I wanted practical unemotional analysis leading to
high-probability-for-success trades, not emotional rants. So I founded
my own research company.
A decade later,
our subscribers continue to thrive. While we have plenty of
silver-stock positions deployed today in anticipation of the coming silver
rally, silver is just one of many markets we track, analyze, and actively
trade. If you like logical and practical analysis like this essay,
you’ll love our acclaimed monthly
newsletter. In it I integrate our vast and
endless market research into current market developments, distilling it all
down into actionable real-world trades as opportunities arise. Subscribe today to
greatly expand your market knowledge and investing success!
The bottom line
is silver remains far too cheap relative to gold. 2008’s stock
panic severed silver’s historical relationship to the dominant precious
metal, and ever since silver has been recovering on balance. But
despite silver’s great gains since the panic, its price still has a
long way to go before it fully normalizes relative to gold. The
reversion to its pre-panic relationship remains very much underway.
Thus the same
anomaly that offered such amazing opportunities in silver and silver stocks
over the past year and a half or so largely still exists. While
the initial easy profits have already been won, silver still has big gains
ahead of it. Its recovery relative to gold that had to be taken on
faith emerging out of the panic is now established fact. Get deployed
in silver and silver stocks and ride the rest of this reversion.
.
Adam Hamilton,
CPA
Zealllc.com
April 16, 2010
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