Silver Reverts To Mean Ratio To Gold - Approaching Relative Value Buying Range

by: Richard Shaw

By March 2011, silver had been out three standard deviations from its one-year mean about six months (since mid-September 2010). It was on a tear and letting profits run was a good thing. However, by mid-March silver had outstripped gold which was also on a tear, and we thought that was overdoing it a bit - so we sold silver and reallocated to gold (which we later sold in August).

Since then, we have watched the ratio of silver to gold prices come back in and silver revert to its mean - so now we are on watch for a re-entry to the metal.

This chart shows the one-year, three-standard deviation plot in red and the one-year, two-standard deviation plot in green.

click image to enlarge

When we published our article on March 17 (see article here) about our decision to exit silver due to the over-stretched price ratio of silver to gold, the ratio looked like this on a 20-year monthly chart. With the combination of a three-standard deviation price position and a ratio to gold not seen in 20 years, we felt taking profits was a good idea - "pigs get fat and hogs get slaughtered:"

Click to enlarge

We revisited the ratio on September 23 (see article here), when the ratio of the prices had come in a lot, but at that time the price of silver had not yet reverted to its mean, which we felt was a likely event after a big pendulum swing out three standard deviations. In fact, we would expect a swing back below the mean after such an unusual up move away from the mean.

The 20-year chart of the ratio of the price of silver to gold looked like this at that time:

Click to enlarge

Now the price of silver has fallen to below its one-year mean price, and the ratio of the price of silver to the price of gold is in the range of its 10-year average. That makes the metal begin to look interesting to us again.

Click to enlarge

Because of a generally downward character to the charts, a skittish market for risk generally, we think there may be some additional downside in both the price of silver and its ratio to gold (in part because silver has a larger industrial role than gold, and world GDP is slowing).

The price of the SLV (a silver ETF) today closed at $31.03, but there isn't much to see as chart support until about $20, back in mid-2010, and before that in early 2008. However, it got below $9 at the low in 2009, so depending on how the European situation evolves, it could take a quick trip down there again.

That said, we are watching silver closely now for a time which may not be too far away where we move some risk money back to the metal.

Disclosure: QVM has written near term, far out-of-the-money PUTs on GLD and SLV in the company account; and does not have positions in any other mentioned security as of the creation date of this article (October 17, 2011).

Disclaimer: This article provides opinions and information, but does not contain recommendations or personal investment advice to any specific person for any particular purpose. Do your own research or obtain suitable personal advice. You are responsible for your own investment decisions. This article is presented subject to our full disclaimer found on the QVM site available here.