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A look at the gold/silver ratio; plus, FIL speaks!

If you are sitting on buckets of silver coins you are a happy guy.  And you know who is a happy guy—the honorable father-in-law (NYSE:FIL).  I told him yesterday, chatting now that he has mastered Skype, which is a huge step for a guy that not too long ago had no clue even how to find the computer’s “on” switch, that the Hunt brothers called, and they said they broke even on their silver holdings yesterday…zoom zoom….[Note: Hunt brothers are notorious in the silver market, having effectively cornered it pushing the price to $50 per ounce back in 1980 before the guys who “run” the exchange changed the rules of the game and Humpty came tumbling down; exchange officials have an interesting way of changing the rules in mid-stream, which is why it is never a bad thing to be very close to an exchange official or two. ]

Silver Futures Weekly:

 [Chart available in PDF format only.]

Gold/Silver Ratio:
  [Chart available in PDF format only.]

As you can see in the Gold/Silver ratio chart above, silver has been relatively much stronger than gold since the peak in this ratio going back to October 2008.  Now the ratio is testing a level not seen in about 13 years. 

From Investopedia, which has an excellent basic summary of how to trade the gold-silver ratio:

Here's a thumbnail overview of that history:

  • 2007 – For the year, the gold-silver ratio averaged 51.
  • 1991 – When silver hit its lows, the ratio peaked at 100.
  • 1980 – At the time of the last great surge in gold and silver, the ratio stood at 17.
  • End of 19th Century – The nearly universal, fixed ratio of 15 came to a close with the end of the bi-metallism era.
  • Roman Empire – The ratio was set at 12.
  • 323 B.C. – The ratio stood at 12.5 upon the death of Alexander the Great.

What is interesting is the degree of correlation between the gold-silver index and the Dow Jones Industrial Average.  You know the old adage, “As the gold-silver index goes, so goes the stock market.”  Haven’t heard that one…well, seems to be playing out now and for the last few years….

Gold-Silver Index (red) versus Dow Jones Industrial Average Inverted (black): We inverted the DJI in this chart so you can see the visual correlation, i.e. as the black line (DJI) falls it means stocks rise. 
  [Chart available in PDF format only.]

The question of course when you look at these types of charts is: Well, who leads and who follows and is there any rationale?  To the first question, we have not a clue which series leads or follows.  And to the second, we might use the rationale as corporations get moving, using silver as base metal for industrial production more so than gold; this ratio tends to favor silver and move in conjunction with rising earnings.

So, pick your poison.  Stocks keep running, gold-silver ratio likely (key word there) declines further.   

Many have asked for FIL’s views on gold which dovetails nicely with FIL’s desire to let others know he isn’t just burying metal in his walls for the coming end…but has what he refers to as Primary Motives (PMs).  Over the years, I have noticed a direct correlation with the number of glasses of red wine and PMs.  That is clear from this note from FIL sent to me late last week:

After several glasses of red I conducted an in depth analysis of PMs. For what it's worth (don't tell me) I offer my investment reasoning which I do not hear from the talking heads.
 
1) I do not regard inflation as a primary motive to buy gold. If inflation strikes, interest rate increases usually follow and better investing returns lure gold sales. And this happens with the speed of light. Just look at the last few years to see an inflation-gold disconnect.
 
2) The prime reason for me to hold (and buy according to prudent diversification) is the world instability, i.e. the Mideast, where a war of sorts would not be a surprise; Europe's banking/sovereign debt threat; China and EM's anticipated economic cycle exuberance; and finally the USA's deficit with inaction to cure. I see no short or possible medium term calming here.
 
3) There is no longer a safe haven currency. The US$ is the "safer dog" among a bunch of mongrels. This somewhat follows your preaching to those who berate the US$, although it's the best relative bet as a currency------then there is gold!

For the near term (few years) the perceived value of this "safer" currency is further reduced by other (central banks) attitude that the US economy (inflation) is in trouble (right or wrong). Also a general distrust for the US and other developed countries adds further to an alternative investment in PM's.
 
As long as there are so many unstable world factors and US$ problems of one form or another even if it is the #1 currency, PM is here to stay inflation or not.


So there you have it.  FIL speaks!

Regards,

Jack Crooks
Black Swan Capital

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 JR here ...

I received some very good feedback after yesterday’s piece on crude oil and the geopolitical environment. I want to share some of the reader responses with you (my comments at the end):

1) European Brent, which is more directly influenced by events in the ME than US light crude, tells a different story...
  [Chart available in PDF format only.]
-PL

2) When analyzing global crude oil prices you must be careful not to use WTI pricing. It is being affected by a glut of Canadian crude into Cushing, OK. Global prices are reflected more by Brent crude pricing in London for the European market which is being impacted somewhat by Egypt, Libya, etc.
-KA

3) Gentlemen, 
Appreciate your endeavors, thank you.
On your chart, note the breakdown in oil price beginning Feb 4th. An Islamic leader in Iran gave a speech on that date. GLD and SLV began recoveries that day. Could it be that speech triggered several players to unload oil and buy metals? Or am I just paranoid?
-JDC

Indeed, Brent crude is more globally traded and its price has certainly has become more susceptible to geopolitics lately. Very likely this is exactly what has led Brent to trade at a significant premium to WTI over the last several weeks (and maybe too the glut of Canadian oil into Cushing, as mentioned above.) Historically though, the two contracts respond rather identically to such events.

I simply thought it was worth noting that WTI crude could be telling us something about the perception of the global supply/demand situation. On this long-term chart you can see the notable difference in the way the two have been trading since January. WTI in orange; Brent in black:

 [Chart available in PDF format only.]
 
As I posed to reader KA yesterday, maybe the question that needs to be answered is this:

Will WTI play catch-up, or will Brent sink once the geopolitical driver begins to subside?

No doubt, WTI has made some strides yesterday and today. It’s now testing the triple top I noted in yesterday’s comments:

  [Chart available in PDF format only.]

WTI crude made short work of the 50-day moving average I talked about yesterday and is now at the top of the 50-day MA Bollinger Band range. Let’s see how things pan out at this resistance level. Time to play catch-up to Brent?

Don’t forget that my new commodities newsletter – I am calling it Commodities Essential¬ – will be launched early next week. Its details and focus will be unveiled starting tomorrow and through the rest of the week.

Because the geopolitical landscape is burning, I will surely be watching crude oil’s every move. Gold, too, is on my radar as it shakes off its recent correction and starts feeling seeing safe-haven inflows. To that point, I do not think JDC with his above comments is paranoid – he made an excellent connection that exemplifies the safe-haven nature of the yellow metal.  

Thanks again for the comments – I do appreciate the feedback.

Regards, JR Crooks