Can Silver Play Catch up Football?

Silver and gold are the two most liquid precious metals, trading around the clock 24-hours per day, nearly 6-days a week.  While gold is generally considered the best hedge for inflation expectations, silver is viewed as more of an industrial metal as it is made partly from the copper distillation process.  Each metal trades like a currency and has a forward curve, allowing investors to take positions in the forward market using their respective forward rates.

That's right. Gold (and silver) have forward rates that make them trade like currencies.  The gold forward rate trades like an interest rate differential as would a currency such as the Euro or the Yen.  When gold forward traders make a market in gold prices that is longer than the spot date, they attach a gold forward rate (the gofo rate) to the underlying spot rate.  In essence, gold trades just like a currency pair.  The interest rate differential is calculated and then added (or subtracted) to the spot rate to generate a gold forward price.

So given how much gold has run up recently, is there a trade that appears too attractive?  Well, if you look at the differential between gold prices and silver prices you might find something very interesting.  The performance of gold and silver prices are highly correlated with one another over the short term, but over the long term, their performance can break down.  The correlation coefficient tells an analyst how closely the performance between two assets moves in tandem.  A correlation above 80 means that the two assets move closely in tandem, while a correlation coefficient below -80 means that the two assets generally march to the beat of their own drum.

The performance of silver and gold seem to have broken down since the financial crisis in 2008.  When the financial crisis hit, investors jumped into gold pushing it higher and forcing the ratio between the two precious metals apart.  Since then, the two instruments have moved up and down at different times, and currently, the difference between them is near an all-time low.  The ratio between silver and gold is now back at the lows seen in 2008 and could approach the all-time lows seen during Gulf War in 1991.

The ratio is calculated by simply dividing the price of silver by the price of gold.  When the ratio is low, prices of silver are cheap relative to gold.
When the ratio is elevated, the price of silver is expensive relative to gold. Currently, the ratio is relatively inexpensive and represents a period when silver is inexpensive relative to its big brother gold.

So can silver play catch up football?  Well, it appears that it is far behind, but if growth is on the horizon, silver prices can move substantially relative to the yellow metal.  In fact, prices of silver can triple relative to gold if they reach the highs last seen in 2011.  If silver really jumped to the highs seen relative to gold that it experienced in 1980, it could experience a 6-fold jump in performance.
By Lovisa Alvin

Copyrighted 2016. Content published with author's permission.

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