Shorting the gold/silver ratio scares the bejesus out of me. Some day Central Banks will come for the gold in a big way, and when that happens, there won’t be enough gold. Even though silver will dragged along for the ride, Central Banks will drive gold to a huge premium compared to other precious metals. This worry stops me from getting too bearish on the gold/silver spread.
Although I expect this to happen someday, it’s not today. Nor will it be tomorrow, or the next day. Central Banks are still trying to monetize against financial assets (Draghi’s new aggressive QE plan is a great example). Gold will be the last desperate straw.
In the meantime, I believe there are opportunities for nimble traders to be cautiously short the gold/silver spread.
I am long too much gold, so shorting this spread diversifies my precious metal exposure into some silver. I won’t actually be shorting gold, just replacing one metal for another.
Over the long run I am extremely bullish on gold, but it is massively overbought on a shorter time frame. Since the turn of the year, investors have piled into gold at a fierce rate:
Some of the best bull markets become overbought, and stay that way for a long time. They never give you a chance to get in on a dip. I sure hope gold has entered such a condition, but I am not sure.
The stock market sell off during January and February scared a lot of investors out of risk assets. The negative interest rates through much of the developed world, along with the fact that gold was so beaten up from a five year bear market, created the perfect conditions for a gold bull run.
As the stock and credit market panic seems to have subsided over the past couple of weeks, there is a decent chance gold will give up a portion of its recent gains. A $50 or $100 move back down to $1,200 or $1,150 would do nothing to harm the technically bullish outlook, and would be completely normal.
I can’t bring myself to risk giving away my long position to try to catch this squiggle of a down move, but I am willing to play for a gold correction through a decline in the gold/silver ratio.
The gold/silver ratio has been on tear for the past five years:
The ratio has gone from 32 all the way to 82 during this period! The recent gold rise has pushed this ratio back to levels not seen since the 2008 credit crisis.
At 82 the ratio is bumping up against a resistance level where it has previously reversed. Shorting here seems like a decent spot to try fade the move.
Previous tops in the GSR
Shorting the GSR ratio is especially attractive if you believe the stock market correction is finished. In recent past, the ratio has tended to top at inflection points in the stock market.
It is not perfect or precise by any means, but previous GSR tops roughly coincided with bottoms in the stock market.
I am not suggesting the start of a secular bull market in stocks by any means. But if the ECB’s stimulus works over the short run, many investors might perceive this possibility to have increased. There might therefore be a decline in the GSR ratio during this period.
My trade might be a little too cute for my own good, but I am hoping to ride a short term “risk on” wave by shorting the GSR spread.
Silver is more of an industrial metal
Although I am uber bearish on future real returns of financial assets, I do not hold the same contempt for the global economy. In fact, compared to the many pessimistic gloomy forecasts, you might even call me an outright bull on world GDP growth. There are lots of reasons for my optimism, but at the end of the day it comes down to my belief the recent hiccup was entirely self inflicted from the Federal Reserve’s foolish attempt to normalize interest rates. If the Fed eases off on the hawkish rhetoric, and then the ECB and Japanese monetary heroin kicks in, global growth could rebound smartly. The recent decline in the price of oil might just be the final kicker that results in growth dramatically out pacing lowered expectations.
In an environment of improving world economic growth, silver should outperform gold. After all silver is also an industrial metal with real world uses. It is yet another reason why the GSR ratio might fall if the growth scare ebbs.
Freezing of commodity credit might be a good thing
One of silver’s problems is that it is often a by-product of other mining. China’s desire for copper over the past decade caused far too many mines to be brought on line, causing silver output to skyrocket. The nuclear winter of the past year for commodity companies has helped diminish this excess supply. From Bloomberg:
Mine production of silver will probably drop in 2016 for the first time in over a decade and demand is set to outstrip supply for a fourth straight year, says Standard Chartered Plc. Much of the world’s silver is extracted from the ground with other minerals, and output cuts announced by the biggest miners will hurt supplies of the metal as well as others such as copper and zinc.
The excess by-product supply helps explain why the GSR ratio went from 32 to 82 over the past five years, but that influence is probably waning. Yet another reason to expect the ratio to slip back down.
The other white metals
It’s not just the gold/silver ratio pushing to new highs. The ratio of the price of platinum to gold has recently hit levels lower than any period of my Bloomberg’s 30 year history! Platinum in gold terms is cheap.
And this cheapness should be no surprise when I show you the following interesting relationship. The platinum/gold ratio has a remarkable correlation to the US 10 year yield.
With yields throughout the world sinking to absurd lows, the corresponding move to new lows for the platinum/gold ratio should come as no surprise.
I am not sure if US yields are headed higher or lower from here. Buying US notes versus German or Japanese fixed income makes sense to me, but I don’t have as much conviction about the absolute direction of US yields.
But the platinum/gold spread is already cheap when compared to US yields. Even if US yields just stay the same, we could correct the recent decoupling with a large move up in the platinum/gold ratio.
Shorting the GSR ratio can also be diversified with a little bit of bottom fishing in the platinum/gold ratio…
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MacroTourist - gone on vacation
It’s that time of year again when Canadians with children on March break, suffering from SAD (Seasonal Affective Disorder) and desperately low Vitamin D levels, head down south to lie in the sun trying to recoup from the harsh Canadian winter.
The MacroTourist will not be writing for the next week. Regular letter service will resume sometime during the week of March 21st to 25th.
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