Gold Ratios

The following is an extract from commentary that was posted at on 13th January 2002. 

Gold versus Silver

In our November 5th commentary we analysed the gold/silver ratio and concluded as follows:

"Our thinking is that the first decade of the new millennium will have more in common with the 1970s than with either the 1980s or 1990s, so after an initial period (2-3 years) in which gold out-performs silver we should see these two metals moving higher at roughly the same pace. The silver market is much smaller than the gold market and the silver price therefore tends to be more volatile than the gold price. The large price gyrations that regularly occur in the silver market will make for some wild oscillations in the gold/silver ratio, but the big picture (as represented by the long-term chart) should be kept in mind.

Before leaving this topic we'd like to reiterate one point. We do not think it is coincidental that the gold/silver ratio began trending higher at the same time as the great stock bull market was rolling over. Gold is the ultimate monetary asset - it is desired during those times when confidence in fiat money and the financial system is falling and disdained during those times when the confidence level is high. Silver is also a monetary asset, but it has significant non-monetary uses (gold's non-monetary uses are trivial in relation to its monetary uses). As such, when gold starts to regularly out-perform silver it indicates a shift in confidence. 1999's upward reversal in the gold/silver ratio is more proof that the major financial market trends have changed."

Below is an updated version of the long-term gold/silver ratio chart included in our Nov-05 commentary (chart source: Gold has been trending higher versus silver for the past 2.5 years, so if the markets are going to follow a similar pattern to the 1970s then we are now close to the point where the gold/silver ratio should flatten out (gold and silver will begin to move up at roughly the same pace). Due to its greater monetary quality we think gold's risk/reward balance is superior to that of silver in the current environment, but if last year's massive monetary stimulation kicks-in (we think it will) then we could see periods when silver dramatically out-performs gold.

Gold versus Platinum

Below is a long-term chart of the gold/platinum ratio (chart source: Gold out-performs platinum during those periods when confidence in fiat money (and the governments that sponsor the fiat money) is low/falling and/or during periods of prolonged economic weakness. When the level of confidence in governments, central banks and fiat money is high/rising, platinum tends to out-perform gold. 

If the next decade is going to give us more of the same (an on-going bull market in central banking and the money that central banks issue/sponsor), then platinum should continue to out-perform gold. Needless to say, this is not what we expect and the gold/platinum ratio might already be showing signs of a trend change.

The Stock Market versus Gold Stocks

Over the past 18 months we've used several different ways to explain why we think that 1997 was the year when the US economy became a 'bubble'. One of those ways was to look at the performance of gold stocks (represented by the XAU) relative to the performance of the overall stock market (represented by the S&P500 Index) as illustrated by a long-term chart of the S&P500/XAU ratio (see below). This chart shows that the S&P500/XAU ratio trended higher at a steady rate from the early 1980s until 1997, at which point it exploded upwards out of its long-term channel (the S&P500 suddenly began to out-perform the XAU at a much faster rate). During the final quarter of 2000 we noted that the ratio appeared to be experiencing its final 'blow-off' and that a return to the long-term trend seemed like a 'no brainer'. We thus have a long-standing (since early-December of 2000) target of 10:1 for the S&P500/XAU ratio.

The time from the S&P500/XAU ratio's break above its long-term trend to its final peak was about 3.5 years. If the bubble deflates at the same rate that it was inflated then the ratio will move back into its long-term trend channel during the first half of 2004. However, bubbles tend to deflate at a faster rate than they were inflated (probably because fear is a more urgent emotion than greed), so the long-term channel should be reached well before 2004. In fact, we expect the S&P500/XAU ratio to be trading at 10:1 or lower by the final quarter of this year.

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Copyright 2002