I used to pay a lot more attention to the gold/silver ratio, especially during the crazy silver market of 2011. However, whether the ratio was 65 or 75 didn't matter much to me and more importantly it didn't tell me anything about the macro-market structure so I have barely paid any attention to this ratio in the last couple of years.
That was until last week when I was suddenly asked numerous times about the gold/silver ratio and what a ratio of 82 might be telling us. I offered the following explanation in the Trading Lab last week:
"Gold is typically seen as a more 'defensive' metal, whereas, silver has many more industrial uses. So if gold is strong and silver is weak it's a 'signal' that the economy and investors are turning more defensive and less expansionary."
I will expand upon this statement with some context as to where the gold/silver ratio is at now and what the future may hold.
Gold/Silver (20 Years)
In the last 20 years the gold/silver ratio has rallied above 80 on four different occasions (including the current one). The previous 3 occasions all turned out to be excellent long term opportunities to buy silver, precious metals mining shares, and precious metals in general. However, the 'turn' often took several weeks, if not months, to materialize.
The current depressed price of silver and mining shares is a bit different from the last 3 blue circles in the above chart; mid-2003 was the end of a brutal bear market in precious metals, Q4 2008 was the most vicious and violent bear market that most people who are alive today have ever experienced, and finally Q1 2016 was the end of a grueling five year bear market and also the initial lift-off in what is presumed to be a new bull market.
The current precious metals market environment is definitely not a confirmed bear market, but it has the makings of a 'stealth' bear market as evidenced by the gold/silver ratio reaching 82 (a level only previously reached in the depths of bear markets). I see two primary scenarios from here:
1. We are on the verge of a tremendous buying opportunity in precious metals and mining shares and a rebound similar to February-May 2016 is imminent.
2. The 'stealth' bear market is about to become a real bear market (which will be confirmed if the December 2016 low at 160 on the HUI is breached).
From my vantage point the odds favor scenario #1 and my portfolio is positioned as such, however, scenario #2 is definitely a real possibility and a painful one at that. For those interested in trading the gold/silver ratio itself, I don't envision a scenario in which the ratio exceeds 90 and a mean reversion to the mid-60s is certainly within the realm of possibility over the next 12 months - this makes a long silver/short gold pairs trade fairly attractive from current levels.
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