Published on 3rd January 2018

It is fair to say that 2017 caught the investment community by surprise. In a year in which the Federal Reserve continued its interest rate normalisation programme, including details on reducing the balance sheet, yet the dollar fell off a cliff during the year. Commodities, especially copper, offered investors a lucrative return that even outperformed the U.S. equities market. Silver, generally regarded as the leveraged version of gold in commodities trading, disappointed the market somewhat in 2017, underperforming its rich cousin by 600 basis points. However, the best is yet to come in 2018, and we also suggest that a possible financial crisis may be looming.

By Samson Li

Gold : Silver ratio and its implication – another financial crisis on the cards?

After bottoming in 2010, the gold : silver ratio has been increasing steadily since. The ratio did retreat for a brief while in the middle of 2016, but has been climbing again since the middle of 2017. The gold : silver ratio can rally in the face of a crisis, although the nature of such a crisis would dictate how the ratio develops. If circumstances suggest that an economic slowdown is imminent then long-term investors will favour gold over silver (the counter to this, of course, is that silver’s higher volatility will often attract shorter-term traders in an effort to lever on the upward move in gold). A good example is during the 2008 Global Financial Crisis, when the ratio reached beyond 80. Meanwhile, the high ratio in early 1991 was in response to the Gulf War. It is arguable that anticipation of a crisis could see 80 or beyond. At the end of 2017, the gold : silver ratio was 76, a high level that suggests that the market is trying to tell us something.

We suspect that the high gold : silver ratio indicates that there has been some smart money in the market that they are foreseeing another major crisis could be looming, or at the least that it is about time that equities corrected, and therefore have been accumulating physical gold in the market.

On the other hand, the high gold : silver ratio may well reflect an abundant amount of physical silver as stockpiles on the ground. Indeed, based on GFMS estimates, identifiable physical stockpiles (exchanges, funds, industry and government amount to two years’ global demand) of this, stocks in ETPs and Exchanges are of the order of ten months’ demand. To put this into context, zinc inventories at the LME are only sufficient for less than ten days’ global demand. Therefore this could possibly be an explanation.

We also look at the gold : platinum ratio:

Some observers could also argue that the high gold : platinum ratio is suggesting that the market is willing to pay for gold at a historical high level compared to platinum, given that global physical platinum inventories are only equivalent to approximately eight months of global demand. This position, however, is more of a platinum story than one of gold given the poor sentiment surrounding platinum because of the pressure on diesel.

While on the surface, the high ratios of gold to silver and to platinum would suggest that the latter two metals might be better investments compared to gold in the long run on a “catch-up” argument, we should not ignore gold’s role as a safe haven, and that some smart money are hedging against geopolitical risk and potential downside in equities.

COMEX activities indicating volatility in 2018?

Technically, silver is ripe for a major breakout to the upside in 2018. The CFTC figures Managed Money positions show that COMEX silver has been in a net short for three straight weeks since 12th December. This is not unheard of but is relatively rare for silver; the last time COMEX silver was net short was between the end of June and the first week of August 2015. As investment sentiment can swing from one extreme to another, and given silver’s innate volatility, this net short position should point to the possibility of a sharp short-covering rally. Looking back at the corresponding period in 2015, silver price was trading at $15.61/oz on the 7th July, and it was the third consecutive week recording a net short position. Approximately a year later, silver was trading over $20/oz in July 2016. In the investment world while past performance does not translate to future performance, the current poor sentiment does suggest that silver could be one of the better performing precious metals in 2018, barring any crisis that could trump most of the commodities but gold.

It does, however, carry a wealth warning. Silver moves can be very sharp and often show swift retracements. Silver may offer lucrative trading possibilities this year, but as it notoriously dangerous and one only for the brave of heart and fleet of foot.