Gold is History (GLD,SLV)
Despite the latest dipsy-doodle in the precious metals market, with silver diving almost fifteen percent in under a month, the outlook for the money metals still looks reasonably good.
We’ll get to the proof and the charts in just a moment, but first a little history.
Silver topped out back in the spring of 2011, losing three quarters of its value in a grinding, torturous bear market that spanned a full five years.
Gold, on the other hand, began its bear later that year, plateauing in September of 2011 and bottoming alongside her cheapskate sister as the bells of New Year’s, 2016 were still pealing.
The whole rollup took some two years to play out – as the chart below shows – and is still proceeding apace (and very likely too slowly for the bulls).
Have a gander –
The above chart spans the period from silver’s high (close to $50 an ounce) through until today.
And as you can see, the picture is brightening.
We have every reason to expect that the fully formed and most sensual rounded bottom (seen above, in red) marks the end of the goldphiles’ impotency, and that the months ahead will bring a renewed vigor for that dysfunctional bunch.
We’re encouraged, too, by the engorgement of volume that we’ve seen over the last fifteen months, precisely from the point the two metals bottomed and began turning higher (blue box).
It’s an altogether lovey-dovey picture that bodes well for the PMs, but, that said, our trade for the week is not exactly a long call on the rich rocks.
Rather, we see an opportunity to play the PMs one against the other, using an historical metric that’s not always so easy to trade, but that we feel is today spot-on ready to be exploited.
It’s an indicator called the Gold-Silver Ratio, and, truth be told, it’s a downright nasty piece of work.
Well, to keep it brief, the price of gold divided by the price of silver has historically yielded a number in the vicinity of 50 (depending upon whom you ask). But that ‘historically’ includes a great many data points spanning well over a millennium. And that means the ratio was careening higher and lower and hitting extremes for extended periods before it reverted to the mean.
A look at the most recent data, spanning the last two years, shows that the ratio hovered most often in the 68-72 range, while today it sits slightly below 76.
Have a look –
We’ve pulled out to nearly 76 in the last few weeks, and that’s a fairly extreme read. Anything in the vicinity of 80 over the last thirty years generally engendered a snapback lower (though once, in 1990, it expanded to 100).
So what do we do with all this?
Well, to begin, the first chart above shows that immediately after silver spiked to its all-time highs and began to decline in April of 2011, the two metals traced a relatively similar price pattern for the next five years. There were moments, of course, when they diverged, but on the whole, their percentage gains and losses remained uniform.
That was while the two were in decline.
Our hypothesis is that we’ll now see a reversion to more typical historical readings for the gold/silver ratio as the market begins to appreciate that the precious metals are now in the ascendant. And as momentum carries the two higher, we expect to see silver outpace her dearer sibling – just as she did in the 2011 race to all-time highs.
How long that will take, and when will the ratio collapse to its tightest range? That’s all guesswork at this stage. But we believe that by arming ourselves with long enough expiries, we can catch the ratio as it tightens and lock in a hefty profit.
But, again, that likely won’t occur until the ‘gold heat’ is back upon us, and the shrill voices of the goldphiles once again capture the airwaves, ballyhooing about government fixes and market manipulations and the secret cabals that meet in Jakarta to micromanage our lives.
Come to think of it, they’ve grown rather quiet of late.
And not only them. According to the World Gold Council, gatekeeper of stats on everything gold related, global central bank demand for the metal dropped 27% in the first quarter, compared to the same period a year ago. And global investment demand also dropped by 34% for the quarter, year-over-year.
That’s a good sign for us contrarians, and it jibes with our understanding that just as those same institutions and individuals should be loading up on the PMs, they’ve stopped their purchases altogether – maybe even lost confidence in the value of the investment.
In any event, when the decibel level among the gold bugs begins again to ratchet up again, we’ll know it’s time to shut this one down.
In the meantime, we have two trades to report before offering you this week’s bet.
The first is from February 16th, a letter entitled How You Feelin’?, wherein we beseeched you to sell the HYG September 15th 86 PUT for $2.65 and buy the HYG September 15th 86 CALL for $2.23. Total credit on the affair was $0.42.
The CALL trades for $1.99 and the PUT for $1.45. Sell the former, buy back the latter, and you come home with $0.97 on nothing laid out. Adjusted for minimal commissions gives you a profit of 547%.
Next up is our effort from a month ago on Tesla.
The letter was called California, Here I Come!, and in it we recommended you sell the TSLA May 26th 240 PUT for $2.07 and the TSLA September 15th 230 PUT for $8.05. Your total credit on the trade was $10.15.
Today the 240 PUT goes for $0.17 and the 230 for $4.05. Buy them both back and you net $5.93 on zero expended. Call it a gain of 146%.
In a month!
Until then, here’s the deal. We’re using the industry standards to set the trade – for gold, we use the SPDR Gold Trust ETF (NYSE:GLD), and for silver, the iShares Silver Trust ETF (NYSE:SLV).
And it goes like this…- Content protected for Normandy Executive Lounge, Option Trader Elite, Executive Lounge members only]
Note well: the SLV options are at-the-money, while the GLDs are a full 25% out-of-the-money! You also get a full 21 months play before expiry!
Many happy returns,