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Silver - A Different View

May 19, 2003

A comparison of the Long Term Silver and Gold markets yields some interesting observations. Both charts are up to date to end April 2003.

In the world of finance, "cruising speed" is very important concept to grasp. If one thinks of cruising speed in the context of a marathon race, it is the speed at which the runner is comfortable to pace himself without doing himself physical damage. In short, it is the maximum, comfortable "sustainable" or "maintainable" speed.

It may surprise some, but cruising speed applies to both fundamental analysis and technical analysis. Fundamentally, every corporation has its own sustainable performance capability which may be expressed by the ratio of (maintainable) Earnings Before Interest and Tax (EBIT) to Shareholder's Funds. As the business model of a corporation typically does not change significantly over time, this ratio remains relatively constant. If the ratio rises, it is a warning sign that management is sacrificing long term stability in favour of short term growth (by screwing expenses down so tightly that the business' infrastructure is being emaciated). Alternatively, if the ratio falls, it is sometimes a reflection of falling sales (flowing from the economic cycle), but sometimes it is a sign of an over-sophisticated infrastructure (inefficiencies have crept in).

"Financial Engineering" is all about getting the relationships right so that the business' expenses are minimised WITHOUT threatening its long term viability or, alternatively, to enable the business to maximise its growth rate without rupturing itself.

In simplistic terms, a lack of understanding of the above by professional investors is what has given rise to the currently dysfunctional equity markets, and this is why the Primary Bear Market has a long way to go before it exhausts itself. The cruising speed of industrial share prices has outstripped the ability of the corporate sector's cruising speed to stay abreast.

From a technical analysis (share price movement) perspective, cruising speed can be measured by the "angle of incline or decline" of the long term trendlines. When one plots price charts on logarithmic paper (so that percentage changes in prices of various investments are comparable with each other) a surprising fact emerges: the angles of incline of the trendlines tend to stabilise at around 25 degrees, 30 degrees, 45 degrees or 60 degrees.

Again, in very simplistic terms - the greater the angle of incline, the more enthusiasm is being manifested in a bull market; and the greater the angle of decline, the more fear is being manifested in a bear market.

Why am I going into all this theoretical stuff? Largely to validate the argument that one should be very circumspect about investing when the angle of incline is steep - because it evidences a high degree of emotion (and typically an absence of rationality). When a steep angle of incline manifests in the "early" stages of a Primary Bull Market, this flashes an orange light that fools may be rushing in where angels fear to tread.

Now let's look at the above charts.

It is clear that the angle of incline of the gold price chart has been greater than that of the silver price chart. At face value this defies logic because BOTH are supposedly precious metals.

Right now, the relative sizes of the gold and silver markets are 10.8:1 with the gold market being 10.8X times as large as the silver market.

The following are the numbers that validate this observation:

However, the ratio of the Gold:Silver price is currently out of whack at 77.7:1 whereas it has historically been as low as 15:1. It follows that either gold is relatively overpriced, or silver is relatively underpriced.

Just for the sake of discussion, if we imagine that the ratio trended back towards (say) 15:1, then silver would trade at around $23/ounce. If this were to happen, then the relative sizes of the markets would be as follows:

Now this is not an argument for silver to rise or for gold to fall. It is merely for the purposes of highlighting that the market currently has a built in anomaly. If BOTH metals were being regarded as precious metals then the latter scenario should be more logical than the former; and the interim conclusion to be drawn is that currently, investment in gold is probably not being driven by decisions to invest in Precious Metals per se.

This conclusion is validated by the fact that the gold price has been tracking the commodity price index quite closely; and it raises a further question. If NEITHER gold nor silver is being regarded as a Precious Metal at the moment, why is silver not tracking the commodity prices? Why is silver underperforming relative to BOTH gold and commodities?

Have a look at the angle of incline of the trendline of the Commodities Index:

Commodities have risen around 29% since their low in Q3 2001, whereas (at its current price) gold is around 35% higher than its 2001 low.

On the other hand, Silver is only around 15% above its 2001 low. Why is this so?

Well, one clue seems to lie in the relative volumes that trade on the futures markets. (Bear in mind that the gold contract is for 100 oz, whilst the silver contract is for 5,000 oz)

It is clear that the volume of trading in silver futures is disproportionate to that in gold futures. Whilst the gold market (demand) is 10.8X that of silver, both the monthly trade and the open interest is only 3X that of silver at current prices.

Interim Conclusion

The hysteria surrounding price manipulation of gold has been misplaced. In fact, gold has been tracking commodities. Conversely, the most reasonable conclusion that can be drawn from the above information is that it is the silver price which has in fact been manipulated. Whether this manipulation has been by governments or by traders cannot be detected from the above numbers. However, it seems rational to argue that traders that have been "scalping" arbitrage profits because it has been easier for stockpiles of silver to have been disgorged to meet artificially created demand than it has been for gold stockpiles to have been disgorged.

Obvious Questions

  • Now that above ground stocks of silver have been all but exhausted, will the silver price play catch-up with other commodities (relative to all other commodities, silver is an obvious bargain). If so, silver will need to stabilise at around $5/ounce to bring it into alignment, and assuming neither gold nor commodities continue to rise.
  • Will the ratio of gold:silver prices trend back to historical norms? If so, silver could rise to around $23/ounce even if gold stays at current levels.
  • What will happen when the precious metals again come to be viewed as precious metals? What will happen to the silver price if gold rises to (say) $540/ounce? Does this mean that silver will rise to between $8.20 and $36/ounce? (depending on which relationship will prevail).

Of interest is that fundamental analysis of share prices points to a gold price of around $540 and a silver price of around $10.50 being factored in to current share prices. CLEARLY, the market is expecting silver to play catch-up.

Now, finally, lets look at the differences between the first two charts above.

  • Gold penetrated its third fan line on the upside, simultaneously with its upside penetration of the rim of the saucer formation. Gold is clearly in a Primary Bull market, whereas Silver has not yet penetrated its third fan line on the upside.
  • Gold's angle of incline appears to be somewhere around the 45 degree mark whereas silver is languishing at around 25%
  • The gold chart is showing some signs of hysteria (it broke out of its 45 degree channel and pulled back into it) whereas silver is showing "apparent" signs of apathy.

Overall Conclusions

When compared to commodities in general, the gold price does not appear to have been the subject of excessive external manipulation for some time now. However, whilst at face value silver has been under-performing gold, there are CLEAR signs that the reason for this has been that the silver price has been the subject of manipulation.

Logic (and history) dictates that the Primary Trend of a market will ALWAYS prevail over any attempts to manipulate short term prices.

When the Primary Trend begins to prevail, it is likely that the silver price will play catch-up.

$5/ounce is the "stable" price for silver. If the silver price penetrates above the $5 level, it is likely that the rate of price gains (angle of incline of its long term trend line) will exceed that of both gold and commodities. Of course, if this happens, then the ratio of gold:silver will begin to trend back to historical norms.

Given that above ground stocks of silver have been all but depleted, it seems that the upside penetration of $5/ounce will occur in the foreseeable future - probably within the next few months.


It is conceivable that - if deflation manifests - commodity prices could pull back. There is therefore room for a contrary view that the silver price may in reality be evidencing a non confirmation. However, at present, the commodity price chart is showing no signs of aborting its fledgling primary bull trend - which manifested when the $CRB penetrated its third fan line on the upside in mid 2002.

A one-ounce gold nugget is rarer than a five-carat diamond.
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