The high-minded metal are quoted on the world’s stock exchanges for decades. We have funds, which invest primilary in this kind of assets and most of us is familiar with the dependence between a gold and a recession, when this metal is used as a safe harbor for many individual and institutional investors. Their basic features are similar (storage of value, applications in various industries) and due to this fact, no one should be surprised, that their prices are connected with each other. On chart below, we have the comparison of the gold and silver prices, for the last 50 years:
In spite of a lot of similarities between the trends directions, we can notice a couple of diffrences too. Let’s think for a moment, where lies the source of them. The gold and the silver have got 2 main characteristics, which distinguish them from each other:
- it is a better tool for storing the value, because it is lighter in relation to its cost. If I would like to buy a gold for 100 000$, I will receive around 2.7 kg. For the silver it will be around 215 kg.
It means, that:
- The silver price presents better the condition of the real economy. When the global economy rises, the demand for silver will go up same as the price.
- The gold price presents better the level of fear among the investors. When they are afraid of the forthcoming collapse, they will run away to gold as to safe harbor. The demand for gold will rise or will fall less, than the demand for silver and the price will do the same.
This dependence is clearly visible in 2008, when the global markets were experiencing a huge slump:
The silver price (a pink line) was falling together with global markets. On the other hand, the gold price (a blue line) was only passing through a tender correction.
With all this knowledge, we can now combine the gold and the silver prices in a one indicator, which can be read as level of investor’s mood. This index will be a very simple ratio – gold price/silver price (we use a small simplification, we compare 1g of gold to 100g of silver).
When the investors are afraid and seek for safety, the G/S will be high, because everyone will buy gold, not silver. On the other hand, when the investor are confident and greedy, they buy stocks of companies, which need silver to operate. The price of silver will go up.
The chart below presents, the performance of G/S and FTSE 250 for the last 30 years:
What we see here is a lot of noise, but the reliance we have talked about earlier, is visible, especially for the last 20 years. G/S indicated almost perfectly the near bull market in the beginning of 2003 and 2009. The ratio dropped significantly before the slumps in 1998, 2007 and 2011. However, this chart cannot be use in any strategy, because it generates too much noise, mainly during the period 1986-1997.
Let’s take a look on the next chart. On this one, we have tried to smooth the G/S ratio.
We will focus on the signals, which should indicate the bull market. As we can see, the indicator operates in the channel from -25% to +25% and is quite regular, especially during the last 15 years, when it has appeared with a frequency of 75 months. Let’s mark the signal points, which are going to be the peaks of a normalized G/S ratio.
The sync points are marked on the chart below:
We have five such points and in five out of six cases, they are above the level of 20%. Only one signal is lower (1997).
FTSE 250 after each of these signals, has behaved liked this:
After one and a half-year we have:
- one neutral path (20%)
- four extremely positive paths (80%)
- ona path, which has appeared after very recent signal (the end of 2015)
The median rate of return for this period is +22%, when the value for FTSE 250 is only+14%. Our strategy is correct and we can expect, that it will generate around +8% better return, than the market during analyzed period. The normalization of G/S ratio has caused, that signals are a little bit moved in time and for this reason, the signal from 1987 has appeared a little bit to early and the slump has been included in the path. The decline of the market, which can be seen on the path, which started on 31.10.1991, was caused be the trouble of UE exchange rate mechanism (Black Wednesday). If we take these two facts into consideration, the G/S ratio can be see as a very good indicator of the bull markets.
A few world about the prediction of bear markets. The normalized G/S cannot be used for this purpose, but let’s go back to the pure G/S ratio. On the chart below we have marked the correct signals of the market declines (green lines) and the slumps, which weren’t pointed by G/S ratio (black lines):
The conclusions are:
- The sudden, deep fall (or the long decline) of G/S ratio can indicate the bear marketand it has got around 60% efficiency,
- The dependence between low G/S level and the bear market is better visible in the last 15-20 years,
- The pure G/S generates a lot of noise and due to this fact, a lot of false signals too. You need to be very careful about the interpretation of them. The best way to do that, is to wait for a very sudden and deep falls or the bottoms after the long-term declines. However, using this sync point without the reading of any other indicator is not wise.
The G/S ratio is the next indicator, that can be used in effective market analysis. We advise to focus more on the growth signals (the high level of G/S). The last signal, generated in the end of 2015 is a very good sign, which could bring a huge market returns during the next year with an 80% of probability. We expect the return around 22% in 2016. The time will show, if the G/S ratio has told the truth once again.