Is the gold/silver price ratio an indicator for the equity markets?

London (Aug 12)  Mine disruptions in LATAM due to COVID-19 shut-ins and lofty gold prices as a result of risk-off investor sentiment have combined to make silver a “safe-haven” or a more intriguing opportunity. Interestingly, the recent uptick in silver prices was foreshadowed by the gold/silver ratio, which can be an indicator of a broad change in the equity markets.

Gold prices have moved up 22% since March 15 and have continued to rise due to investor angst around the supply of gold. Thus, many ETF holders, as well as money managers who invest in precious metals, now look to silver for two primary reasons: It is a less costly alternative to gold and the current change in ratio between gold and silver is trending in the direction of silver.

.As the ratio of gold to silver prices gets higher (indicating gold has gone up more relative to silver), the price behavior of one or the other is anticipated to cause the ratio to revert to its average (either gold down or silver up). For example, the ratio got as high as 124 in March 2020 and is now at 81, which is high given that the 10-year average has hovered around 70. Silver has recently gone from $18 an ounce to $24.

Bloomberg clients can chart the gold/silver pricing ratio on the Terminal.

Backtesting the gold/silver ratio as a signal to measure the broader impact of the equity markets

Since March 15th of this year, the inverted gold/silver ratio has been a barometer for moves in the broader equity indices. For example, a strategy of buying the equity indices on a + change to the gold/silver cross rate (XAGXAU) has recently produced positive results.

Screenshot of SPY US Equity on the Bloomberg Terminal

Backtesting analysis shows that out of 14 trade opportnities in 2020, this strategy worked 11 times (78%), and the average win was larger than the average loss. These results demonstrate the strong correlation between the gold/silver ratio and the markets. In addition, the Sharpe Ratio – a traditional investment return gauge, shows a very high 8.68 expected rate of return versus risk.

Similar to the gold/silver ratio, there are many commodity and equity correlations that can provide insight and market direction. To get more information or to gain access to these studies and backtests, please reach out to a Bloomberg commodities specialist. They are available to help clients optimize these tools for a portfolio and schedule alerts for similar signals in the future.

Bloomberg

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