There’s Something Happening Here*

There’s Something Happening Here

“The Canary in the Gold Mine” in the June 24th TLR quoted several prominent hedge funds managers who believe we’ve entered a gold bull market. Their break-out level was $1400/ounce, a level breached in the last week of June. In short order, gold held that level, consolidated and began climbing. “The Canary in the Gold Mine” suggested that if the $1400 level continued to hold and if gold then proceeded upward, it might just be that a proverbial canary had died – that is, the canary in the global economic coal mine – heralding a period of economic pain turmoil turbulence. As it turns out, a subsequent commentary and a confirmatory market move have lent support to that view. The relevant commentary is Ray Dalio’s July 17th opus, “Paradigm Shifts” (see the July 24th TLR), in which Dalio engaged in a superb analysis of historical economic cyclical analogues and the reasons why Central Banks currently have limited room to provide further support to national and global economies and markets, how it is that governments have made too many promises they will be unable to keep, how rising social and geopolitical conflict is undermining economic growth, and why there are fading secular supports for profits and growth – in short, why we are about to experience a global paradigm change. The confirmatory market move came from silver’s July 14th break-out and the consequent material decoupling from gold represented by the force of that break-out. If silver continues its upward spike, such a move would carry significant meaning … and significant confirmation that things economic are not quite right.

The ratio of gold-to-silver represents the number of ounces of silver it takes to purchase one ounce of gold … and it’s that ratio that has tumbled during the month of July. For example, if the price of gold were $1400/oz. and the price of silver $16/oz., the ratio of gold-to-silver – or what the industry refers to as the gold-silver ratio – would be 87.5:1. That ratio exceeded 93:1 on July 7th. It’s now at 86:1, a 7.5{29ea29b64b10057f61377b2c087cd5b7537a0cd24da4295a308b0bf589469f35} gain in the value of silver over gold in 2-1/2 weeks! That’s one heck of a move.

The ratio of silver to gold in the earth’s crust is 17.5:1. In Roman times, the price ratio was 12:1. The gold-to-silver price ratio in the 18th and 19th Centuries was fixed by law in the United States at 15:1 – it took 15 ounces of silver to buy one ounce of gold. A ratio of 15.5:1 was enacted in France in 1803. The average gold-to-silver ratio during the 20th century was 47:1 and that ratio has crept up over the past 40 years to average ~65:1. (One reason for the increased average ratio dates back to 1971 and will be explored in a subsequent TLR.)

The gold-silver ratio is not static. In the past, it’s fluctuated with economic cycles, often presaging an economic top or bottom. For example, the ratio reached its highest level in 1991 at almost 100:1, which was the bottom of that period’s economic cycle. The July 1990 to March 1991 recession was driven by the Fed’s restrictive monetary policy and Iraq’s invasion of Kuwait that drove up the price of oil, decreasing consumer confidence and exacerbating the then-existing downturn. So, the conclusion might be that recessions drive up the price of gold compared to silver and that a marked increase in the gold-silver ratio means that a recession is underway or imminent. The ratio reached its lowest modern level of 15:1 in 1980 when inflation and interest rates peaked. So, another conclusion might be that inflation and high interest rates drive up the price of silver compared to gold and a marked decrease in the gold-silver ratio means that inflation is underway or imminent. Interestingly, the ratio’s peak during the Great Recession was only 84:1. So, a further conclusion might be that economic chaos drives up the price of gold compared to silver, though not all that greatly, and a modest increase in the gold-silver ratio means that economic concerns are warranted.

Perhaps the clearest conclusion that can be drawn from the modern gold-silver ratio precedents is that silver overreacts to movements in gold and, in doing so, often confirms the message of gold. Silver, it seems, often is gold-on-steroids. It goes up faster when gold is going up; it goes down faster when gold is going down; and in all events the decoupling of the two signals that something is happening … imminently. The ratio typically spikes to its most extreme levels during the depths of an economic crisis or leading up to a significant correction in the equity markets, and falls fastest when there’s the specter of inflation.

What is it saying today?

The stock market once again is testing new highs and enjoying an unprecedented 10+-year bull market. In such an expanding economy, since silver, unlike gold, is used in manufacturing, it should be in greater demand than gold … and that may explain its recent rise. In the opinion of any number of analysts, the equity market’s moves are based on positive statistics that point to a growing economy. And, yet, despite the fact that recent economic data have featured an upside surprise in nonfarm payrolls (dismissed by the Fed), in inflation (contradicted by a Fed Governor), and in retail sales (contradicted by the Fed), the Fed believes that weakness lies ahead. That’s why the Fed is about to cut interest rates and is considering further rounds of quantitative easing … which a number of economists believe could trigger inflation. The Fed has been looking at statistics that lead it to conclude that the economic future is uncertain … and that it therefore shouldn’t be taking chances. Like Dalio, the Fed apparently believes that we may be on the verge of a paradigm shift. Perhaps silver’s spike therefore has a different cause?

Of course, both optimists and pessimists delight in cherry-picking the economic statistics that support their world view. Which set of statistics, and which set of experts, should be believed? Unless the Fed is bowing to political pressure, it probably is best to go with the Fed’s view of a weakening economy. After all, the Fed has done one heck of a job inflating supporting the global economy – and the stock market – since the Great Recession. In furtherance of the Fed’s view, the table below compares manufacturing statistics today with those in September 2007, on the eve of the Great Recession:

The world’s manufacturing sector is suffering, and suffering badly, and the Fed is less interested in current U.S. economic data that may be transitory. It’s only more interested in focusing on those leading economic indicators that portend future economic reality. The Fed’s concerns center on global growth, international trade, and global manufacturing … and the first is weakening by the day, the second is becoming more uncertain by the day and, as the table above shows, the third already is weaker than it’s been in decades (although that could be because services and technology now are the primary economic drivers and manufacturing is of far lesser importance).

As Pericles said , “The key is not to predict the future, but to prepare for it.”

Silver is saying that something’s happening here … and what it is ain’t exactly clear.

Finally (from a good friend)

*┬® Copyright 2019 by William Natbony. All rights reserved.

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