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Nadeem
Veteran Investor
Joined: 11 Jul 2004
Posts: 639
Cash Points ££ 13955.74
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 Posted: Fri Jan 19, 2007 2:58 am Post subject: Leveraging Gold Investments with Silver |
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If you have been a regular reader of the various precious metal websites, you will know that gold is the metal that dominates the discussion. This should not surprise us. Despite that fact that less than 2,500 tonnes of gold are mined out of the ground each year as opposed to the 20,000 tonnes of silver, it is market cashflow that matters and a look at the recent statistics of the international London bullion market shows that in November 2006, $12.1 billion worth of gold was cleared through that city as opposed to $1.41 billion worth of silver. Clearly, when it comes to business transactions as well as Internet chat, it is gold that talks louder than silver.
However, though the majority of those transactions will be for end products such as jewellery, it is the investment returns on gold and silver that are attracting increasing attention today. Investment demand for gold bullion is on the increase but so is the demand for investments that leverage the price of gold. One such class of asset are gold mining shares, others are gold futures and options. The other asset class we wish to publicise is silver.
It may seem strange to call silver a gold derivative but that is essentially what it is. It may have its own unique fundamentals that distinguish it from gold but by and large when gold goes up, silver goes up and when gold goes down, silver goes down. However, being a gold derivative, when gold goes up, silver goes up higher and when gold goes down, silver goes down lower.
So how much is silver a derivative of gold compared to say the HUI basket of unhedged gold stocks? To answer that question we need to define what we mean by leverage. For our purposes, leverage is defined as the greater return on investment an asset will produce compared to the asset it is dependent on over a given time period.
So, for example, if gold goes up by 10% in a four-week period but silver goes up by 20%, then the leverage silver gives over gold is positive at 2 (i.e. 20 divided by 10). If they both go up by 10% then silver is deemed to have offered zero leverage against gold at 1. If silver made only a small gain of 1% and gold made 10% then silver is offering a negative leverage of 0.1.
Note that the gold-silver leverage is not the same measurement as the well-known gold-silver ratio. The gold-silver ratio compares spot prices while the gold-silver leverage compares spot price changes. That price change is measured over a certain period of time and it is important to define the period over which we measure the leveraged return.
To demonstrate the point of choosing the right time period, we will display charts showing how silver has leveraged the price of gold over two different time periods. Firstly, we show the leverage of silver to gold over a rolling one-month period from June 1995 to December 2006.
Using the first point on the graph to explain the charting method, we divide the price of silver on the 12th July 1995 by the price of silver one month previously on the 12th June 1995. We repeat this procedure for gold. That gives us 0.95 and 0.99 respectively. Dividing the silver number by the gold gives us a silver leverage of 0.96. So our first point on the graph shows that silver was underperforming gold by four percent over that month.
By "rolling" I mean we roll on one day and repeat the one month calculation for the next two sets of days (13th June and 13th July 1995) and so on until the present day. Bring all these data points together and you have the graph below. The first thing we deduce from the chart is that the leverage of the silver to gold price over a month is essentially a random walk as prices oscillate around the zero leverage point by a few percent with the odd foray into the 10% to 20% region. In fact, the average over this 11 year period is 0.4% as the negative and positive leverages almost cancel each other out.
The big rise above 30% is the Buffet spike followed by the -20% drop when that mini-mania ended. We also note a sharp under leverage to gold when silver dropped dramatically from its April 2004 high of $8.50 to $5.50 in a matter of weeks. Apart from such rare instances, the performance of silver compared to gold offers no real investing advantage over such a short time period.
Full article - http://www.marketoracle.co.uk/Article224.html |
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