June 2011
Strong trends, corrections, and exceptionally wide ranges have made for exciting times for gold and silver futures traders in 2011. And in silver’s case, add hyper-volatility and you have markets that are full of opportunities. From the beginning of 2011 through May 20, gold prices experienced a $257 range and silver prices nearly a $22 range. On May 20, NYSE Liffe US 33.2 oz. mini gold futures were up 6.4% on the year at $1512.10, while 1,000 oz. mini silver futures prices were up 13.6% at $35.098. Higher prices and volatility have occurred on the back of increased interest in gold and silver, which can serve as a portfolio diversifier, a hedge against currency debasement (the USD is down 5.8% against the Euro on the year as of May 20), a hedge against inflation or deflation, a form of savings and more.
While gold and silver prices can trend together, the complexion of each market is very different. This article will discuss some of the key differences between the gold and silver markets and associated trading opportunities.
Why are Silver Prices More Volatile Than Gold Prices?
Many market participants consider both gold and silver to be financial assets, “yet in terms of depth of market and global reach, gold far outstrips silver” says Dr. Paul Walker, CEO of GFMS and an internationally respected commentator on precious metals for nearly 20 years. For investment depth comparison, as of May 20, the gold ETFs (including GLD) stood at $65 billion of AUM while the silver ETFs (including SLV) had $11 billion of AUM or 83% less.
Gold is a part of many countries’ reserves. The United States is the number one holder of gold in ounces, followed by Germany, Italy, France and China (see Table below). Central banks hold nearly 30,000 tonnes of gold, or approximately 16.5% of all gold.
Central bank participation in the gold market is important because it provides depth and confidence to the market. Emerging countries including India, Sri Lanka, Bangladesh, Mauritius and Mexico have bought gold to diversify their assets in the last year and a half. Sovereign wealth funds invest in gold too.
Pension funds invest in gold – consider the University of Texas’ endowment taking delivery of $1 billion worth of gold futures contracts earlier this year. Central banks, sovereign wealth funds, and pension funds do not participate in the silver market in this manner. Jeffrey Christian, founding managing director of CPM Group and recognized precious metals authority, says the upshot of the lack of a deep and diverse client base in the silver market is that “smaller influxes and withdrawals of capital from the silver market have a more dynamic effect on price,” which translates into higher volatility.
Ten day historical volatility (1 Historical volatility measures the risk of a financial instrument via standard deviation, or the average deviation from the average price of a commodity over a given time period, in this instance, 10 days.) in NYL US mini silver futures from January 2000 through May 20, 2011 averaged 21.68%, compared to 14.72% for mini gold futures, as noted by CQG. In 2011, also through May 20, the same metric for mini silver futures and mini gold futures were 38.79% and 13.33%, respectively.
On May 10 this year, mini silver futures 10 day historical volatility went as high as 94.2%. Following the high trade of $49.814 on April 25, the silver market failed to break the high of $50 set during the Hunt Brothers era. That led to significant liquidation in a highly volatile environment. In April and May, there were many outsized volume days: 18 days saw volume in excess of 10 thousand, and 10 of those were above 15 thousand. Two days saw volume over 20 thousand.
Investment Drivers
Dr. Walker believes the low or negative interest rate environment and excess currency liquidity have been key factors driving investor demand in gold in China, India, Europe, and the United States, with “the primary catalyst being a background of negative dollar real interest rates.” In the face of financial turmoil including the European debt crises, a weak dollar, and a weak Euro, investors have moved to gold for protection and a store of value, as indicated by the uptrend in ounces held in gold ETFs. The number of ounces held in GLD more than doubled from 2008 to 2011, with a high of 42.4 million ounces reached in June 2010.
Jeffrey Christian says “Gold is an excellent portfolio hedge,” because it is a non-correlated asset. The 40-day correlation of the mini gold price to the CME e-mini S&P Index is 0.02. Other common reasons investors are drawn to gold: political unrest, like North Africa and the Middle East, as well as event risk, like the Japanese earthquake tragedy. Some use gold as a hedge against inflation, others, against deflation.
Since silver is also a precious metal, silver prices generally benefit from all the factors affecting gold prices, in addition to robust physical demand. At the beginning of 2009 though, with NYSE Liffe U.S. mini silver prices at $11.989 and mini gold prices at $874.30, it appeared that investors increasingly viewed silver as a cost effective way to access the precious metals market, as indicated by the doubling in silver ounces held in ETFs’ to nearly 600 million oz.
Spread Trades
In the precious metals complex, many participants focus on trading spread relationships such as the gold:silver ratio (see Chart 3), where they long one metal and short the other in equal notional dollar amounts. With gold prices at $1500 and silver prices at $35, that would mean a trader would put on 3 NYL US 33.2 oz. mini gold contracts against 4 NYL US 1,000 oz. silver contracts. If you do trade two different commodities on a ratio basis, note that the two markets are not entirely price correlated, so you are by no means perfectly hedged – in fact, you may want to treat this position as a “new” or “different” commodity. Other ratio ideas: silver versus oil (see Chart 4), considering silver’s industrial bent; and gold versus corn or wheat. Trading gold as the currency of other commodities is sometimes referred to as trading the “purchasing power” of gold.
Conclusion
The gold and silver markets are very different. The depth, breadth and global participation in the gold market, in terms of investment, is much more significant than in the silver market. Additionally, the largest fabrication sector for gold is jewelry – and in many parts of the world, that is considered investment. Silver, because of its characteristics as an element, is more widely used in industry. As an industrial metal that does not have as deep an investment base as gold, silver can experience significant price volatility on relatively small dollar flows. The bottom line: if you like volatility, silver is your market; if you prefer depth, gold is for you. Whichever metal you prefer, consider trading the gold:silver ratio and purchasing power ratio trades as well.
Complimentary Precious Metals Research
If you would like to receive complimentary, third party research that NYSE Liffe US exclusively sponsors, email metals@nyx.com for either/both the John Lothian Metals Edition Daily Newsletter (a comprehensive aggregation of news, commentary) and The Bullion Weekly (thebulliondesk.com’s definitive snapshot of the OTC markets). (Please Note that NYSE Liffe U.S. distributes such reports for informational purposes only and does not recommend, endorse, control, nor accept any responsibility for the content therein, which is written by third parties unaffiliated with NYSE Liffe U.S.)
Jennifer Ropiak is responsible for precious metals futures and options product and business development at NYSE Liffe U.S. She has been with the exchange since 2008. Jennifer has over 20 years of precious and platinum group metals trading and marketing experi- ence in the over the counter market. She can be reached at jropiak@nyx.com and 212-656- 5145. Neither Jennifer nor NYSE Liffe U.S. make any claims as to the profitability of trading futures and direct interested persons to discuss the relative benefits of futures trading with an appropriately licensed broker or advisor.
