When markets turn volatile or remain stuck in a ranging mode, conventional wisdom is to step back away from the turmoil and look for long-term trends or correlations for guidance as to what the future might bring. We are often so consumed by the moment that we forget that it is permissible to take a breather from the action and ruminate on what our next moves should be. Investment advisors understand this principle and have been counseling their clients to withdraw from the fray to focus on long-term goals. Today’s markets are being buffeted daily by any news related to the European debt crisis, the impending deadline for the “Super Committee” to act on government spending, or the slightest possibility that the China “engine” might be slowing down more quickly than even the Chinese have disclosed. Uncertainty has led to rampant volatility and whipsaw swings in the daily pricing behavior witnessed in our financial markets. In the midst of this “fluid” situation, are there any certainties that stand out? Precious metals are most certainly one “shining” example. As a group, this sector has produced gains of 33% and 25% for 2009 and 2010, respectively, while the current year, despite an anticipated pullback, is already posting a 33% rise year-over-year. Driven primarily by the performance of Gold and Silver, precious metals are showing positive trend signals for the past two months, perhaps due to improving economic data on the U.S. front. In the past, investors have generally used the Gold/Silver price ratio to divine when it was better to own one or the other of the two shiny metals for the medium term. What insights going forward can be gleaned from the following diagram?

Much of the literature on this ratio often cites the historical average as being “16”, thereby suggesting that a bull market in Silver is a forgone conclusion if this figure is ever repeated. The likelihood of this “16” value (actually “15.5”) ever happening again is highly doubtful since this ratio was widely used in the nineteenth century and before by miners to arrive at a personal assessment of their finds, hardly a statistic that would have meaning in today’s technology-driven world. The recent “mean” average, however, has been steady at the “55” level, as depicted in the chart. Investors have used the “gyrations” in the ratio to signal when to switch positions in each metal. Similar to modern statistical arbitrage algorithms, the time to switch is when the ratio rebounds off one of the two dotted lines formed by the evolving triangle. The presumption now is that Gold will appreciate more quickly than Silver for the short-term future (the current ratio value is 51.5). What happens beyond the next six months is open for debate. Gold will benefit more when uncertainty is high, as is now the case, but increased industrial production, coupled with more favorable economic activity, will soon shift demographics in 2012 to favor Silver. Silver is more than a “safe haven”. It has an industrial component that creates its own type of volatility in daily valuations. Silver’s relationship with Gold is very similar to the “GBP USD” currency pair’s relationship with the Euro. Each tends to have a more erratic “personality” when it comes to reacting to shifts in fundamental data. Industry experts expect Silver to eventually outshine Gold, once fundamentals overtake the political influences of the present and economic recovery stabilizes. The past decade has favored Gold, but many of the same experts are predicting that Silver will own the next one. Only time will tell.