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What Recent History Says About Today’s Gold Rally

While the investment world attempts to make sense of the burgeoning tensions arising from the so-called "trade war" between China and the Trump administration, the US Dollar Index (DXY) has moved sideways along with the major stock-market indices. 

Meanwhile, smart money has piled into precious metals gold and silver, which have witnessed remarkable dollar gains over the past three months: the spot price of gold has gained $270/ounce, or twenty-one percent, compared to $2.31/ounce, or fourteen percent, for silver. 

For the investor seeking alpha, gold and silver stocks present tremendous upside, while silver bullion and miners are particularly appealing at a time when the metal continues to trade at historically-low premium compared to its yellow rival. 

At the beginning of June, one ounce of gold traded against 93 ounces of silver. 

The last time gold traded so expensively in terms of silver, quarterback Brett Favre was preparing for his rookie season with the Atlanta Falcons after being selected thirty-third overall in the 1991 NFL Draft. 

This was also the peak for the gold-to-silver ratio, when one ounce of gold traded against nearly one-hundred ounces of silver. 

On the other end of the extreme, in December of 1979, gold traded against silver at a fifteen-to-one ratio as Paul Volcker, newly-appointed Fed chairman at the time, began his contractionary monetary policy by ratcheting up short-term interest rates from 10.25 percent toward 20 percent in March of 1980, by which time the gold-to-silver ratio had reached twenty-nine to one. 

The average gold-to-silver ratio over the twentieth century was forty-seven to one, whereas the ratio has hovered around a sixty-to-one average over the past twenty years, placing the present ratio forty-two percent above the twenty-year average, a full eighty percent over the twentieth-century average. 

Over the long run, statistical probability dictates that the ratio will eventually revert to the mean, which implies tremendous opportunity in the market for silver bullion, and an even greater opportunity in leveraged positions such as stocks and exchange-traded funds (ETFs). 

Either way, the foreseeable future is bright for both metals, and the gold investor need only ask himself whether he has the stomach to endure some short-run volatility in the riskier silver market en route to greater returns. 

Regardless of the investor’s risk profile, both metals will provide reliable insurance against economic, geopolitical and counter-party risk, only silver will invariably lead gold higher over the longer term of this bull market in precious metals. 

At this juncture, many investors are pondering whether they ought to wait patiently for a pullback before pouring into gold and silver positions, after the precious metals market has telegraphed its direction and the public has become increasingly leery of recession. 

In order to appreciate the opportunity that presently exists, one might journey back in time to the 2011 run-up in the dollar price of gold, when the yellow metal, in the wake of the housing bust and financial crisis, surged from $1,360 at the beginning of the year to $1,900 near the end of summer. 

For the purposes of comparing this year’s rally to that of 2011, I have graphed them together. 

Conveniently, in 2011 gold peaked in dollar terms near the end of August, which is precisely where we find ourselves eight years later, with gold holding strongly above the $1,500 level for the first time since April of 2013. 

In fact, in this recent rally gold has maintained this level for nearly four weeks, and its only marked pullback thus far took place between the fifteenth and the twenty-second of August, posting a dip of $22.70, or 1.48 percent. 

While historical trading performance cannot independently predict exactly how this trade will play out into the future, we can employ the information as a basic guide for understanding how the market once moved the price of precious metals in a time of economic uncertainty. 

In evaluating the twelve-month chart, it’s apparent that both rallies, with only a handful of exceptions, experienced mostly higher highs and higher lows across the interval. 

Across those exceptions during the twelve-month period, we find that the 2010-2011 rally pulled back on only seven occasions, averaging 3.4 percent per pullback; during that period, the maximum percentage pullback was 5.68 percent. 

Put another way, the average pullback amounted to $51.27, while the maximum pullback amounted to $80.70.

In the present context, under the average percentage pullback of 3.4 percent, the price of gold would decline by $52.70; under the maximum percentage pullback of 5.68 percent, the price of gold would decline by $88.04.

During the present 2018-2019 rally, there have been nine pullbacks averaging 1.70 percent, with only two pullbacks exceeding two percent and a maximum pullback of 3.14 percent.

The average pullback over this twelve-month period has amounted to $22.60, while the maximum pullback witnessed a loss of $41.70.

Upon closer examination, we find that the run-up in 2011 witnessed only minor pullbacks en route to the peak, whereas the 2019 rally has yet to experience even one meaningful pullback over this period. 

Over the five-month period between April and August of 2011 and 2019, the yellow metal traded remarkably steadily in moving toward the upside. 

On the whole, the average between all pullbacks during this particular period in 2011 was $58.73, while the average percentage loss was 3.60 percent. 

The most severe pullback amounted to $64.80, or 4.16 percent; this percentage loss would equate to $64.48 for the present price of gold. 

If gold today were to experience that average pullback of 3.60 percent, it would amount to a loss of $55.80. 

If gold trading is to resemble its rally from 2011, one must then consider whether he is willing to pay a modest premium to position himself now, or whether he will greedily wait for a meager pullback that may never come. 

Put another way, in deciding to secure a position in gold, is the investor inspired by speculative riches or by the characteristics that qualify the yellow metal as sound money?

Ultimately, if the fundamentals are sound for any given asset class or investment, and if those fundamentals demonstrate that it is radically undervalued, it is simply foolish to wait for a paltry discount that may never come, that may only prevent the investor from ever securing that position. 

In terms of the present gold and silver market, the upside is just far too great, while the downside is far too limited, to warrant waiting for the next sale. 

Meanwhile, the risk of owning US equities and Treasurys is far too great to justify holding positions there. 

From the dot-com bubble and the housing bubble to today’s "everything" bubble, the stakes have grown and the sidelines have been squeezed: the current bubble threatens purchasing power, institutional solvency and sovereign debt. 

This means that your cash positions, just as your bonds, your equities and your entire portfolio, are directly in play. 

While it certainly pays to reserve some dry powder for a future buying opportunity, it’s the responsibility of the investor to determine how much he’s going to keep, and whether the expected gains are enough to risk the guaranteed losses.

One thing's for certain: there's no floor protecting the dollar, which means the present rally in gold and silver has a far greater ceiling than the one that preceded it.


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