Tuesday, December 25, 2007

Yield Curve and Gold/Silver Ratio

early this year (see 01/21/07) I wrote about the correlation between the gold/silver ratio and the interest rate yield curve, specifically the thirty-year bond rate ($TYX) relative the three month discount rate ($IRX). I discovered that over the longer term when silver outperforms gold, the yield curve tends to move toward inversion.

but what about when viewed from a shorter term perspective? events in financial markets of recent months provide us with test case that would be hard to ignore. first look at this chart of the 30/3 ratio:

we see that at the beginning of August the ratio stood near 1.00, meaning that the three month and thirty-year rates were very near to each other. then the 'Liquidity Crisis' hits. short term T-Bills, being the 'specie' of our specious monetary system, became the most coveted assets on earth, at one point yielding less than half that of the Company Store's official rate. over in the metals markets meanwhile, the silver market crashed, pushing the bimetallic ratio up into the high 50s:

wait, is that a double top I see on the gold/silver ratio? and wasn't there something similar on the 30/3 chart above? let's look at the two overlaid:

while there is certainly nowhere near a 1 to 1 correlation over the span of the chart, I do find it significant that they topped out within a day of each other both in August and December.

on the G/S chart it looks like a classic bullish arch inverted has just been fulfilled. a decline here below 55 should indicate that the metals are ready to rock again, with silver at the forefront. additionally, this would make me confident that the recent top on the 30/3 will hold, indicating a gradual reprive from the crisis situation in the credit markets.

in summary, while viewed from a nearer-term perspective little evidence can be found to conclude that the bimetallic ratio leads the yield curve (or vice-versa), the price data from these recent months does seem to demonstrate that they tend to move concurrently, especially near their respective extremes.

how to play it? long silver, obviously. also a long position with the 30 year bond may be worth looking at. I truly believe another up-wave is coming which should take the yield below 4%, but I question whether this current period of weakness couldn't put us another point or two down first.