Saturday, February 8, 2014

Precious Metals Complex Ratio Index

allow me to introduce an additional indicator used to track the health of the precious metals complex: the PMC Ratio Index.

it's simple really, I just combined into a single series the three ratios that Everyone uses to analyze the metals:

SLV:GLD (the ratio of silver to gold)

GDX:GLD (the ratio of gold stocks to gold)

GDXJ:GDX (the ratio of junior golds to major gold stocks)

it is generally agreed that the stronger each of these ratios, the more favorable the outlook for the precious metals complex as a whole. but often each of these ratios, when viewed separately, will lead to conflicting outlooks. and that's fine for analysts who enjoy reconciling the divergences with nuanced interpretations. but I don't have time for so much confusion anymore. I'd prefer to look at a consolidated picture from the start and reserve the underlying components for the occasional indulgence.

but how does one combine three such ratios into a single series? just take an average of the three? yes... but.. a regular arithmetic average won't produce anything very useful. sure you could rebase each one to 1 or 100 at common point in the past and then average them out, but eventually your combined series will get so distorted that it becomes useless. no, the best and most truthful way of averaging non-commensurable series is by using the geometric mean (=GEOMEAN in excel)*.

so with that explanation of method out of the way here's a chart of the PMC Ratio Index going back a few months:

looking back, that handle that formed in December proved to be a positive indication, especially since it formed as the underlying ETFs were testing or hitting new lows. since then the index developed into a defined (albeit broad) uptrend.

In the next post we will compare this ratio index to the PMC ETF Index.

*incidentally, geomean is the only valid way to average a group of ratios. unfortunately this fact isn't widely known among market analysts and amateur statisticians, often leading to embarrassing (if comical) errors.