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Monitoring the 'Risk Trade' with the Gold/Silver Ratio

The gold/silver ratio is not just for gold bugs; it can help us monitor the appeal of the 'risk on' trade relative to the 'risk off' trade in many markets, including global stocks (SPY) and commodities (DBC).

While gold (GLD) and silver (SLV) are often grouped together in investment discussions, gold has more of an Armageddon appeal and silver has more of an industrial appeal. Generally, when the gold/silver ratio is rising, it signals higher levels of fear and concern about the economic outlook. Notice how gold was much more attractive in the minds of market participants during the 2008 portion of the last bear market (see below).

Gold Silver Ratio 2008

The current gold/silver ratio, shown below, recently broke through the downward sloping trendline that was formed as risk assets rallied off the July and September 2010 lows. While it is too early to read too much into the break of the red trendline shown below, it is worth keeping an eye on.

Gold Silver Ratio 2010

If the gold/silver ratio makes a higher low, followed by a higher high, then our concerns would be increased relative to a possible bout of risk aversion in all markets. As of Thursday's close, the risk-on trade still rules the day. Sentiment and possible overhead key S&P 500 levels are two other ways to keep an eye on the health of the current bullish trends in stocks and commodities.

On Thursday, the CCM Bull Market Sustainability Index (BMSI) closed again at 3,745, a level that continues to favor bullish outcomes over bearish outcomes. The CCM 80-20 Correction Index dropped down to 1,176, which historically points to favorable risk-reward conditions for risk investors looking out one-to-twelve months (see table below).

Risk Reward Ratios for Stocks 1983-2011

Notice the risk-reward ratio of 3.76, looking out three months, is the most attractive three month ratio in the table. This aligns well with the positive fundamental and technical developments we identified in late December 2010

 

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