Posts Tagged ‘Ratio’

Gold and Silver Update


When Fundamentals clash with Technical Charts who to follow? What role does the Gold-Silver ratio play? What happens if Gold breaks above $1000? What does that mean for Silver? And what should the prudent investor do?

How Intelligent Investors Think

We are approaching another critical point for the Precious Metals Trader. Notice how I say “trader” not “investor”. An investor doesn’t follow a position. He buys low – when demand is virtually non-existent, and sells high – when demand is irrationally justified. A trader on the other hand, may profit from medium term trends. What’s interesting is that more often than not, the investor wins. The reason for this is that generally markets follow trends. “Generally” implies most of the time, however when they do buck the trend they do so with “shock and awe”. Thus, we must approach this current scenario like an investor/long-term trader, and not like a little kid out to make a few dollars.

Many recall the March 2008 highs. Note that Silver is still 20% below its 2008 high and 65% below its all-time. At the time, we did not sell and our reasoning was very clear and even in hindsight “justified”. “If the downside is significant we can always wait it out. Yet if prices pivot to the upside – and they have strong reason to do so – then there will be no way for the investor to re-enter the market”. Basically, you can’t jump onto a moving train. (Well, you could, but its not advised).

One note on the matter: We don’t really “invest” in gold or silver. Gold is the ultimate currency and should be the default holding of any investor. Only an investment of significant upside and strictly limited downside should be wagered for its value.


What we see now is similar to March 2008 in the sense that the Technicals look bleak, while the Fundamentals look increasingly resilient. Gold has just broken-out above $1000. This has stood as a significant resistance level and its abolition holds the keys necessary to bring thousands of traders and funds into the market again. These are mostly people who are waiting on the sidelines to see if the rally is sustainable.

Another factor, that will definitely play a key role in the longer-term is the fact that Central Banks are now buying gold, not just selling it. This create a fascinating equilibrium in a once Dollar-dominated monetary system. The game may be up, this time for good. In addition, mining companies, such as Barrick, intend to de-hedge their positions in gold shorts – which were profitable when Gold was falling in the 80s and 90s but with rising prices has now turned against them. These two development are decade changing events and will alter the precious metals market for years to come.

Finally, there is not a lot that the U.S. and the Dollar have to gain from expensive gold. It destroys their credibility and instills fear in the hearts of fiat-borrowers. This being the case, it would be of no surprise if governments make one last-standing effort to contain the gold price. Problem is, that while this was once going with the flow, its now battling an uphill trend – a strong one to say the least.

When Fundamental and Technical indicators clash one must look at Sentiment. This is the one differentiating fact between 2008 and today. While March 2008 was met with great fear and anxiety regarding the future of the economy causing extreme bullishness in precious metals, September 2009 is met with confidence and calm, to the point of skepticism that Gold can old above $1000.

The fact remains, that the precious metals are over-bought and reaching stress levels on the upside, but these factors are merely short term. The overall trend remains up and amidst the strongest buying month of the year, the top may not yet be upon us.

The Gold-Silver Ratio

Many market followers don’t reallize that silver is due to outperform simply due to its recent under-performance and under-valuation relative to gold. Geologists estimate that the in-ground Gold-Silver ratio stands at something between 8-20. This means that there is approximately 8-20 times more silver than gold. Yet above ground reserves have dwindled significantly in recent years as much of the metal has been used industrially or has gone into private hoards and won’t come out until prices increase over-and-above current estimates.

The ratio, now at about 60 as of this writing, is still high relative to its suggested variant. This means that if one could expect a mean ratio of say 45, then with Gold hovering at $1000, Silver can still rally straight up to $22. If Gold rallied to $1650, as many expect within the next 12 months, we can expect to see Silver as high as $36. Again this is all if we revert to a mean ratio. But markets tend to over-extend their pre-defined impacts. Only time will tell.


There is no question that the bull market is intact. As for corrections, “they’re as predictable as snow storms in winter”. Yet, when it comes to making sound financial decisions, the ones that don’t require much thinking are those that warrant action. The best action is often no action. I saw many people who call themselves “investors” pile out of Gold in 2008. Yet, they did so for the wrong reasons. No one saw the collapse of Lehman Brothers sweeping the market causing a massive full-scale sell-off affecting each and every asset class – precious metals included.

On the flip side, had the market rallied on the COT short-squeeze, or had a major buyer stepped into the market, they’d probably still be locked out of the market forever. This time is no different. Maybe prices will decline, maybe they’ll rally… but its a bull market you know!

A Story

In Reminisces of a Stock Operator, the famed trader Jesse Livermore teaches many valuable lessons about markets and trends. In one event, he was told the following

“When you are as old as I am and you’ve been through as many booms and panics as I have, you’ll know that to lose your position is something nobody can afford; not even John D. Rockefeller. I hope the stock reacts and that you will be able to repurchase your line at a substantial concession, sir. But I myself can only trade in accordance with the experience of many years. I paid a high price for it and I don’t feel like throwing away a second tuition fee. But I am as much obliged to you as if I had the money in the bank. It’s a bull market, you know.”

On Stock Values

Some Stock Advice from Dan Ferris, editor of Extreme Value

I don’t expect investors will make much money in stocks on the long side from current price levels. Dividend cuts, weak earnings, and unattractive valuations are telling you to be careful. Most long term returns in stocks have come in from dividends, not capital gains (because arbitrageurs and institutions make it too hard for the majority of investors). On the dividend side, Procter & Gamble has raised its dividend every year for 53 years. ExxonMobil has done so every year for 27 years. Most stocks are just too expensive compared to earnings. The S&P 500 is trading around 16x earnings. And with banks failing, 10% unemployment, and the middle innings of a once-a-century meltdown. With housing and debt in charge of the economy now, this means a worse outlook for earnings and stocks. In the 1970s valuations sank for a decade through the Great Inflation.

Year P/E
1974 7.3
1975 11.7
1976 11.0
1977 8.8
1978 8.3
1979 7.4
1980 9.1
1981 8.1
1982 10.2
1983 12.4
1984 9.9
Average P/E 9.5

Based on historical standards, the ultimate bottom could be another 39% below the March 2009 low of 667 (12x S&P 500 earnings estimate).

For more information on P/E ratios see:
Investopedia – The P/E Ratio – Understanding Price to Earnings Ratio
Sentiment of Success – What is the Price To Earnings Ratio

You Are Here!

Remember the last time you were somewhere you expected to know so well and suddenly found yourself lost as to where exactly you are? It’s so frustrating. But then we see it. That big map on the side of the road, in the mall or whatever have you, that so eloquently proclaims “You Are Here!”. At that moment we once again regain our sense of clarity and with it the revival to continue.

As I logged into my brokerage account to make my incremental deep-value long-term minded investments I hesitated. It’s not so important as to why I did but more so that I did at all. Long-term investing should be simple math. Day Traders spend hours setting up their big moves every day, while it’s known that great investors make their decisions based on a few short minutes of thought.

“So where exactly are we?” I asked. We’ve had quite a run recently (of course I am talking to those investing in commodities, with precious metals particularly in mind). Are we do for a sharp pull-back? As you may see from the historical charts gold rallied from 1968-75 then took a breather until late in 78. That’s 3 years that your money would have been far better off earning interest or even better put to work in an undervalued security (its 1975 – there were plenty) with a hefty dividend to go with it.

That’s my final answer. Gold had just broken $85 on the COMEX. Oil was relatively stable at $5-6 a barrel. Oil shocks were unheard of (contrast with today’s premium). Interest Rates were similar to what they are now – under the 5% range – nothing compared to the 20% the market would see in the coming years. The Dow had just gone to all-time highs and was about to plunge 40%, along with corporate earnings.

But most importantly, the only number your really have to watch is the Dow/Gold ratio. Every major bull market started with Dow trading at over 20x the price of gold and then followed by a bear market that cut that ratio to 2 and sometimes to parity. The current ratio is 15.5.

Past and Present
Past history is never a guide for the future but it tells us firstly, what markets are capable of and secondly, what the future will rhyme with. If this is even a similar guide to future performance then it seems plausible to assume that much of the gains made in this commodities bull market will be made in the next two years.

The Price Per Earning Ratio

What is Price? What is Earnings? What is the Price-Earnings ratio? Why is it so important and what does it mean for investors today?

What is Price?
Every single share sells for a price. The price is what the company would sell for on the open market. Commodities generally sell its intrinsic value. The pricing of a company is slightly more complicated because you are not merely speculating on its intrinsic price in the future but also on its growth value.

What is Earnings?
Since businesses generally earn profits its intrinsic value grows over time. This means if a company is selling for $1 today but is expecting to make $1 tomorrow a buyer may buy a share for $2. If the buyer is willing to wait 3 days the business may now be worth $3.

What is the Price-to-Earnings Ratio?
The price-to-earning ratio (or P/E for short) is the price divided by the earnings. In other words, what the share sells for today and at what rate the share may be worth more.

Why is it so important?
Consider for a moment that the buyer may not be the only one buying shares. Millions of more offers may come in with Investors with different time horizons. Additionally, the general sentiment in the market may favor different P/E ratios. Now you are not only betting on price but at what valuation investors will pay in the future.

The Math
Today the Dow Jones Industrial Average sells for 13,265. This is high considering it once sold for less than 5. Actual earnings of all 30 companies this quarter was 645. This means that the Dow is selling for a little less than 21 times earnings. It also means that even if the companies’ profits were to remain completely stable, the Dow can fall to 645 and still maintain its intrinsic value.

Margin of Safety
Ben Graham, the father of value investing, said to always buy below a P/E of 15. The investor must also consider how much earnings themselves will grow by but must be careful not to over valuate.

The reason for this figure is simple. Over decades of market history the most that the average share has sold for in times of a good market has been 30. Conversely, the lowest common valuation given for a bad market has been 7.5. This brings us to an exact median figure of 15.

This enables us to maintain an adequate margin for safety. While a share of say $10 at a P/E of 15x may fall to 7.5x (a loss of 50% – halving its investor’s capital), it may also sell for 30x (generating a profit of 100% – doubling the investor’s capital).

An Example in The Market
This is an example of what a typical conversation would sound like between an eager seller and a potential but cautious buyer.

Seller: I would like to sell my shares for 20 times earnings.
Buyer: Are you crazy? That means that you are betting that earnings are going to continue like this for 20 more years.
Seller: So, what’s your point?
Buyer: And you are willing to hold onto those shares for 20 years?
Seller: Well if I sold them for less, then I’m betting that earnings may drop sooner.
Buyer: And, what’s your point?
Seller: That earnings may continue for 20 years and may not! How do I know how much earnings will increase over time?
Buyer: Welcome to the marketplace buddy!

What This Means for Investors Today
We are in what is known as a Secular Bear Market. This is when P/E ratios are generally falling. Remember that this may happen even though earnings may be rising. Therefore, the stock investor must now find good companies, with increasing profits that are selling for prices that have already filtered in any possible decline. While this is very easy when the ratio is low (below 10), this gets very complicated when the ratio is high (above 20).

As the ratio falls companies will become cheaper, bringing more long-term investors into the market while driving the short-term speculators out. This one of the reasons why many investors do better when prices are falling than when they are rising.

“Fools are those who know the price of everything and the value of nothing.”

Why Value Investing always beat Growth Speculating

They say that successful investors are not those who are able to forecast declines or call tops but those who are able to pinpoint definite gains and targets to be reached. Once met they would then make a decision to either continue holding the company or sell it off.

In other words: Buying a stock, anyone can do. It’s selling one that takes a genius.

Thus we are left with two general methods in stock picking. Growth and Value.

Growth “investors” act more like speculators. Betting on trends and predicting future situations. Generally supported by a high prices-to-earnings ratio these stocks offer nothing more than a quick dollar. This type of analysis need more faith than education. A quick change in sentiment can change a price dramatically. Furthermore, prices usually include future earnings. This leaves little room for surprise announcements and achievements.

Value investors hunt for bargains much the same way frugal buyers search for good merchandise. They look for issue selling at distressed prices due to current sentiment that may soon change, problems that could easily be fixed or simply those that have been overlooked or ignored. When they do find one they know they’re getting what they pay for.

Growth stocks usually benefit short-term traders with short quick jolts while Value stocks offer much better and steadier returns to long-term investors over many years.

Here are a few math abilities needed to be a security analyst:

To appreciate this, it helps to understand some basic valuation theory. The value of a stock, theoretically, is the “present value of future cash flows.” Loosely translated, this is what all the cash a company will pay to shareholders from now until the end of time would be worth if it were delivered in one lump sum today.

To determine the “present value of future cash flows,” an analyst needs to know the following:

1) the amount and timing of the future cash flows

2) an appropriate “discount rate” with which to determine what the cash flows are worth today. (Thanks to inflation, risk, and opportunity cost, a dollar expected to be received in a year is worth less than a dollar delivered today, and a dollar expected in 10, 20, or 100 years is worth a lot less than a dollar today.)

and usually

3) A “terminal multiple” with which to value the cash flows that will be received after an explicit forecast period (usually five or 10 years).

Simple put into things we can see, Earnings per Share tell us what it’s worth today, the price tells us what it will be worth tomorrow. The Price-to-earnings ratio then tells us how may years into tomorrow.

It can thus be seen from good old analysts like Ben Graham why many value investors will never buy a share with a price-to-earnings ratio of more than 15. Who can predict that far into the future?

So how can one buy a great company for a good price?
You either need guts and money to gamble (something any growth investor can offer you) or patience and diligence (something only a value investors knows well).

Over the years, and I refer to tens of years not just the last seven, P/E ratios have generally varied between the single-digits and the triple-digits. During the Tech boom some stocks sold at 44 times earnings, while as prices began to subside were still selling at prices well over 100 times their earnings. This means that investors (some mere speculators) were expecting profits (if any) and investor demand (otherwise read “lunacy”) to continue for another hundred years!

Meanwhile, in the late 70s ratios were beaten down to bargain levels, sometimes 5 or 6. This was at times when a 10% return in the overall market sounded more like wishful thinking.

With ratios at currently 18-20 for the indexes it would seem that lower ratios seem in the cards. This does not mean that prices must fall (although they most probably will) and it does not mean bargains are not out there (although much harder to find). But with all the current interest in such issues the small investor might as well just speculate on top of the crowds and large institutions.

But when you do go out and buy your stocks, be it today or in 10 years from now, Buy at Value!


Dow in 2007 is Cheaper Than in 1929!
Michael Nystrom at quotes Robert Prechter

The nominal Dow peaked at 381 in September 1929, and today it is hovering somewhere around 11,500, a 30x increase over 77 years. Not bad, right? But amazingly, measured in gold, the recent Dow highs are actually right about where they were at their 1929 peak!

For those interested in the actual details, he says, “It took 18.5 ounces of gold to buy the Dow on September 3, 1929. On May 10, 2006, it took 16.5 ounces of gold, so it is actually cheaper.

So gold made slightly more gains! Hahaha! He adds, “As Dr. Gold would put it: One dollar won’t buy what it did in 1929, but one ounce of gold (about $20 at the time) sure will (about $650 today)!

So to put it straight, If you were interested in starting to “invest” – Read: Save Money” – in 1929, it would have been smarter and easier to just buy Gold.

Many analysts say that if you don’t know the first thing about investing, buy an index fund. We say… just buy Gold.

The Dow/Dollar Ratio
For some long-term perspective, today’s chart illustrates the Dow adjusted for inflation since 1925. There are several points of interest. For one, when adjusted for inflation, the bear market that concluded in the early 1980s was almost as severe as the one that concluded in the early 1930s. It is also interesting to note that the inflation-adjusted Dow is now a touch less than three times higher than where was in 1929 and a little over double where it was in 1965. Not that spectacular of a performance considering the time frames involved. However, the magnitude of the bull market of 1982 to 1999 (even when adjusted for inflation) was truly of historic proportions. While the Dow has recently been making new record highs on a non-inflation-adjusted basis, today’s chart does illustrate that on an inflation-adjusted basis the Dow still trades below its 1999 peak. Further proof that time is money.

What more can I say other than “I think it’s about time to start thinking about commodities…at least for the next 10-15 years”. An economic slowdown (which the short-term-minded world is so speculative about) would last about a year, even considering the most bearish predictions. This bull market in commodities however should last for over a decade. When you see stocks trending towards the green line, you’ll know to get out.