Gold and Silver Pricing Update: Mid July 2021

Many variables can drive the price of gold and silver. These include Fed meetings/speeches, inflation data, jobs numbers, risk appetite, etc. Some people speculate that the price is suppressed and manipulated by the banks and Fed. While coordinated suppression is not impossible, there are other more probable explanations for gold and silver price action. This price action manifests with changes in Open Interest in futures contracts traded on the Comex.

See What is the Comex for more details.

It could be argued that simply having future/paper trading of gold and silver can be considered price manipulation. Speculators can short and go long using leverage that represents a massive amount of physical metal. Obviously, this metal is not readily available and is traded as speculation only. But this is the nature of commodity markets. The Comex facilitates these trades and guarantees transactions when contracts stand for delivery. See the latest Comex Stock Update to explore ratios of open interest to Comex stock.

This analysis will review some of the drivers to the gold and silver price and then look at open interest and trade volume data.

Reactionary Price Drivers

The price of gold and silver can move rapidly and dramatically in a very short period of time. Obviously, the supply and demand for physical metal is much slower to move, so this price action is driven by the futures market. Skeptics usually claim “price suppression” when the price goes down, but are more than happy to see the price go up.

Many times, when this type of action occurs, it can be driven by activity in the Treasury market or the US Dollar exchange rate. A big move up in gold will oftentimes occur simultaneously with a move down in US debt rates (a move up in Treasury prices) or a move down in the dollar. This relationship can also be seen over longer time periods as the chart below demonstrates. While gold magnifies the move, the pops and dips tend to move in the same direction.

Please note: IEF is the 7-10 year iShares ETF (a move up represents falling rates) and the Dollar return is inverted in this chart to show a positive correlation.

Figure: 1 Price Compare DXY, GLD, 10-year

Gold and silver are also very highly correlated, but do not move in perfect lockstep. The Gold/Silver Ratio is used by traders to determine the relative value between the two metals. Historically, the ratio averages between 40 and 60, so outside this range can indicate a coming reversion to the mean. Currently, the ratio has settled into a tight range just below 70 after blowing out last March. Investors need to decide, is silver undervalued or is gold overvalued?

Figure: 2 Gold Silver Ratio

Technical Price Drivers

Because gold and silver are commodities and do not generate cash flow like stocks, it can be hard to place an exact value on the two metals. This makes them appealing to technical traders and speculators who focus solely on price action and ignore fundamentals. These investors look at technical indicators. One very popular indicator is the relationship between the 50-day and 200-day moving price averages (DMA).

As the chart below shows, the Gold 50 DMA just passed through the 200 DMA. This is referred to as a Golden Cross and can be a very bullish indicator. The opposite is called a Death Cross and is a bearish indicator.

The chart below shows these occurrences in 2016, 2017, 2018, 2019, and 2021. Each instance led to the expected outcome of the move, perhaps becoming a self-fulfilling prophecy. If gold 50 DMA is able to convincingly push through the 200 DMA in the coming trading days this would negate the Death Cross from February and perhaps create bullish momentum.

Figure: 3 Gold 50/200 DMA

The silver chart shows more bullish price action. As shown below, when silver’s 50 DMA crossed the 200 DMA in July 2020, it led to an absolute explosion in price. Despite recent consolidation and sideways action, the 50 DMA has stayed above the 200 DMA and even put in some distance recently. Unlike gold, there is nothing in the chart below to trigger an immediate reaction in the coming trading days other than that the two metals tend to trade in tandem. Also, remember, this is only one trading indicator, and although popular, it cannot be looked at in isolation.

Figure: 4 Silver 50/200 DMA

These trading indicators can cause spikes in volume as technical levels are approached. Although long-term coordinated price suppression is hard to prove (especially considering both metals are up over 5x since 2000), short-term “spoofing” has occurred and banks have been fined for such activity.

Spoofing can occur in both directions though as technical indicators are reached. For example, to push gold’s 50 DMA through its 200 DMA, in theory, a speculator could use leverage to enter a large long position and push the market enough to trigger other traders to follow allowing the initial trader to close their position for a profit.

Open Interest

When traders and speculators get triggers to buy or sell based on their indicators, they take action in the futures market. This can cause price moves to become more extreme. Open interest tends to be highly correlated with price. The two charts below show the open interest compared to the price in both gold and silver. Again, the overlap is not perfect, but major moves in one generally occur in tandem with the other.

Figure: 5 Gold Price vs Open Interest

Focusing on the silver chart shows how the big price spike down last year in March followed by the big price spike up in July was highly correlated with open interest. Again, open interest cannot be looked at in isolation as current open interest is far below where it was leading up to 2020 yet the price is far higher.

Figure: 6 Silver Price vs Open Interest

Sometimes, looking at notional open interest (dollar value) can be helpful. Looking at notional assumes traders speculate in dollar amounts rather than the number of silver ounces. The chart below shows that although the number of contracts is lower, the total dollar value is higher due to an increased silver price. This should be considered before a trader assumes the open interest as shown above will mean revert (creating a spike higher).

Figure: 7 Silver Open Interest Contract vs Dollar Amount

To evaluate the true relationship of Open Interest and price action, the table below calculates the correlation between the two. The methodology takes the percentage change over a specific period and then calculates a correlation across multiple periods between the two variables.

Figure: 8 Price/OI Correlation

As shown, the correlation is not always high but at times it can be very high. One thing to note is the daily lead lag correlation. This correlation is calculated by leading or lagging the data to see potential causation in the correlation. For example, for the daily same period, gold has a correlation of .26 vs a much higher .6 in silver. By leading the data by a day (i.e. comparing the price change from today with the OI change from the previous day), the correlation jumps to .48 in gold for the most recent 20-day period.

Zooming out to look at bigger periods shows an even stronger correlation. This calculates the correlation of weekly or monthly changes in price and open interest. No reason to lag as the longer time periods give traders and the price to react to each other. Both show very high correlations at certain points. For example, over the last year, gold and open interest are highly correlated in both weekly and monthly periods. Silver sees an even stronger correlation except for monthly returns over 1-12 months. This could be due to a mere calendar lineup with the big price move last July.

Seeing the trading in action

The two charts below overlay open interest and trade volume. The big moves (up or down) in open interest are generally accompanied by large spikes in trade volume.

This type of action also draws criticism from the skeptics who point to the massive amount of paper gold/silver traded that may not physically exist at the prices changing hands in the futures market. While this may be true, it is also the nature of commodity markets and even stock markets. Some ETFs can turn over more than their entire value in a single day.

Figure: 9 Gold Volume and Open Interest

Figure: 10 Silver Volume and Open Interest

Bringing it all together

The table below shows a snapshot of the trends that exist in the plots above. It compares current values to one month, one year, and three years ago. It also looks at the 50 and 200 daily moving averages. While DMAs are typically only calculated for prices, the DMA on the other variables can show where the current values stack compared to the recent history. For example, Open Interest in both gold and silver is sitting below the 50 and 200 DMAs. Is it possible this indicates an oversold situation or is it a result of notional values as mentioned above?

Other takeaways:

• Gold is almost exactly the same price as last year where silver is up 38%. This has caused the Gold/Silver Ratio to fall by 27% over the year.
• Gold is below the 50 and 200 DMA. Gold needs to move up through these to signal bullish momentum.

Figure: 11 Summary Table

Obviously, no one can predict where the price of gold and silver are going in the future. Many articles in the Exploring Finance series look at the fundamental cases that theoretically should drive prices higher in the medium to long term. This analysis looked at some of the short-term drivers and showed how Open Interest is a major factor in the price of gold and silver regardless of what may be occurring elsewhere.

Numbers and analysis will be updated monthly. A deeper look into the distribution of Open Interest (i.e. who is holding long and shorts) will be forthcoming with an analysis of the CFTC Commitment of Traders report (COTs report).

Data Source: https://www.cmegroup.com/ and fmpcloud.io for DXY index data

Data Updated: Nightly around 11PM Eastern

Last Updated: Jul 12, 2021

Gold and Silver interactive charts and graphs can be found on the Exploring Finance dashboard: https://exploringfinance.shinyapps.io/goldsilver/