The debate over whether the liquidity-induced excesses of the last ten-plus years will result in a deflationary collapse or a hyper-inflationary spiral is one that could well occupy its own website, and the time and brain power of people far smarter than I am. I happen to be in the hyper-inflation camp, but I assure you that it would not take much to make me switch sides.

I raise this because the behavior of precious metals over the last year has me more than a bit confused. On the one hand it could easily be argued that the 2005 high was a secular peak, that the action since has been a re-testing process, and that we are now coming onto a rollover of this massive top.


Click here to enlarge.


Click here to enlarge.

On the other hand, shift the same charts from a weekly to a monthly timeframe, and you could easily convince yourself that what you see constitutes bullish pennants. Even beyond simple price patterns, popular indicators such as Momentum, DMI, and Money Flow are inconclusive, while the MACD – which back-tested rather poorly – is currently leaning Boo’s way.

Therefore, at risk of rationalizing my current exposure to this group, I suppose that my heavy longs in names such as Goldcorp (GG), Newmont Mining (NEM), Golden Star (GSS), Pan American Silver (PAAS), and Silver Standard Resources (SSRI), covered by a heavy dose of Market Vectors Gold (GDX) puts and a smattering of Streettracks Gold (GLD) short, are at least consistent with the existing state of confusion.

However, confused offsetting positions rarely provide satisfying results, which brings me to the real point of this column.

As I was looking for an edge in the fray, I came across a rather unusual divergence between gold and silver futures prices (using the Powershare DB Gold (DGL) and Silver (DBS) as proxies). In the chart below you can see that over the last few weeks the relationship between gold and silver futures has broken down rather remarkably, with gold far outperforming silver.


Click here to enlarge.

Back-testing it to the beginning of the year (I agree that’s not a large sample but that’s as far as this particular data series goes) the current spread between the two precious ones is approaching 3 Standard Deviations away from the mean.


Click here to enlarge.

Using gold and silver spot prices in order to reach back to 2000 on a weekly basis, the spread is still rather extreme at nearly 2 Standard Deviations.


Click here to enlarge.

However, the one odd aspect to this is that looking at spot prices since the beginning of the year, the current spread is not at all that unusual.


Click here to enlarge.

This raises the possibility that this discrepancy is inherent to the specific prices series (futures versus spot) rather than some substantive “event” that has decoupled gold from silver.

I have tossed this last question to Prof. Limantour for her learned comments and her take on whether the current discrepancy presents a relatively clear trading opportunity in what has otherwise become a rather confused environment.