It is a commonly held belief by many precious metal investors and even a good percentage of market pundits that silver always outperforms gold during the latter stages of a precious metals rally. When the chart action goes parabolic — such as in January 1980 or May 2006 — silver is at its most profitable, or so the thinking goes. The truth, however, is that silver outperforms gold only during orderly and strong price advances that remain trend-bound. Once gold and silver prices achieve the wildfire stage, the blond metal can outshine its albino sibling both on the way up and especially on the way down (by falling less, of course). With incorrect notions in hand about gold and silver price action, both pros and amateurs can make fundamentally-mistaken allocation decisions in their precious metals portfolios that can be painful in the short and long run.

We will employ a visual construction in this analysis that essentially reconsiders the traditional market perception of gold/silver prices and ratios. At first our approach may appear a bit convoluted but even cursory study should reveal its utility. What we have done is plot the gold and silver price on the same chart, adjusting the silver price by a factor that causes a confluence with the gold price at each market top that we are attempting to analyze. For example, the market top in January 1980 occurred near a ratio of gold to silver prices of 20-to-1 so we multiplied the silver price by 20 on that chart. The gold/silver ratio has also been plotted on the chart with red arrows drawn to indicate the trend during each market phase.

Prices are COMEX daily highs for the futures contract that was active during the market top. There are no contract rolls or continuations using this method and therefore prices become sharper and more focused as time passes. This is because the contract goes from lightly traded in the outer months to heavily traded as it becomes the front month. Furthermore, plotting only the daily high removes a lot of noise and magnifies the trending characteristics of each rally. The net effect is subtle but useful in a way that would take a long time to describe in words so we’ll let the charts do most of the talking.  Note that each chart is also labeled with a graphic to indicate the phases when silver is in a strong, sustained price advance. Interim price peaks and blow-offs are visually separated to help isolate price action and gold/silver ratio changes during these market events.

While it would be preferable to use spot gold and silver prices for our analysis, the lack of historical (and current) spot price granularity would blur or even obliterate many of the relational features found in charts constructed from active, exchange-based market data.

Let’s now look at the first chart, which displays the classic 1979-1980 rally in gold and silver ending with the ultimate blow-off high on January 21, 1980. The chart shows that, amazingly, the vast majority of that historic price rise occurred during just two 45 day periods. Moreover, almost the entirety of silver’s relative strength was limited to these two short intervals of time as indicated by the vertical arrows pointing down in the below chart. Note that our unique chart construction makes silver look like a machine on a mission. It is actually gold that appears to be careening out of control as the afterburners are lit during the final few days of this historic move.

Note that the gold/silver ratio spent the vast majority of its time during 1979-1980 drifting sideways or slightly up while silver was not advancing strongly. Of particular note is that during the interim price peak of early October 1979, the gold/silver ratio interrupted its ultimate decline to under 20-to-1 and did not resume it until gold and silver prices started to strongly advance again in late November. Moreover, most of the relative gains in silver were made while advancing into the interim peak in October and not the final blow-off in January.

As the rally went parabolic in early January 1980, the gold/silver ratio actually flattened out prior to turning up sharply in March (not shown). Therefore, the time to profitably own silver over gold was actually quite limited in duration and it certainly did not include the final blow-off stage, especially given that silver was back to $10 by April 1980 (not shown).

The above chart obviously shows a peak high for COMEX silver slightly over $40 whereas spot prices reached and even exceeded $50 around January 21, 1980.  While this is a valid point, it doesn’t materially change the story told by the above chart. Gold at $850 and silver at $50 results in a gold/silver ratio of 17-to-1 which is exactly where the chart shows the ratio bottoming during the demarcated blow-off stage. In other words, using spot prices would still result in the same conclusion that silver did not outperform gold during the January 1980 blow-off whereas gold did substantially better during the subsequent price decline (not shown).