Gold/Silver Ratio

Gold/Silver Ratio

How to use the Gold / Silver ratio to interpret precious metals

Among the many analytics that traders in precious metals often use, the gold/silver ratio is one of the most popular measures. The gold/silver ratio measures the ratio of the dollar price of one ounce of gold to one ounce of silver. The bigger question is what does this ratio signify and how to actually interpret the gold/silver ratio?

What is the gold/silver ratio?

Gold silver ratio is nothing but an equation between the price of gold and the price of silver. Currently, 1 oz (troy ounce) of gold trades at $1510 while 1 oz of silver trades in the international spot market at $18. That gives you a gold/silver ratio of 83.9. What this ratio effectively means is that one ounce of gold can be exchanged for 83.9 ounces of silver. This gold/silver ratio normally ranges between 50 and 80 but there are occasions when the ratio diverges from this range by a big margin. For example, when the gold/silver ratio goes sharply above the 80 mark, it is economical for traders to convert their gold for more ounces of silver. This increases the demand for silver, raises the price of silver and brings down the gold/silver ratio back to the range. In case of a sharp fall in the ratio well below the 50 mark, the traders prefer to convert silver into gold and that pushes up the gold/silver ratio back into the range. By looking at the gold/silver ratio vis-à-vis its historical range, tells how to trade based on mean reversion.

Why does the ratio fluctuate?

One can argue that both gold and silver are precious metals and hence they are also safe haven investments. Then why does the ratio fluctuate? It has to do with demand patterns. The price swings for gold happen more from central bank and ETF buying. That means gold is more of a hedge against uncertainty. Silver finds nearly 75% of its usage in industries like electronics and hence silver demand and price is more linked to industrial cycles. If you look back at the last 10 years of the gold/silver ratio, it has gone as low as 35 in 2011 and as high as 92 in 2019. How to play the metals using the gold/silver ratio?

Rather use it as a pair trade

When the gold/silver ratio had touched 35 in 2011, it was a signal to either buy gold or sell silver. While selling in silver would have been a great trade, a buy on gold would have been disappointing. A better way would have been to go for a pair trade where you bet on relative outperformance rather than on specific assets. Recently, in June 2019, the ratio touched a high of 92 and is still at around 83.9. How to take a call? Should you go short on gold; that may not be a good idea with global uncertainty high? Should you buy silver; that would work only when the economic cycle picks up? Like in previous cases, mean reversions of the gold/silver ratio can be best used for designing pair trades!

Bharti INVIT Bet

Bharti Airtel’s INVIT bet could hit 3 birds with one stone

Bharti Airtel is hinting at another round of fund raising, but this time around it is going to be through the INVIT route. Infrastructure Investment Trusts or INVITs were permitted in 2014 as a special purpose vehicle (SPV) to help monetize the assets of a business. So what exactly is Bharti trying to monetize through the INVIT route?

Big optic fiber plan

Bharti plans to use the INVIT route to monetize its 2.7 lakh KM of optic fiber assets spread across India. What this means is that a block of optic fiber assets (either fully or in part) will be transferred to the INVIT structured as a SPV. This SPV will have pass through status and so Bharti will be in a position to transfer its said assets into the INVIT and issue INVIT units against these assets. Structurally, INVITs are just like REITs with a couple of fundamental differences. Firstly, REITS are used to monetize real estate projects into SPVs and issue units while INVITs essentially are used to monetize infrastructure projects in select sectors like roads, expressways, telecom, power etc. Secondly, REITs are structured more like equity participation instruments but INVITs are normally structured to be fixed return instruments. This makes INVITs more attractive to institutional investors. Incidentally, Reliance Jio has already managed to transfer all its optic fiber assets into a separate SPV and has issued INVIT units against them.

Creates a war chest for Bharti

Bharti plans to raise nearly $2 billion by monetizing these optic fiber assets and that gives Bharti the necessary fire power to take on the pricing and data challenges posed by Reliance Jio. With $2 billion in its kitty, Bharti has a good enough war chest to take on the Jio competition for another few years. This is also ensures that the risk of the volatile telecom business gets partly hived to other investors and reduces the risk in the books of Bharti.

Makes Bharti asset-light

What happens in the process is that assets go out of the balance sheet and into the INVIT. This helps Bharti to become more of an asset-light business and in the process it also improves the ROE. Improved ROE means better P/E valuations and that will be another stock currency for Bharti Airtel.

Focus on service aspects

The biggest advantage of this move is that the focus of Bharti shifts more towards managing the service than the assets. It is here that telecom companies can create a differentiator by laying much greater emphasis on the quality and breadth of service provided. The old model was too asset heavy and hence services suffered. In the process is also creates an investment class that could attract institutional interest!

Slowdown Blues

Economic slowdown is beginning to show and it is time to act

Even when the June quarter GDP came in at just 5%, most policy makers were refusing to acknowledge that it was an economic slowdown. Actually, it is time to admit there is a distinct economic slowdown and take quick measures. We are lucky to be at the start of the slow down cycle and need to act fast before its hits jobs and income levels.

Signs are everywhere

The signs of an economic slowdown are almost everywhere. Auto numbers are down nearly 30% on a YOY basis and auto companies are being forced to cut production days to balance demand. Most economic slowdowns begin with a financial tightness and that is visible from banks to NBFCs. Another way is to look at rising instance of defaults in loan repayments, which is normally a clear lead indicator of an economic slowdown. We had IL&FS, Dewan Housing, Cox & Kings, Suzlon, RCOM and now Altico. Each of these cases highlight that payment cycles are stretched to such an extent that managing asset liability mis-matches is getting tougher by the day. No less a person than the CFO of Parle has warned about the huge layoffs that may be necessitated due to weak demand. Even other FMCG companies like Britannia and Marico have warned that slowdown is beginning to pinch. Aviation growth is sharply down and the biggest manifestation came in the form of the GDP at 5%. Rural inflation is also an eloquent reminder of a slowdown.

Monetary measures needed

The government needs to bundle a bunch of monetary measures quickly so that the early signs of slowdown do not exacerbate into something big. The first thing required is to embark upon big cuts in repo rates. Forget about all else, the real interest rates in India at above 4.25% are among the highest in the world. The government has to infuse a lot more capital into banks to make them capable of lending; otherwise output is not going to pick up in a hurry. The next step is to make liquidity easily available to the stressed sectors like NBFCs, realty segment, auto dealers, auto ancillaries etc. These are sectors where an infusion of easy liquidity will show immediate results. Low rates and abundant liquidity are the answers.

Fiscal push too

Fiscal measures alone won’t suffice. India will have to give up its obsession with FRBM and adopt pump priming as a conscious strategy. This includes major spending outlays on projects for infrastructure, more of helicopter money payouts and aggressive tax cuts. If GST cuts and income tax
rebates can spur spending, then it is absolutely worth the risk. After all, once the slowdown is allowed
 to fester, it starts to hit jobs and spending. That has already begun and it is essential to act fast. As
spending returns, it will automatically solve the slowdown challenge!

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