Silver bugs got quite a shock last week the precious metal fell by nearly a third in just a few days from a recent peak of near-$50 an ounce. Meanwhile, gold also fell but much less dramatically it was down around 5% last week.
But scary though such short term volatility can be and a reminder of why commodities markets are no place for the lily-livered these types of moves can create an opportunity for a particular breed of spread better the pairs trader. Novices beware don't attempt this type of trade until you are very comfortable with single bets. Anyone else read on.
Ever since the sell off, commentators have been scrambling to explain what happened. It's actually pretty simple whilst silver is seen as a poor man's gold and therefore a safe haven in times of economic uncertainty, currency debasement and possible inflation, it's a rather different beast.
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For starters, it has a range of industrial uses that gold simply does not. More importantly, the global market for the metal is much smaller, making prices much more volatile. So when exchange traded funds suddenly dumped silver en masse as investors panicked that the recent commodity boom might have got out of hand, silver was always in for a much bigger pasting than either, say, gold or copper. So how could a canny investor have cashed in?
Well, a few weeks back I explained that a dip in the silver price was imminent. Gold, on the other hand, emerged from last week's commodities rout battered but intact. This is manna to a pairs trader.
That's because, by placing two spread bets, you can make money from the relative position of two assets say, gold and silver even if both fall.
For example, if you think silver will fall faster than gold, sell a silver spread bet and buy gold. If, on the other hand, you now think the silver price will stage a comeback much faster and further than gold, buy a silver spread and sell gold.
Sure, you'll need to back out both trades to take a profit, and you'll need to consider paying for two stop losses should your pairs trade backfire. But at a time when the direction of commodities prices as a whole is uncertain, pairs trades offer a way to make steady gains all the same.
Tim graduated with a history degree from Cambridge University in 1989 and, after a year of travelling, joined the financial services firm Ernst and Young in 1990, qualifying as a chartered accountant in 1994.
He then moved into financial markets training, designing and running a variety of courses at graduate level and beyond for a range of organisations including the Securities and Investment Institute and UBS. He joined MoneyWeek in 2007.
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