VOLATILITY SPIKES FOR GOLD AND SILVER / THE FINANCIAL TIMES ( HIGHLY RECOMMENDED READING )

Note from the editor

Volatility spikes for gold and silver

By Jack Farchy in London

It’s hard not to feel sorry for Odyssey Marine. The company just announced it had found a shipwreck containing 7m ounces of silver – having seen the value of its hoard drop $95m, or 34 per cent, in three days.


Odyssey Marine is just one victim – and probably not the worst affected – of the huge volatility that has struck precious metals markets in the last few days.


The jump in volatility is a big warning sign to gold and silver bugs: it is this, rather than simple price falls, that is most likely to scare investors away from the precious metals.


And volatility has risen dramatically. Historical volatility – a measure of the wildness of price movements – and implied volatility – the cost of options, a measure of the market’s expectations for future price swings – have both spiked to their highest since 2008 or early 2009 for gold. Silver volatility has also jumped, though by some measures it remains below the levels of May this year.


Why does this matter? For a start, rising volatility has been a reliable predictor of previous corrections in the gold price.


In its decade-long bull market, gold has only twice fallen more than 20 per cent price from peak to trough: in 2006 and in 2008. Both peaks were preceded by a sharp run up in implied volatility. Indeed, 2006 and 2008 were the only times in the last decade that one week at-the-money gold vol has traded above 40, according to Bloomberg.


Now gold implied volatility has reached those extreme levels once again. And the fall from the peak of $1,920 earlier this month to Monday’s low of $1,534.49 is just over 20 per cent.


The rather gloomy history lesson (for gold bulls at least) is that it took about 1.5 years from the peaks in 2006 and 2008 for the yellow metal to regain its former highs.


Volatility is so damaging to the gold market (and by extension the silver market – although punters there are girded for a fairly stomach-churning ride) for two reasons.


First, it is a sign of uncertainty. When gold can move $100 in a day, only to move $100 back in the other direction, it is baffling and worrying for investors. When the cost of options spikes, it suggest traders are expecting more of the same.


Second, volatility raises the cost of trading. It does so directly, by triggering increases in margin calls, as happened this week in gold and silver. But it also makes trading and holding the precious metals less attractive, since it makes the risk models of banks and funds rank them as riskier assets.


Thus, even if traders and investors remain bullish – and without doubt, they do – volatility can still hobble the gold rally.


Of course, high volatility runs in both directions. After its 35 per cent collapse to a low point on Monday morning, silver rallied some 28 per cent in a little over 24 hours.


By the time they have rescued it from the sea, Odyssey Marine might find their treasure trove has regained its former value.