Is the metals correction over? RAM suggests so

Precious metals prices have declined substantially in recent months. But speculators now appear to be largely out of the market. That's a strong indication that the correction is probably over.

Back in January I presented some evidence of dangerously high speculative interest in metals, in particular silver. Sure enough, a large correction began shortly thereafter and has continued, if in less spectacular fashion, in recent weeks.

My strongest evidence was my proprietary measure of “risk-adjusted margin” or RAM. Here is a brief explanation from my January post as to why RAM is such a useful metric for estimating the level of purely speculative, rather than commercial activity:

There is another way, however, to try and estimate the degree to which certain commodity price increases are being driven by speculation rather than commercial supply and demand. This is to look at the “cost” of speculating, as measured by the amount of margin (or collateral) that the speculator must put up on the exchange in order to open a position in a given commodity futures contract. The less it costs to speculate, so the thinking goes, the more potential for speculation.

RAM goes one step further than simply look at exchange margin requirements, however, as it adjusts the margin for the implied volatility of the commodity in question, as observed in the options markets.

Here is a table of a selection of major commodities contracts, their values and margin requirements at present:

Based on the numbers above, the apparent up-front “cost” of speculating in soyabeans is currently very low, whereas that of speculating in crude oil is high. But crude oil prices are normally much more volatile than soyabeans.

Looking at the metals, it currently appears to be much less “costly” to speculate in gold than in silver. But that can be misleading too, as silver tends to be 2-3 times more volatile than gold.

By taking into account volatilities, RAM provides a much better guide as to which commodities might be attracting speculative interest or not. In the table below I include volatility, risk and RAM:

The “cost” of speculation in risk-adjusted terms changes the picture somewhat. For example, the “cost” of speculating in copper or wheat, say, is currently quite high, rather than moderate.

Silver no longer an outlier

When compared to the situation back in January, the “cost” of speculating in silver has now risen quite dramatically, from 12% to 18% in RAM terms. The “cost” of copper speculation has also risen somewhat, from 20% to 24%, nearly as high as crude oil.

Gold’s RAM has remained more stable, due in large part to its lower volatility, both realised and implied. But given the higher “cost” of speculation today, metals prices generally are more likely to follow underlying supply and demand in the months ahead. In other words, if you believe that the fundamental picture remains supportive—I do—then you should now consider rebuilding positions.

As a further step, consider that mature mining firms—those with proven, extractable resource in the ground—continue to trade, in most cases, at multiples well below historical averages when adjusted for the market prices of the metals. That stands in sharp contrast to the broader stock market, generally trading at a P/E well above the historical average.

My recommendation remains to build a “balanced” portfolio across the metals risk-spectrum: royalty/streaming companies, mature miners, and a handful of more aggressive, growth-oriented firms. That way, you can enjoy the benefits of some diversification, with specific weightings calibrated towards whatever desired risk/return target.

PS — If you’ve yet to visit my other substack, The Daughter of Time, you can do so here.