For the past 20 years, the gold-to-silver ratio has been a great indicator of when to invest in emerging markets. The last 3 times it moved above 80, and then began to decline, emerging markets started rallying, sometimes dramatically.
Source: LPL Research
The gold-to-silver ratio is the price of gold per ounce over the price of silver per ounce, and indicates how many ounces of silver it takes to buy one ounce of gold.
This is an important indicator for the performance of emerging markets because, while gold is purely a precious metal and a store of wealth, silver is a precious metal that also has multiple industrial applications. The performances of emerging markets tend to be positively correlated to the performances of industrial metals, because their economies often rely heavily on the production of goods, due to their low wage costs.
That is, when silver closes the value gap between gold, it is often a sign that conditions for the global economy are improving. When that occurs that often leads to more demand for manufactured goods, which leads to more goods being produced, which is good for emerging economies and the companies within them.
In the last 20 years, when the ratio reached 80, and started to decline, this was a very good indicator that economic conditions in emerging markets were bottoming. The last time this happened was early last year, and since then the Emerging Markets Index has outperformed the S&P 500.
Source: LPL Research
This also coincided with a reversal in earnings and revenue forecasts.
Today, the gold-to-silver ratio is at around 70, which is still a historically high value. Also, it’s important to note that these uptrends last years, and emerging markets have just started to outperform after years of underperformance.
In fact, if we compare emerging markets to other regions on a valuation basis, we see signs of significant undervaluation.
Global Emerging Markets (GEM) are the most undervalued
Source: Wall Street Journal
Forward P/E multiples, for example, are just 12x in emerging markets, compared with 18x in the US and 15.6x here in Australia, which represents a historically high gap.
Therefore, we see emerging markets as an attractive opportunity if investors know where to look.
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The information contained in this article is General in nature and has been prepared without taking into account your objectives, financial situation and needs.