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Silver's Underperformance Against Gold

April 26, 2013, 6:55 AM

Based on the April 25th, 2013 Premium Update. Visit our archives for more gold & silver articles.

What happened on Friday, April 12 and Monday, April 15 on gold and silver markets looked like a gigantic earthquake – a drop of about $200 (13%) for the yellow and almost $5 (18%) for the silver metal. There has been a lot of hyperbole going on. We even heard it said that a move of that scale would statistically only be expected “once every 4,776 years.” Going even further, John Kemp of Reuters calculates that, based on a normal distribution (by the way, market returns are not normally distributed), movements like this can be expected once in every 500 million trading days, or two million years. Sounds far-fetched?

There have been plenty of attempts to explain the cause of this enormous plunge. China's economy grew “only” 7.7% in the first quarter, undershooting market expectations for an 8% expansion. China is the world’s second largest buyer of gold. There were concerns that the U.S. stimulus may be cut short since minutes of the Fed released just before the big decline in gold prices showed some officials were interested in ending the QE program this year. Another theory posits that since the new Japanese central bank governor promised to re-inflate the Japanese economy, Japanese government bonds (JGBs) have been on a wild ride. When investors in volatile assets are asked to put up wider margins they often sell assets they are holding. In this case, CME’s decision to raise margins for the entire precious metals sector is another bearish factor for the short term.

While what happened looks disastrous, we don’t think that this means the end of the great, secular bull market in precious metals. Bull markets have a parabolic stage when everyone is in a frenzy to get in and prices go up in a straight line. We have yet to see that spike.

Furthermore, we don’t see any changes in the fundamentals for gold and silver to make us think the bull market is over. There is still large unemployment, ballooning national debt, currency debasement and currency war, eurozone problems, QEs etc. etc. We like gold and silver for the same reasons we have liked them for the past decade.

The fundamentals are intact which ‘forces’ silver to rally in the long run but let us now turn to today’s technical portion to see whether recent events have marked the final bottom in the white metal or rather further declines are to be expected – we’ll start with silver’s long term chart (charts courtesy of http://stockcharts.com).

Long-term Silver price chart

We don’t see the same corrective price action as we saw for gold – the yellow metal rallied for 7 out of last 8 days. Silver prices declined this week, except for a quite substantial move up on Thursday.

Overall, declines simply continue here (there was a small pullback within the 2008 decline as well); gold prices corrected quite a bit and silver did not. If this underperformance continues and gold prices move lower by $100 or so, the implication appears to be that silver will decline sharply to perhaps the $18 level or so. This price level is created by the July local bottom and the declining trend channel (parallel, green lines on the chart above), and the price level where the huge 2010 to 2011 rally began.

Let us now move on to the short-term timeframe.

Short-term SLV ETF price chart - iShares Silver Trust

Here, in the short-term SLV ETF chart, the underperformance of silver is very clearly visible. While there has been some sideways trading, prices have declined overall, and the lack of any real pullback indicates the overall weakness of this market at the present time.

Given Thursday’s close in the SLV ETF at $23.49 (silver at $24.30), we still see no significant change in silver’s performance – its correction is still very small compared to the one seen in gold.

Since silver’s underperformance is such an important issue at this time, we decided to examine it particularly closely, using silver-to-gold ratio.

Silver to Gold ratio chart - SILVER:GOLD

In today’s silver to gold ratio chart, we present a somewhat new view of this ratio. We've discussed the underperformance of silver for some time now so we felt this graphic would be useful. We believe it’s best to plot the rate-of-change indicator (ROC) on this ratio as it does a very good job at measuring sharpness of given moves. The solid line in the chart is the ratio itself with gold’s daily price in the background and represented by the gold line.

The key point here is this: major bottoms used to be preceded by a sharp drop in the silver to gold ratio. We used to see either capitulation of silver investors or artificial sell-offs before the declines were over. Regardless of what the reasons were, it’s something that used to happen before the bottom was truly in. Recently, however, we saw silver’s price decline, but not as sharp as expected relative to gold if a major bottom was forming. In the recent days, we have seen steady underperformance rather than a very sharp drop in the ratio. It looks on the chart like the trend is accelerating, though, sort of like a reversing parabola.

Ideally, we’d like to see a lower rate-of-change indicator, say -10 or -15 at least before stating that the final bottom is in. This indicator barely moved when the precious metals declined heavily earlier this month. The declines seen in 2008 and in the first 2 months of 2010 provide a good example of what the indicator can do. At first, metals declined but silver not as significantly as gold. Only when gold formed a major bottom, did the ratio decline sharply. We would like to see this confirmation also in case of the current decline.

Summing up, silver has been underperforming recently but not as extremely as we would expect during a major bottom. It seems therefore that the final bottom is still ahead of us. Thursday’s move to $24.30 doesn't invalidate the above. This is not the time to give up on this market - it's the time to be particularly focused on it as it is during the volatile times that particular opportunities are created. If you're interested in our target levels for gold and mining stocks as well as detailed plan for getting back on the long side of the market, please join our subscribers.

Thank you for reading. Have a great weekend and profitable week!

Sincerely,
Przemyslaw Radomski, CFA

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Gold Market Overview

In the recent years, the Federal Reserve dropped inflationary bombs on the market and some commentators believed that the US dollar would soon evaporate. It hasn't and, in fact, the USD Index has been moving higher since 2008. Why? How is that possible given all the dollars that have been "printed" since that time? Doesn't the basic law of supply and demand work anymore? In the February 2014 Market Overview we analyze this critical issue and - as always - we discuss the implications for the gold market.

Read more in the latest Market Overview report.

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