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What Lessons Can PMs Take from Silver Now?

July 29, 2019, 8:17 AM Przemysław Radomski , CFA

Briefly: in our opinion, full (250% of the regular size of the position) speculative short position in gold, silver, and mining stocks is justified from the risk/reward perspective at the moment of publishing this Alert.

Friday's session didn't bring much of easily noticeable action in the precious metals. While the day-to-day picture remains calm, the mining stocks' move has brought us direct short-term implications. Also, we'll examine the message both the gold-to-silver ratio and silver are sending us. Let's get right into it.

We'll start today's analysis with a quick look at the daily changes.

The Very Short-term in PMs

Very little happened in gold and silver on Friday, but that didn't prevent gold miners from declining visibly below the recent lows and - most importantly - the rising support line. To be clear, we had already seen a small breakdown below the rising support line in the HUI Index on Thursday, but it was too small to be viewed as significant. However, we now saw the breakdown clearly and it took place in terms of the weekly closing prices. This means that the implications are bearish for the short term.

To be clear, this is not the first or early sign of the reversal - there were quite a few indications previously, including gold's inability to hold the breakout above the pennant pattern, huge volume readings in silver and silver stocks, as well as silver's outperformance in general.

There is much more to the performance of gold and silver than meets the eye. There are important medium-term implications of the performance of their ratio, and there are major short-term indications from their quick day-to-day moves.

Let's start with the former.

The Many Views of the Gold to Silver Ratio

The gold to silver ratio had soared recently and it corrected its huge upswing in the last couple of weeks. How should one interpret this decline? The interpretation relates to the support and resistance levels that we have on the above chart. One thing is that the breakout above the rising red resistance line was invalidated, which is bearish for the ratio. However, the ratio didn't move below its 2008 high nor the rising long-term support line that we marked with blue. This means that the breakout above the previous highs was not invalidated and that the uptrend remains intact. This - combined with the rising support line remaining unbroken - means that the trend remains up, despite the invalidation of the breakout above the rising red line. The latter is simply not as important as the combination of two other - just as strong - long-term levels. It's a simple trading rule that the greater number of equally or more important signals or support/resistance lines, the more important the outlook confirmation.

Please note that it was the first time that the red resistance line was broken, so its strength is only theoretical. The rising blue support line is something that already worked multiple times, so its strength is already proven. All in all, the trend remains up and the implications for the precious metals market remain bearish, because the ratio tends to move in the opposite way to the individual PM prices.

Having said that, let's take a look at the implications of the short-term price movement.

The above chart appears very different from the previous gold silver ratio so we'll explain. The above chart simply provides a different (mirror) perspective on the ratio as it divides silver price by gold price. It's just a cosmetic change that doesn't really impact the data in a direct way. We like to look at the key ratios from all angles to make sure that we don't miss anything important - even though the dataset is the same, sometimes it might be easier to spot something in an uptrend and sometimes in a downtrend. As far as the ratio itself is concerned, we see that it moved below the previous low and now it moved back up without invalidating the breakdown. This is in tune with the implications described below the previous chart. What is new on the above chart, are the positions of indicators (note: they are both based on the ratio, so they are silver to gold ratio indicators, not simply gold indicators).

The indicator in the upper part of the above chart is RSI and the important thing about it is that it was just above 70 and now it moved back below it. It doesn't seem like a big deal at first sight, but it becomes a critical development once one examines what happened in practically all previous cases. These were almost all major tops and the very few exceptions were either close to major tops (early 2014) or a major top in silver but not that significant one in gold (early 2019). With this kind of performance (almost throughout!) seeing this signal right now is extremely bearish.

But wait, there's more. Not all silver rallies are equal. In some of them, silver is moving higher relative to gold in a rather slow manner, and sometimes silver shoots up with a dramatic (and usually fake) scream. The latter kind of performance is more meaningful as it indicates more emotionality in the market. And whenever emotionality gets extreme, a price extreme also forms. The more emotionality we see, the more profound the price extreme usually is. That's the theory. What about practical implications for predicting silver prices?

The Rate of Change indicator measures the sharpness of a given move and we applied it to the ratio to detect exceptionally sharp rallies. As it turns out, there were only several cases when the rally was as sharp as it was been recently. Since the 2011 top in gold (which was also accompanied by silver-to-gold ratio's sharp rally) we saw five similar cases. They all confirmed tops in the ratio and painted a bearish outlook for gold. Four of them were the final tops and the one case that was exception from this rule was actually a relatively important top anyway (and it was not too far from the final top either).

These cases are: two 2012 tops, the 2013 top, and two 2016 tops (including the final top). These were indeed major tops and given their prominence, the odds are that a top of similar importance has just formed as well.

The analogy to the late-2012 top is particularly important because of what we wrote about it on Thursday:

There is actually much more to the silver story than just a breakout above the recent highs. In fact, the breakout itself is not that important. What is important, is the resistance that was just reached and how it relates to what we saw in the past.

By "resistance" we actually mean two resistance levels. One is created based on the line that's parallel to the rising support line created by connecting the 2018 and 2019 bottoms. Copying this line and moving it higher so that it touches the early 2019 high creates the upper border of the rising trend channel. This is silver's second move higher and the "C" part of a rising ABC correction pattern (the late-2018 - early-2019 rally was the "A" part of the move and the subsequent decline was "B"). The ABC corrections (a.k.a. zigzags) are relatively common corrective patterns that don't change the preceding trend. In this case, the trend was down.

We can speak of the big downtrend that started in 2011, or we can speak of the more medium-term downtrend that started in 2016 - either way, the corrective ABC pattern seems to have already run its course as silver moved to the upper border of the trend channel.

There is also additional reason for silver to turn south from the current price levels that's even more important. Taking the 2016 top as the starting price for the decline and using the 2018 bottom as the final (so far) bottom, we get $16.70 as the 38.2% Fibonacci retracement. This is a good reason on its own for silver to turn around, especially if we also consider the fact that silver moved to the above-mentioned upper border of the trade channel.

The extremely bearish outlook comes from something else, though. There are many things that emphasize that the outlook is extremely bearish (such as the recent volume readings in silver and silver stocks), but with regard to the price level that was reached yesterday, there is one more very important detail that most investors will likely miss.

The entire 2016 - now situation and the 2011 - late-2012 price movement are very similar.

In both cases there were actually four bottoms at very similar price levels that preceded the final upswing and the first one of them was very sharp (late 2011 and mid-2017). The timing between the following bottoms was different, but there are two major similarities that just can't be ignored or left unmentioned.

The first thing is that all major tops were lower than the previous ones. The only outlier is the early-2019 top, which - as it turned out - wasn't the final top for the rally, so overall it seems that the analogy remains intact.

The second thing is that the top (the one in early 2012) that preceded the final top of the consolidation is extremely similar to the mid-2018 one and this an extremely useful roadmap sign that tells us where silver is in light of the entire analogy.

The key thing is that the final pre-slide (late-2012) top formed at the 38.2% Fibonacci retracement level based on the preceding decline. The early 2012 top formed slightly below the 50% retracement (intraday high) and the weekly close was a bit below the 38.2% retracement. The mid-2018 top (analogous to the late-2012 one) also formed a bit below the 50% retracement and the weekly close of that top was a bit below the 38.2% retracement.

This means that if the analogy remains intact, silver should top at the 38.2% retracement right now, which is at $16.70. And what was silver's high yesterday? $16.68 - almost exactly the level of the retracement. This price level is today's pre-market high based on and prices.

The top that was just reached is likely much more important than it seems based on just today's intraday chart.

Given what we're seeing in the gold to silver ratio and the silver to gold ratio charts, the above-described analogy becomes even more important. This also means that the follow-up action is even more likely to be similar. This, in turn, makes the very bearish outlook for silver, extremely bearish.

Before summarizing, let's take a look at the little-known very long-term silver cycles.

Silver: the Very Long-Term

The white metal tends to form an important price extreme about every two years. In the last two cases, silver formed local tops before declining at least in the short run. In the last case, in 2017, the top that silver reached was never exceeded up to this day. This very long-term cycle is playing our right now. Given the huge-volume signs, silver's outperformance and all the other silver-related signs that we discussed today, it seems that this cycle can be used as a confirmation of all these bearish indications. The outlook is indeed extremely bearish right now.

Please note that the above chart also includes upside targets for silver. It's not a mistake - we do think that silver will reach those levels and probably exceed them. However, it is unlikely to do so before declining profoundly first. The current situation can be somewhat similar to what we saw in 2008, before the decline. Silver did move much higher in the next few years, but it didn't do so before plunging in a volatile manner first.


Summing up, the breakdown in the gold stocks and the multiple signals coming from the silver market clearly confirm that the rally in the precious metals sector has most likely already ran its course. Moreover, let's keep in mind that gold has recently invalidated its breakout above the previous highs, the late-2013 highs, and the upper border of the pennant pattern, which is also a very strong bearish sign. The situation in the currency market confirms the bearish outlook for the PMs. In those circumstances, we simply cannot predict higher gold price in the medium term. There will most likely be times when gold is trading well above the 2011 highs, but they are unlikely to be seen without being preceded by a sharp drop first.

As always, we'll keep you - our subscribers - informed.

To summarize:

Trading capital (supplementary part of the portfolio; our opinion): Full short position (250% of the full position) in gold, silver, and mining stocks are justified from the risk/reward perspective with the following stop-loss orders and exit profit-take price levels:

  • Gold: profit-take exit price: $1,241; stop-loss: $1,468; initial target price for the DGLD ETN: $51.87; stop-loss for the DGLD ETN $30.27
  • Silver: profit-take exit price: $13.81; stop-loss: $16.73; initial target price for the DSLV ETN: $39.08; stop-loss for the DSLV ETN $22.87
  • Mining stocks (price levels for the GDX ETF): profit-take exit price: $17.61; stop-loss: $29.27; initial target price for the DUST ETF: $32.28; stop-loss for the DUST ETF $6.88

In case one wants to bet on junior mining stocks' prices (we do not suggest doing so - we think senior mining stocks are more predictable in the case of short-term trades - if one wants to do it anyway, we provide the details), here are the stop-loss details and target prices:

  • GDXJ ETF: profit-take exit price: $23.71; stop-loss: $43.47
  • JDST ETF: profit-take exit price: $73.32 stop-loss: $13.87

Long-term capital (core part of the portfolio; our opinion): No positions (in other words: cash)

Insurance capital (core part of the portfolio; our opinion): Full position

Whether you already subscribed or not, we encourage you to find out how to make the most of our alerts and read our replies to the most common alert-and-gold-trading-related-questions.

Please note that the in the trading section we describe the situation for the day that the alert is posted. In other words, it we are writing about a speculative position, it means that it is up-to-date on the day it was posted. We are also featuring the initial target prices, so that you can decide whether keeping a position on a given day is something that is in tune with your approach (some moves are too small for medium-term traders and some might appear too big for day-traders).

Plus, you might want to read why our stop-loss orders are usually relatively far from the current price.

Please note that a full position doesn't mean using all of the capital for a given trade. You will find details on our thoughts on gold portfolio structuring in the Key Insights section on our website.

As a reminder - "initial target price" means exactly that - an "initial" one, it's not a price level at which we suggest closing positions. If this becomes the case (like it did in the previous trade) we will refer to these levels as levels of exit orders (exactly as we've done previously). Stop-loss levels, however, are naturally not "initial", but something that, in our opinion, might be entered as an order.

Since it is impossible to synchronize target prices and stop-loss levels for all the ETFs and ETNs with the main markets that we provide these levels for (gold, silver and mining stocks - the GDX ETF), the stop-loss levels and target prices for other ETNs and ETF (among other: UGLD, DGLD, USLV, DSLV, NUGT, DUST, JNUG, JDST) are provided as supplementary, and not as "final". This means that if a stop-loss or a target level is reached for any of the "additional instruments" (DGLD for instance), but not for the "main instrument" (gold in this case), we will view positions in both gold and DGLD as still open and the stop-loss for DGLD would have to be moved lower. On the other hand, if gold moves to a stop-loss level but DGLD doesn't, then we will view both positions (in gold and DGLD) as closed. In other words, since it's not possible to be 100% certain that each related instrument moves to a given level when the underlying instrument does, we can't provide levels that would be binding. The levels that we do provide are our best estimate of the levels that will correspond to the levels in the underlying assets, but it will be the underlying assets that one will need to focus on regarding the signs pointing to closing a given position or keeping it open. We might adjust the levels in the "additional instruments" without adjusting the levels in the "main instruments", which will simply mean that we have improved our estimation of these levels, not that we changed our outlook on the markets. We are already working on a tool that would update these levels on a daily basis for the most popular ETFs, ETNs and individual mining stocks.

Our preferred ways to invest in and to trade gold along with the reasoning can be found in the how to buy gold section. Additionally, our preferred ETFs and ETNs can be found in our Gold & Silver ETF Ranking.

As a reminder, Gold & Silver Trading Alerts are posted before or on each trading day (we usually post them before the opening bell, but we don't promise doing that each day). If there's anything urgent, we will send you an additional small alert before posting the main one.

Thank you.

Przemyslaw Radomski, CFA
Editor-in-chief, Gold & Silver Fund Manager

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