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Silver Outperforms Gold, So Should I Sell My Metals or Buy More?

Commodities / Gold & Silver 2009 Aug 16, 2009 - 12:03 PM GMT

By: Przemyslaw_Radomski

Commodities

Best Financial Markets Analysis ArticleLegendary investor Jim Rogers says he can't wait for the International Monetary Fund to sell some of its gold holdings. Should that cause the price of gold to dip, Rogers says he will buy some more.

In fact, Rogers says he buys gold whenever he thinks about it.


"If it goes down I'll buy some more, and if it goes up I'll buy some more," Rogers said in a CNBC interview. "I periodically buy some gold. I don't have a method to it. I just buy it."

The IMF is the world's third largest owner of gold reserves. The number one holder of gold is the United States, followed by Deutsche Bundesbank.

In last week's essay I discussed the new Central Bank Gold Agreement signed recently by 18 countries limiting the amount of gold they can sell each year. They agreed to sell no more than a combined 400 metric tons of the yellow metal each year through September 2014. The agreements were originally introduced to give the gold market stability in the knowledge that sales by central bank would take place in a regulated framework removing the wild card that gold would get dumped ad hoc on the market.

But that still leaves the IMF, which is not a signatory. The U.S. Congress passed legislation in June which allows the American representative to the IMF to agree to the planned sale of some 400 metric tons of gold to finance aid to poor countries. (The IMF holds 3,217 metric tons.)

Last week I reported that the signatories to the agreement sold 73 per cent less gold in the first six months of the year when compared to the previous year. It was the lowest level since 1944 - definitely a bullish sign.

I think the market has already discounted the planned IMF sale and that it won't cause any disruption to prices. It is completely possible that one of the other countries, China, for example, eager to beef up its reserves, might snap up the entire amount as they have already indicated that they would like to do.

Getting back to Jim Rogers, he said he buys gold whenever he thinks of it. However, we are much smaller investors and need to time our trades with more caution. Therefore, let's turn to the charts for some clues.

Silver

Recently, relative to gold, silver has been acting very strongly. Gold is more or less where it was a month ago, whereas silver is about $1 higher. Since previously I have said that silver tends to outperform gold during the final stages of an upleg, this recent tendency might cause some nervousness. Before I move on to the silver-to-gold ratio analysis let's take a second look at the silver chart.

Besides silver's recent out-performance, and the fact that the $14 level has turned from resistance into a support level, there is one more thing to consider.

I'm referring to the bottom/top cycles present since the beginning of 2009. I have marked them on the chart with red vertical lines. My research shows that every time this particular period passed, silver either put, or was close to putting, a bottom or a top. This signal is not precise as far as the exact day/price is concerned, but it is reliable in indicating the general tendency

Please note that according to these cycles we are close to the "bottom" vertical line, and are still in the early part of a bigger upswing. This would imply that we can expect higher prices.

Yes, the Stochastic Indicator is at the overbought territory, but it has been more useful in estimating bottoms than calling tops. As far as RSI is concerned, silver is not at the overbought territory. It is close to it, but the same levels (as today) have not meant a top in the past - i.e. the beginning of February and early May 2009.

Silver / Gold Ratio

As I mentioned earlier, silver's recent strong performance relative to gold could cause worry since in the past this has often happened during the final stage of a rally, and thus would indicate lower prices ahead. Still, this time, the visible rally in the silver-to-gold ratio is already behind us.

If you take look at the ROC indicator and the levels it achieved prior to a sell-off, you'll notice that we are currently much below that level. (The Rate of Change momentum indicator informs us how much the price of a given security changes in a given period.)

The reason I include the ROC indicator here is that its construction allows us to isolate really rapid, meaningful moves from the steady, slow ones. In this case, the ROC tells us that the recent out-performance of silver is not really bearish.

For more information about what might be causing the disparity in the performance of the two precious metals, we will need to take a look at the precious metals correlation matrix

Precious Metals Correlations

Although not much has changed in the 30-day column (which is statistically significant), the past two weeks (10-trading-days column) were indeed characterized by only moderate correlation between gold and silver (barely 0.09).

Further analysis reveals that gold and gold stocks have been driven by moves in the USD Index (-0.84 and -0.86 correlation coefficients respectively), whereas silver has been rather independent from the dollar (0.18). On the other hand, the correlation between gold (and gold stocks) and the general stock market has been very weak while silver has been trading a little more in tune with it.

Thus, this week's price disparity could be explained by the fact that gold followed the USD, while silver (to a small extent) followed stocks. Historically (1500-trading-day column), silver is much more highly correlated with stocks, than gold (0.43 and 0.09 respectively). Keep in mind that gold's little brother has many industrial uses.

Summary

The technical situation in the gold and silver markets is still positive. However, two key drivers of PM prices are now vulnerable to a strong move in either direction. The odds favor the continuation of the previous down trend in the U.S. Dollar, but this is not a sure thing. A move higher in the main stock indices has recently become more probable as they have managed to stay above the critical support level. They have been moving sideways, taking a breather, and making the continuation of the previous rally more probable.

Getting back to the question raised in the topic of this essay - long-term favorable fundamentals have not changed, so there is no need to sell your long-term holdings. On the other hand, if you are trading precious metals, you will need to remain cautious in the coming days, and wait for a significant breakout in either direction. In this case subscribing to a professional support service seems to be a good way to go.

To make sure that you get immediate access to my thoughts on the market, including information not available publicly, I urge you to sign up for my free e-mail list Sign up today and you'll also get free, 7-day access to the Premium Sections on my website, including valuable tools and charts dedicated to serious PM Investors and Speculators. It's free and you may unsubscribe at any time. Additionally, if you considered subscribing to the Premium Service in the past, but didn’t want to use monthly subscription type, we have good news for you – we have just introduced 90-day and yearly subscriptions, which are available at a discount.

    P. Radomski
    Editor
    Sunshine Profits

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    All essays, research and information found above represent analyses and opinions of Mr. Radomski and Sunshine Profits' associates only. As such, it may prove wrong and be a subject to change without notice. Opinions and analyses were based on data available to authors of respective essays at the time of writing. Although the information provided above is based on careful research and sources that are believed to be accurate, Mr. Radomski and his associates do not guarantee the accuracy or thoroughness of the data or information reported. The opinions published above belong to Mr. Radomski or respective associates and are neither an offer nor a recommendation to purchase or sell securities. Mr. Radomski is not a Registered Securities Advisor. Mr. Radomski does not recommend services, products, business or investment in any company mentioned in any of his essays or reports. Materials published above have been prepared for your private use and their sole purpose is to educate readers about various investments.

    By reading Mr. Radomski's essays or reports you fully agree that he will not be held responsible or liable for any decisions you make regarding any information provided in these essays or reports. Investing, trading and speculation in any financial markets may involve high risk of loss. We strongly advise that you consult a certified investment advisor and we encourage you to do your own research before making any investment decision. Mr. Radomski, Sunshine Profits' employees and affiliates as well as members of their families may have a short or long position in any securities, including those mentioned in any of the reports or essays, and may make additional purchases and/or sales of those securities without notice.

Przemyslaw RadomskiArchive

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