Intermarket Analysis Part 1: Gold, Silver And Miners

 |  Includes: FXY, GDX, GDXJ, GLD, SIL, SLV, TIP
by: Market Scholar

The intermarket outlook I published last week advocated that equities are in the final leg up of the 2009 bull market, and that strength can be expected in the energy sector, notably in oil. A near-term pullback in equities may occur in at any point as stocks are overbought, however until any selling is seen, one must remain bullish. Last week's analysis proved to be quite timely, as it still remains.

While the previous article was very broad, the following articles are much more focused with specific trade ideas included. The intermarket outlook has been broken into three separate articles, each of which focuses on different markets. This article serves as the first of three articles and covers gold, silver, gold miners and silver miners. Article two covers copper, coal, and oil, while article three cover bonds, currencies and equities. There is obviously some overlap in the three articles as all asset classes are related. For example, the CRB, China and the $USD are discussed throughout.

Ratio charts are often used in intermarket analysis as it is one of the most effective ways to examine relative strength in one group compared to another, and accordingly have been used frequently in my work. Put simply, a declining line means that the numerator is underperforming the denominator, and vice versa.

Correlations are also analyzed frequently to determine the strengths of certain relationships in identifying favorable trade setups. Correlations used in my analysis will involve various time periods, from 20 days to 200 weeks. Important signals are often given when correlations cross the zero line - when they go from positive to negative, or vice versa.

The conclusion of all three articles is that commodities, and commodity related equities, could be the best place to be invested in the near future. I would also be looking for opportunities to short bonds.

Gold (NYSEARCA:GLD) was strong last week, and may have put a short term base in. I noted last week that it will likely trade sideways for some time, and that it can still be considered consolidating until a breakout above $1,800 occurs. That being said, it looks like there may have been a near term base established recently. Note the significance of the 1630 region (1625-1650):

  1. Support area March and April 2012
  2. Support became resistance May through August
  3. Once this resistance was broken, a considerable rally ensued
  4. Last month again this level acted as support, coinciding with both trend lines of the consolidation period.

Given the significance of this level, as well as a number of technical indicators not mentioned, I think one must be bullish on gold until $1,625 fails. $1800 will obviously be a key level to get over, and until that happens any longer term investor may be best served waiting on the sidelines.

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It is important to note that gold doesn't trade just as a commodity, it also acts as a currency, as well as an inflation hedge. The chart below illustrates one of these relationships, as an inflation hedge. Note that in 2011 and 2012 Gold and TIPs (NYSEARCA:TIP) (Treasury Inflation-Protected Securities) were almost perfectly positively correlated. Through 2012 however this relationship weakened and gold failed to experience gains that TIPs received. The correlation appears to be returning, and gold could catch up to gains TIPs experienced in 2012.

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One of the signs of a bull market in gold is when it rises in value faster than foreign currencies. The below chart illustrates a few important relationships. There exists a high negative correlation between the performance of gold and the ratio of the Japanese Yen (NYSEARCA:FXY) to gold. Notice however the significant divergence since around November. The Yen to gold ratio has broken support and trended down while gold has also trended downwards. The long term correlation has completely reversed from its natural relationship. Such divergences typically are short lived, and one could expect that the normal relationship returns and accordingly gold reverses up.

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The drop in the Yen to gold ratio can be attributed to the historic selloff in the Yen, as seen in the 8-year chart below.

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There also looks to be support in gold miners (GDX, GDXJ), and after much patience, I personally will be looking for long opportunities in the sector. It has been beaten down continually, and has severely lagged returns experienced in gold.

The below chart illustrates two bullish developments. First, in the upper section, notice that the miners currently are finding support on the upwards trend line that has twice previously acted as support. Second, in the lower section, note that after severely underperforming gold for over a year, relative strength has actually transitioned to miners since the summer of 2012. As evidenced in 2011, relative strength in any sector or asset class tends to persist; gold was the clear outperformer from April 2011 to summer of 2012. However it appears that trend has reversed and that investors will be better served being invested in gold miners rather than gold.

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Silver miners (NYSEARCA:SIL) may actually be the better trade for a miners or precious metal position. Given silver's (NYSEARCA:SLV) industrial application, and recent strength in equities, it could very well make a significant move to the upside. Note in the chart below SIL (black line) is currently resting on support at $22, and has lagged the move up in silver throughout January. The correlation between the miners and silver is extremely strong long term, and has just recently dropped. This could be an excellent opportunity to get long miners.

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While silver is a precious metal, it is also an industrial metal. Gold on the other hand is bought in times of fear or deteriorating economic conditions. A strengthening silver to gold ratio is considered good for the economy, while a weakening ratio is bearish. Note how well the silver to gold ratio tracked movements in the S&P 500 in the chart below.

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Turns in the silver to gold ratio often precede stock market action. Note the extreme selloff in April/May 2011 in this ratio that preceded the equity selloff in summer of 2011. The failure of this ratio to confirm gains in equities in the last year is concerning and must be monitored. A break to the upside in the ratio would confirm equity gains however.

To sum up, gold and silver both look poised to be strong performers in the near future, with gold and silver miners potentially outperforming. Longer term, $1800 will be critical for gold; a close above it would be strong conviction of a renewed uptrend. Failure of the $1630 region however would be bearish, with the next support area coming in around $1530.

Please see articles 2 and 3 for copper, oil, coal, bonds, currencies, equities, and an intermarket summary outlook.

I'd like to thank John Murphy for publishing his recent book "Trading with Intermarket Analysis" where most of these relationships are more thoroughly discussed. I would also suggest to anyone investing in any markets whatsoever to read it. I have no professional relationship with John, and I am simply acknowledging him as his work is the best I have read in all my years of studying and research.

I'd also like to thank Chris Vermeulen at The Technical Traders for sharing thoughts on current market conditions.

Disclosure: I am long ACI, ANR, CLF, HAL, HOV, LOW, NIHD, RDN. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: I may get long JJC and other commodity related stocks this week. I may short airline stocks. I am currently short LNKD. My time frame is typically shorter term, from a couple hours to a couple weeks