By Chad Karnes
Gold and silver have been all over the map in 2014. Through February, they were both up over 10% and outperforming stocks. Since then, they have given back all of their gains.
To figure out what’s next for the metals we need to recognize their deep and long term status as speculative assets and the relationship between the two metals.
Sentiment and Technicals Suggest a Coming Bounce
If you followed our research at the turn of the year, you saw us turn bullish the metals and capture their turnaround into the spring as our “Why We Were Bullish on Gold When Everyone Else Was Bearish” video outlines below where we netted our subscribers a 60% return in one of our trades.
One of the reasons we were bullish on precious metals in early 2014 was because of the prevailing sentiment in the metals. Frankly, investors were panicking then as gold and silver were the worst performing asset class falling over 30% in 2013. Long time bulls were throwing in the towel, and speculators had jumped on the bearish metals trend to a point rarely seen. That was a recipe for a short squeeze. Are we setting up for a similar short term rally again today?
As was stated in our 6/4/2014 Technical Forecast, “Gold is also now oversold, the first time that has happened on the precious metal and its ETF since the June 2013 $1200 (GLD $115) price low panic”. The following day gold and silver were up 1% as their next bounce likely kicked off.
Should we expect this bounce to hold?
The Gold/Silver Relationship
To understand the prevailing price drivers of the metals we turn to their historical relationship with one another.
It is pretty much understood that silver is the more volatile of the metals, the one traders turn to for more speculative interests. The fact that silver has the more popular leveraged ETFs than gold (NASDAQ:UGLD) such as the ProShares Ultra (NYSEARCA:AGQ) and the VelocityShares 3x (NASDAQ:USLV) helps support this fact.
However, to really accept that silver is the more volatile and speculative play, we turn to a chart comparing its historical relationship with gold.
The first chart below shows the long term relationship between silver and gold and that gold generally outperforms silver during the times the precious metals are moving sideways in price or declining, such as the last three years.
Silver is the greater benefactor during the precious metals’ rallies, outperforming gold significantly during such times as the chart also shows.
But, there is a bigger picture theme here.
Gold and Silver – Long or Short?
The chart above shows when gold is outperforming silver (shown in the shaded blue areas and when the ratio is rising/flat), the metals markets are typically flat or in decline, or at a minimum susceptible to a pullback (as was the case in the 2007 precious metals rally which ultimately gave back all those gains in 2008).
The next chart displays this relationship over the short term. Since the 2011 precious metals’s top, gold has continued to outperform silver with a few short term opportunities to get long the metals before the next leg of their decline.
The short term metals rally in mid-2013 occurred as the gold:silver ratio broke down from its trend channel shown in red on the middle of the chart (after almost a year, silver finally started to outperform gold in 2013 as the gold:silver ratio fell).
A similar occurrence happened during the early 2014 metals rally, helping us get subscribers long the metals as the ratio also turned down as sentiment reached extremes. These were just short term opportunities though as the longer term gold to silver ratio continues higher and warns us of a continued decline in the metals’ markets.
So far in 2014 silver has underperformed gold by 6%, staying true to form and warning that the overall metals trend remains sideways to down.
Until silver can start outperforming gold on a weekly and monthly basis (the first chart's ratio turns down), investors should not expect any longer term precious metals rally to take hold.
In the meantime investors should expect only short term long opportunities available to the gold bugs (NYSEARCA:GDXJ), like the one we are expecting now as this ratio breaks down from its short term trend.
But, until the gold to silver ratio turns down and silver again starts to outperform over the longer term, it is unlikely the precious metals have formed a major bottom.
The ETF Profit Strategy Newsletter and supporting publications provide investors actionable trading and investing opportunities utilizing technical, sentiment, and fundamental analysis sprinkled in with some common sense. Gold Bugs likely will remain disappointed until the gold to silver ratio turns decidedly down and silver can finally start to outperform gold, helping us recognize a precious metals rally that has legs.