The Gold/Silver Trade Is Trying To Tell You Something

Sep. 5.14 | About: SPDR Gold (GLD)

Summary

The last time I profiled the GLD/SLV ratio, I recommended getting long.

Now, with profits being made, I'm recommending traders take profits or flip the trade and get long silver and short gold.

The longer-term trend is very much intact for gold to outperform silver, but over the short term, I think we will see the opposite.

Over the past year and a half or so, I've profiled the gold/silver ratio, as expressed by the SPDR ETFs for gold (NYSEARCA:GLD) and silver (NYSEARCA:SLV), a few times. Each time I felt the ratio was at an inflection point, and anyone who followed my recommendations has made money at a time when investors that simply got long the metals have stagnated or lost money. The last time I highlighted this trade, the ratio was about 6.2; if we look at the chart below, the ratio has once again increased to the 6.6 area. With the last trade working out and gold outperforming silver as predicted, what do we do now?

Click to enlarge

Above is a longer-term chart of the GLD/SLV ratio, and as you can see, the ratio goes through periods of high volatility. Keep in mind that this ratio is simply measuring the performance of gold versus silver, and not the absolute performance of either metal. The metals themselves could skyrocket or plummet, but the ratio would only show one's outperformance relative to the other. This is the reason I prefer this trade instead of simply owning the metals; there is no way to predict the price of gold or silver, because they have no earnings or dividend or any other way to value them. You've got to value them against something else like the stock market, each other or some other metric. In this way, we can cut through the haze of trying to value gold or silver, and make an educated guess as to where the pair will go and make some money.

Each time I've profiled this trade, I have had the recommendation to go long gold against a short silver position. The reason is clear; each time I've written about this pair, the trade had set itself up nicely for gold to outperform silver, and thus, I recommended getting long the GLD/SLV trade. As I said in the open, the most recent recommendation saw the ratio rise from 6.2 to the current 6.6, making traders some money in the process. I also said in my most recent article that if the ratio reached 6.6 to 6.7, it was time to look at taking some profits. We are there, so what do we do now?

In short, I'd recommend taking some profits right now; and for the bold, you can consider flipping the trade and getting long SLV and short GLD. If we take a look at the longer-term chart above, we can see 6.6 is the level where this trade has made a top before, and I don't see any reason it won't happen again. The trade has worked beautifully, but I think it's time to ring the register.

In the shorter term, if you want to flip the trade, I'd have a target of 6.3 on the GLD/SLV ratio. If you notice, the ratio keeps making higher lows each time it retraces, and once again, I don't see any reason that won't continue. I see a wedge pattern forming in this ratio, and thus, I think the low will be higher than the ~6.2 we saw last time before the uptrend resumes.

The longer-term trend is still very much intact here, so I like the GLD/SLV long trade from a longer-term perspective. However, I think we are set to see silver outperform gold in the short term, so I'd at least get out of this trade or flip it for a short-term swing. With the longer-term trend still intact, I think eventually the ratio will break out of its wedge that is forming and move higher. We're not there yet, but if it plays out, we could see the ratio run up to 7, perhaps sometime early next year. The stage is set for this ratio trade to continue to perform well, but please take some profits if you took my earlier recommendation; and for those more enterprising traders, consider flipping the ratio trade for a short-term swing down.

Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.