"Hit 'em where they ain't." This quote from old-time batting champ and Hall-of-Famer Willie Keeler was the inspiration for our Big Move Trade Alert, "Silver Could Surprise Soon," back in January. Silver has surprised everyone by rallying 42.5 percent since then. Is it too late to buy it now? The answer depends on whether or not the current negative interest rate environment continues. We believe it will - at least until the American presidential election and perhaps as long as it takes Britain to complete its "Brexit."
Silver and gold pay no interest and generate no return. Holding physical gold and silver actually costs money in terms of storage, insurance, etc. In a "normal" interest rate market, investments in traditionally "safe" assets like government bonds pay interest, making them a preferred alternative to precious metals for stashing "safe" money. But this is not a normal interest rate market.
Central banks are buying government securities by the bucketful, driving up their prices and pushing down yields. They are forcing investors to pay for the privilege of lending money to governments. It now costs money to lend funds to Germany, Switzerland and Japan for ten years or less. Other nations are within a few basis points of going negative as well. Gold and silver start to look pretty good when compared to guaranteed losses in government bond investments.
As we noted in our January Alert, "Negative rates send a signal that things are bad and could, in fact, get worse. Safety quickly becomes something that investors are actually willing to pay for -- defeating the whole purpose of negative rates in the first place and forcing central banks to make them even more negative to achieve the desired effect."
By artificially suppressing interest rates, central banks have created a negative feedback loop in which, the stimulative power of lower interest rates is sharply reduced or non-existent. Instead of juicing the economy, lower rates reduce expectations, leading to stagnant growth and even lower rates as central banks futilely "push on a string."
Silver Tends to Outperform Gold in Bull Markets
Silver is known as "the poor man's gold" because it is cheaper than gold. Silver nearly always outperforms its yellow cousin in precious metal bull markets. Smaller traders that can't afford to buy gold, buy silver instead. Silver tends not to be as liquid as gold which means moves can be exaggerated, making silver far more volatile. We expected silver to outperform gold when we issued our January long silver recommendation. This has played out in spades since.
The gold/silver ratio spread tracks how many ounces of silver it takes to buy one ounce of gold. Charting this spread lets us see the relative value of silver to gold over time. This is what it looked like when we issued our bullish recommendation last January.
Date Source: Futuresource / E-Signal
It took roughly 78 ounces of silver to buy one ounce of gold, which meant silver was about as undervalued in relation to gold as it had been since 1995. It now takes only 66.5 ounces of silver to buy one ounce of gold. Silver's higher intrinsic volatility is working in favor of the bulls right now. This is creating a positive feedback loop in which higher prices lead to more buying and higher prices. A declining gold/silver ratio is bullish for precious metals in general and especially bullish for silver.
This is what the spread looks like now:
The spread has narrowed dramatically. Silver has gained substantially on gold in the past six months, confirming the strength of current precious metals bull market. We believe there is plenty of room for silver to gain even more ground. As the chart indicates, past declines in the gold/silver ratio spread have extended as low as 32 ounces of silver to one ounce of gold. Trend changes in this spread tend to be long-lasting, so it wouldn't surprise us to see a ratio of 55 to 1 -- or even 45 to 1 before all is said and done.
Let's say gold stays right where it is ($1,335 per ounce as we write this) and the gold/silver ratio drops another 10 points to 55, which right in the middle of the spread's long-term trading range. 55 divided by $1,335 equals a silver price of $24.27 per ounce. A drop to the lower end of this range at 45 per ounce of gold would make silver worth $29.66 per ounce with no help whatsoever from gold.
While the odds of a $7 per ounce rally in silver without some rally in gold are virtually non-existent, the gold/silver ratio indicates that, from a pure trading perspective, silver is where you want it to be in a metals bull market.
Declines Are Opportunities to Buy or Add to Positions
The chart below is another solid visual confirmation that the trend in silver is now bullish. Silver is overbought, so it would not surprise us to see a corrective move lower soon. We believe this correction -- if and when it occurs -- should be bought.
To say silver is strong right now is an understatement. A move to $30 per ounce or even higher in the next year is not beyond the realm of possibility. Silver has solid support right around old swing highs of $18 per ounce, so we would strongly consider adding to our bullish positions on a decline to that level. That said, there is no guarantee that silver will drop that low or that it will drop at all. If you don't already have a long position in silver, you may want to consider establishing a partial position soon.
RMB trading customers who already own the $20/$25 bull call spread and no-cost bull spread silver positions we recommended purchasing in January's Alert, should consider using the next big drop in silver as an opportunity to add to your positions. If you sold the December 2017 $10 puts to pay for the December 2017 bull call spreads we suggested purchasing for roughly $2,000, consider placing an order to buy these puts back now for $300 or less. Get ready to sell another set of puts with higher strike prices and greater dollar value on the next downward correction.
If you didn't sell the puts, and you own more than one of the December, 2017 $20 / $25 bull spreads recommended in January, consider selling enough to cover your initial risk and perhaps lock in some gains in the process. These spreads closed Friday for roughly $7,300 each. Hold the balance for a move to our original objective of $25 per ounce. If more nations adopt negative interest rates, we believe our $25 per ounce objective could be achieved by the end of the year.
Disclaimer: If you don't own bullish silver positions, waiting for a correction that may not come could leave you standing on the sideline. Consider gaining some fixed risk exposure to this market using the March 2017 silver options traded on COMEX. The strategy we are recommending now has a maximum risk of approximately $1,500. It could be worth as much as $10,000 should silver reach our $25 per ounce target prior to option expiration on February 28, 2017. Prices can and will change, so make sure to stay up to date. The risk of loss in trading futures and/or options is substantial and each investor and/or trader must consider whether this is a suitable investment. Past performance, whether actual or indicated by simulated historical tests of strategies, is not indicative of future results. Trading advice is based on information taken from trades and statistical services and other sources that R.J. O'Brien believes are reliable. We do not guarantee that such information is accurate or complete and it should not be relied upon as such. Trading advice reflects our good faith judgment at a specific time and is subject to change without notice. There is no guarantee that the advice we give will result in profitable trades.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.