An Explosive Rally In Gold And Silver Is About To Begin

Includes: AUMN, GDXJ, GLD, SLV
by: David Vengerov

An explosive rally in gold and silver can start any week now (but with a small probability, gold and silver will trade sideways for a couple of months before the rally begins -- more on that below).

First, take a look at the 2-year chart of iShares Silver Trust (NYSEARCA:SLV) and connect the lows since January 2011 to get a horizontal support line, and then connect the highs to get a declining resistance line. This is called a declining wedge pattern. Such patterns almost always break to the upside. We have reached the apex of this pattern, so the moment of truth is upon us, most likely within the next few weeks. A similar declining wedge pattern can be observed over the past year in SPDR Gold Shares (NYSEARCA:GLD), with 150 acting as a support level.

Some of you may say: what happens if this pattern breaks to the downside -- wouldn't we have a huge decline in gold and silver once their 1-year supports are broken? I would reply as follows: we can't have a major decline when there are almost no sellers left and a huge number of potential buyers are waiting for the rally to start before jumping in.

Well-known sentiment guru Mark Hulbert wrote the following last week about the gold sentiment:

The average HGNSI reading over the last four months is minus 3.3%. You have to go back as far as 1991 to find another four-month period in which the average HGNSI reading was this negative.

In addition to Hulbert's proprietary sentiment index, the spread between long and short positions of small speculators (the crowd) in gold and silver futures is lower now than during the December 2011 low, which itself had a lower spread than December 2008 low (see for yourself at the CFTC web site). In the past, major lows in the spread had always corresponded to major lows in silver/gold, and all major tops in silver/gold corresponded to huge spreads in favor of longs.

Fundamentally, the gold/silver bull market that started 10 years ago has been driven by the explosion of US government debt/GDP ratio, which is now at around 100%. As long as this ratio is growing, the gold bull market will remain intact. So far, no proposals have been made by the politicians to reduce the budget deficit in the next 10 years to below 5% of the GDP (the predicted budget deficit for 2012 is close to 10% of the GDP), and no one currently expects the US economy to grow at above 5% over the next 10 years. Recently, UBS issued a warning about a possible hyperinflation in the US, which shows that the fundamental factors driving up the price of gold and silver are becoming more and more pressing.

There is a small chance that gold and silver will continue trading sideways until the next stimulus measure is announced (QE3 by the Fed or some fiscal stimulus from the government). Something along these lines will most likely be announced before the presidential elections in the fall, but the market will likely predict the inevitability of such an announcement ahead of time, so we may not even have to wait that long. Get ready now!

The simplest way to play such a rally is to buy Market Vectors Junior Gold Miners ETF (NYSEARCA:GDXJ) -- an ETF of small gold producers and explorers, which themselves are now greatly undervalued relative to the gold price (more so than at any time in the past 30 years, judging by the ratio of AMEX Gold Bugs Index (HUI) to gold) and will thus move up much more than gold once the rally begins.

My personal favorite is Golden Minerals (NYSEMKT:AUMN), which is the largest position in my portfolio because it will be trading many times higher in a year if they achieve their own production forecasts, and they don't even require the price of gold and silver to go up!

Disclosure: I am long GDXJ, AUMN.