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The precious metals and producers have had quite the impressive run off their bottom. I alerted readers to the opportunity in this article and in this article described the historically low valuations providing a margin of safety. Since its bottom in May, gold (SPDR Gold Trust ETF: GLD)has climbed around 13%, silver (iShares Silver Trust ETF: SLV) has climbed around 29%, most impressively the Market Vectors Gold Miners ETF GDX has climbed 38%.


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The primary drivers of this increase have been the depressed valuations as well as the anticipation and implementation of unprecedented central bank easing all over the world. The flooding of fiat currency around the world is without a doubt positive for precious metals. My theory remains and so far has been validated that policymakers will choose inflation via monetizing debt to alleviate economic pressures rather than liquidation to deal with excessive debt loads. Of course, each choice has its own consequences in the short term and long term. I'm sure much opportunity lies in taking advantage of these consequences.

However, the most pertinent question is whether this rally is due to continue, pause, or reverse. In this article, I give my reasons for expecting this rise to continue.

Valuation Remains Attractive

No doubt, the rally is overbought on some shorter time frames, and at some point it will pull back or consolidate as weak hands will be shaken out and shorts will be sucked in. Yet, there is still room to move higher on longer time frames. Further, in uptrending markets "overbought" can be a dangerous word just like "oversold" in a market trending down.

These ratio charts of junior miners (Market Vectors Junior Gold Miners ETF: GDXJ) to larger producers, miners to gold, and silver miners (Global X Silver Miners ETF: SIL) to gold miners compared to performance of the gold miners provides us with a good perspective.

Specifically, we see that although these measures have reverted closer to the mean, they are far from the overvaluation levels which scream caution and would prompt some profit taking. Typically, at the top when this bull market reaches exhaustion these limits are stretched to the point where people even doubt whether they mean anything.


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Currencies

One of the effects of the Fed's QE3 is increasing the amount of dollars in circulation, of course this pushes down the value of the U.S. dollar and is supportive of precious metals prices. In our QE influenced market since the March 2009 bottom, precious metals have had their best runs during QE1 and QE2. I believe we will see an even more impressive performance this time given the severe undervaluation.

Periods of dollar strength have coincided with dollar weakness or consolidations. For gold to break out to new highs, we need the dollar to keep moving lower. Another interesting aspect is that although gold is off its all time high, in many currencies it is at all time highs already.

The chart below shows the dollar performance vs gold performance since March 2009.


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Gold/Silver Ratio

I'm posting a chart of the gold/silver ratio - for reasons that I don't fully understand, the miners have their strongest gains during periods when silver is outperforming gold. I am always careful to differentiate correlation and causation, however until the relationship breaks down, I will continue to keep close watch on this ratio. An important takeaway from the two charts below is that silver is fairly valued to gold at least to historical norm.

My hypothesis is that silver outperformance indicates an interest in risk assets in the precious metals space. Of course, the miners are the ultimate risk asset in this space so they benefit the most from an environment where greed is the predominant emotion while they suffer the most when fear reigns. Basically, when this ratio is rising, the miners are the most lucrative place to be in the precious metals space.


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Platinum and Palladium

Platinum and palladium are the two overlooked metals in the precious metals complex. Both are more prone to industrial demand, however their performance is also a sign of liquidity and interest in the precious metals space. While, they have lagged gold and silver significantly, I expect them to make up this difference. However, it is a very good sign that unlike the earlier rise in May, they are also benefiting from the liquidity inflow.

North American Palladium Ltd. (NYSEMKT:PAL) and Stillwater Mining Company (NYSE:SWC) are two stocks that track palladium and platinum prices, respectively.


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The ratio of platinum to gold has also become quite stretched which supports the notion that platinum should outperform gold in this leg up.


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Conclusion

As discussed previously, the rise in the miners displays footprints of massive breadth and liquidity which are requisite for the sustainable rallies consisting of higher highs and higher lows. Rallies lacking these characteristics are more difficult to trade and are often accompanied by vicious pullbacks.

In order to profit off those moves, good timing is required. With a "healthy" rally, timing errors are corrected by being patient. In late May, I wrote an article giving my reasons for doubting the initial move off the lows and this skepticism was rewarded as miners retraced most of their move higher. The indicators detailed here did not confirm that a true trend change was taking place with the miners.

This time, the outperformance of silver miners to gold miners, silver to gold, junior miners to major producers, and miners to gold indicate strong breadth and impressive liquidity. These are signs that this rally has further to go to reach extreme levels that caused profit taking in past moves. Further, the action in currencies, platinum, and palladium are more pieces of evidence that this move in precious metals could continue higher even taking out their all time highs.

Disclosure: I am long PAL. 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.

Source: Gold And Silver Miners Continue Rampage, Targeting All Time Highs