Gold And Silver Recover, But Sell This Rally

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Includes: AGOL, AGQ, BAR-OLD, BARS, DBS, DGL, DGLD, DGP, DGZ, DSLV, DZZ, GEUR, GLD, GLDI, GLL, GYEN, IAU, OUNZ, PALL, PGM, PPLT, PTM, SGOL, SIVR, SLV, SLVO, TBAR, UBG, UGL, UGLD, USLV, USV, ZSL
by: Andrew Hecht

Summary

The recovery is tepid at best.

Divergences continue to plague precious metals.

Rallies running out of steam.

The U.S. dollar is the reason for new lows ahead.

In the wake of the Fed announcement that interest rate increases in the United States will come later rather than sooner, gold and silver prices moved higher. Gold moved from lows of $1142.40 on the now active month June COMEX futures contract to close on Friday, March 27 at $1198.60 per ounce -- an increase of just under 5%. The move in silver was even more dramatic, with silver appreciating from lows of $15.26 on March 11 to close on Friday at $16.97 on the active month May futures contract -- an increase of 11.2%. July Platinum futures rallied from multi-year lows at $1088.80 to close Friday at $1137.50 -- an increase of just under 4.5%, while palladium has actually moved lower. Palladium is now trading at $737.65, the lowest level since October 2014. Meanwhile, given current world events, the move has been disappointing for precious metal bulls.

The Recovery is tepid at best

The action in platinum group metals continues to indicate that industrial metals are suffering under the weight of a weak global economic landscape. When it comes to gold and silver -- I would have expected much more. While gold and silver recovered as the U.S. dollar moved lower, the situation in Yemen is a watershed event that the metals paid little attention to, so far. When the Saudis and coalition forces announced airstrikes that will precede a ground invasion of 150,000 troops, I would have thought the prices of gold and silver would have taken off. You see, the Saudi action is a clear signal that the war between the Sunni and Shiite Muslim world has reached a new boiling point. The action in Yemen goes far beyond reinstating a deposed Yemeni leader. This new war is an escalation of a proxy war between the Saudis and Iran. Gold and silver are both ignoring the situation. In fact, both metals look weak on a technical basis. Gold got up to a high of $1220.40 last Thursday but it ran out of steam. Open interest, the number of open long and short positions on the COMEX futures market, actually decreased during the rally. This indicates that the rally did not attract new long positions; rather it just caused shorts to cover positions. Falling open interest and rising price is not a bullish indicator. Additionally, the slow stochastic, a momentum indicator, appears to be turning after the rally, while relative strength exhibits an overbought condition. Meanwhile, a look at the silver chart shows a similar technical picture. Silver rallied more than gold after the Fed statement, however, that rally appears to be suspect as well. Silver needs to get above the $18.535 level, which is key resistance, in order to look good again. Lower open interest during the recent rally leads me to believe that the buying was nothing more than short covering. As with gold, momentum indicators could be turning negative here and relative strength is in overbought territory.

The Fed statement, which will keep interest rates low, and the incendiary situation in the Middle East, only caused a tepid response in both the gold and silver markets. Price action has been less than bullish and a continuation of divergences in two inter-commodity spreads makes me wonder whether these metals can hold current price levels.

Divergences continue to plague precious metals

While the nominal prices of gold and silver provide key information as to the current state of markets, inter-commodity spreads often put current prices into some perspective. The price relationship between July platinum futures and June gold futures fell to a new low this week to close at the $60 level. Gold is currently at a $60 premium to platinum and this is the lowest level for the relationship since December 2012. Over history platinum tends to trade at a premium to gold -- platinum is a rarer metal and it has many more industrial applications. The current level of the platinum-gold spread tells me that either platinum is too cheap or gold is too expensive at current levels.

The silver-gold ratio or the number of ounces of silver value in one ounce of gold value closed the week at around the 70.63:1 level. Silver has outperformed gold recently, which means that the price of silver has rallied more than gold on a relative basis. However, the long-term average (over the past four-plus decades) for this relationship is 55:1. This means that on a historical basis, either the price of silver is too cheap or the price of gold is too expensive at current price levels.

These relationships indicate that there could be trouble ahead for the bulls, particularly because the rallies are running out of steam.

Rallies running out of steam

What really concerns me about the action in gold and silver is that open interest has decreased with the recent moves higher. This is a red flag for prices. Volume has also been interesting. Gold had a big volume day on Thursday, March 26 -- over 372,000 contracts traded, which is the most active day in a very long time. However, the price of gold traded up to just over $1220 and failed, closing $15 lower on the session. Meanwhile silver volume has been unexciting -- on March 20 when the silver price vaulted higher by 77 cents and closed on the highs of the session, only 65,364 futures contracts traded, very weak volume for a market that tends to trade over 100,000 contracts on a busy day.

Meanwhile, it is clear that the gold and silver markets are not reacting to the situation in the Middle East, rather only to the gyrations in the dollar. If that is the case, these metals are likely to head lower.

The U.S. dollar is the reason for new lows ahead

In hindsight, it seems clear that the Federal Reserve put off raising short-term interest rates because of the trajectory of the U.S. dollar. It is in the best interest of the U.S. central bank to smooth volatility in currency markets. The Fed is well aware that keeping their promise and even a symbolic rate increase would add fuel to the dollar move. Instead, a prudent approach of kicking the can down the road in terms of higher rates will take some steam out of the dollar's ascent.

The fundamentals that underpin the dollar remain strong. Lower rates around the globe and a weak global economic landscape combined with growth in the U.S. continue to be a bullish factor for the dollar. The dollar has corrected lower for the time being, but it may only be a matter of time until it resumes its rise. The euro currency closed on Friday at just over the $1.09 level versus the greenback. Issues in Europe continue to erode the value of their currency -- not least of which are interest rates that the ECB will keep low via quantitative easing until late 2016 at the earliest. Expect the dollar to climb against the euro, reaching parity at a minimum later this year. In the meantime, the stronger dollar will likely weigh on gold and silver prices. The recent rally in the precious metals could be just another chance to sell at attractive prices. So long as gold and silver remain below key areas of resistance -- $1225 in gold and $18.535 in silver -- selling them is a low risk/high reward strategy.

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.

Additional disclosure: The author always holds part of his portfolio in precious metals, that percentage varies according to current market conditions.