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One of the Best Low-risk Buy Points in the Last 20 Years?

I asked Dave Blais, a full-time investor of gold and silver stocks, for an update on his take on the action in the precious metals markets. Here’s his report…

Is the current gold and silver stock sale one of the best in years?

Is the current gold and silver stock correction offering one of the best low-risk buy points in the last 20 years?

As outlandish as that may possibly sound — it just may be.

Throughout this correction, I have been buying the dips, picking up some of the most promising gold and silver mining companies at what I expect will be seen as bargain prices several months from now.

I’ve been a buyer because the charts are telling me that there is a high probability that this current “sale” is likely one of the better ones from a historical perspective.

With all the drama that an extended and deep precious metals correction like this one can entail, it’s important to keep perspective and look to see the proverbial forest through the trees. In this case, the “forest” we are witnessing is a period of relatively rare historical underperformance of the precious metals shares versus the metals.

Another way to put this is to say a buying opportunity like this may not come again for some time.

I’ll show you what I mean in the case of the Philadelphia Gold and Silver Sector Index, which contains 16 companies involved in gold and silver mining (symbol XAU).Because the XAU contains of both gold and silver producers, it offers a representation of the gold and silver markets as one entity.

If you look at the relative strength of the XAU in relation to the gold price (first chart) and the silver price (second chart) over the past 20 years, you will see that we are in an area of an area of an extreme low of relative strength for the gold and silver shares. (Relative strength can measured by dividing the XAU index by the gold or silver price – a rising chart line (or ratio) means the shares are outperforming the metal and vice versa).

Relative strength ratio of the XAU index to Gold (20 years):

The 2008 stock market panic was likely a once in a generation event, so it is probably useful to omit that period from this analysis.

Relative strength ratio of XAU index to silver (20 years):

The point here is that we are at a historically low ratio in the value of the XAU index in relation to the gold price. When the ratio hits the lower-most support line, it tends to vibrate around that area for a spell, before heading back up and hitting one or both of the upper two trend lines.

That does not mean the gold (and silver) stocks won’t go lower from here. It just means the odds are pretty high we are in an area of historic value.

What it tells me is purchases in this area should likely pan out in a few months’ time.

What I found is looking through every conceivable index and permutation, is that the XAU-gold ratio appears to be a controller” measure for the current precious metals run. What I mean by that is it is speaking for both gold and silver and a combined entity, in a consistent and accurate way. The XAU-gold relative strength ratio works the same for both gold and silver, and is telling the same story for both metals over the last two decades. If you were to ask me, I would be at a loss to say precisely why, but the fact is it is doing precisely this. So I’m not going to second guess it. But when you look at the charts above, they are a thing of pure beauty and simplicity for both metals.

The trendlines shown in the charts above are potentially important tools as one of several trading signals. Trendlines are like magnets. Now that we have hit the bottom-most trendline, we should be “reversed magnetized” if you will to attract to one or both of the higher trendlines.

As an example, I would possibly look to be taking profits if we approach the first upper trendline and “see what happens.” There is no guarantee we will go straight to the uppermost trendline/resistance line or beyond, none at all. However, the probabilities of hitting the first one are now quite high indeed. Now, if we hit the first trendline, say in the middle or late first quarter (or at a key overhead resistance level for gold) I would be a seller for sure — 80, 90 to 100 percent out. The reason is that we would be in a period of seasonal strength, combined with hitting a key upper trendline in the chart above — the probabilities of an intermediate top would beso high, I would just sell, and wait for the next optimal re-entry point a few months down the road.

The HUI gold mining index – comprised mostly of unhedged gold miners – shows a similar relative strength pattern as the XAU in relation to gold but on a shorter time frame, 10 years.

Relative strength ratio of the HUI index to gold (10 years):

From a risk-reward perspective, this may turn out to be a relatively low-risk entry point for gold and silver shares, with a potentially high reward.

As such, if the long-term trend lines in the charts above contain the decline – the current undervaluation of the precious metals stocks may come to be seen in hindsight as a significant buying opportunity.

- Dave Blais