What happened on Friday,
April 12 and Monday, April 15 on gold and silver markets looked like a
gigantic earthquake – a drop of about $200 (13%) for the yellow and almost $5
(18%) for the silver metal. There has been a lot of hyperbole going on. We
even heard it said that a move of that scale would statistically only be
expected “once every 4,776 years.” Going even further, John Kemp of Reuters
calculates that, based on a normal distribution (by the way, market returns
are not normally distributed), movements like this
can be expected once in every 500 million trading days, or two million years.
Sounds far-fetched?
There have been plenty of
attempts to explain the cause of this enormous plunge. China's economy grew
“only” 7.7% in the first quarter, undershooting market expectations for an 8%
expansion. China is the world’s second largest buyer of gold. There were concerns
that the U.S. stimulus may be cut short since minutes of the Fed released
just before the big decline in gold prices showed some officials were
interested in ending the QE program this year. Another theory posits that
since the new Japanese central bank governor promised to re-inflate the
Japanese economy, Japanese government bonds (JGBs) have been on a wild ride. When
investors in volatile assets are asked to put up wider margins they often
sell assets they are holding. In this case, CME’s decision to raise margins for the
entire precious metals sector is another bearish factor for the short term.
While what happened looks
disastrous, we don’t think that this means the end of the great, secular bull
market in precious metals. Bull markets have a parabolic stage when everyone
is in a frenzy to get in and prices go up in a straight line. We have yet to
see that spike.
Furthermore, we don’t see
any changes in the fundamentals for gold and silver to make us think the bull
market is over. There is still large unemployment, ballooning national debt,
currency debasement and currency war, eurozone problems, QEs etc. etc. We
like gold and silver for the same reasons we have liked them for the past decade.
The fundamentals are
intact which ‘forces’ silver to rally in the long run but let us now turn to
today’s technical portion to see whether recent events have marked the final
bottom in the white metal or rather further declines are to be expected – we’ll
start with silver’s long term chart (charts courtesy of http://stockcharts.com).
We don’t see the same
corrective price action as we saw for gold – the yellow metal rallied for 7
out of last 8 days. Silver prices declined this week, except for a quite
substantial move up on Thursday.
Overall, declines simply
continue here (there was a small pullback within the 2008 decline as well);
gold prices corrected quite a bit and silver did not. If this
underperformance continues and gold prices move lower by $100 or so, the
implication appears to be that silver will decline sharply to perhaps the $18
level or so. This price level is created by the July local bottom and the
declining trend channel (parallel, green lines on the chart above), and the
price level where the huge 2010 to 2011 rally began.
Let us now move on to the
short-term timeframe.
Here, in the short-term
SLV ETF chart, the underperformance of silver is very clearly visible. While
there has been some sideways trading, prices have declined overall, and the
lack of any real pullback indicates the overall weakness of this market at
the present time.
Given Thursday’s close in
the SLV ETF at $23.49 (silver at $24.30), we still see no significant change
in silver’s performance – its correction is still very small compared to the
one seen in gold.
Since silver’s
underperformance is such an important issue at this time, we decided to
examine it particularly closely, using silver-to-gold ratio.
In today’s silver to gold
ratio chart, we present a somewhat new view of this
ratio. We've discussed the underperformance of silver for some time
now so we felt this graphic would be useful. We believe it’s best to plot the
rate-of-change indicator (ROC) on this ratio as it does a very good job at
measuring sharpness of given moves. The solid line in the chart is the ratio
itself with gold’s daily price in the background and represented by the gold
line.
The key point here is
this: major bottoms used to be preceded by a sharp drop in the silver to gold
ratio. We used to see either capitulation of silver investors or artificial
sell-offs before the declines were over. Regardless of what the reasons were,
it’s something that used to happen before the bottom was truly in. Recently,
however, we saw silver’s price decline, but not as sharp as expected relative
to gold if a major bottom was forming. In the recent days, we have seen
steady underperformance rather than a very sharp drop in the ratio. It looks
on the chart like the trend is accelerating, though, sort of like a reversing
parabola.
Ideally, we’d like to see
a lower rate-of-change indicator, say -10 or -15 at least before stating that
the final bottom is in. This indicator barely moved when the precious metals
declined heavily earlier this month. The declines seen in 2008 and in the
first 2 months of 2010 provide a good example of what the indicator can do.
At first, metals declined but silver not as significantly as gold. Only when
gold formed a major bottom, did the ratio decline sharply. We would like to
see this confirmation also in case of the current decline.
Summing up, silver has been underperforming
recently but not as extremely as we would expect during a major bottom. It
seems therefore that the final bottom is still ahead of us. Thursday’s move
to $24.30 doesn't invalidate the above. This is not the time to
give up on this market - it's the time to be particularly focused on it as it
is during the volatile times that particular opportunities are created. If
you're interested in our target levels for gold and mining stocks as well as
detailed plan for getting back on the long side of the market, please join our
subscribers
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Thank you for reading. Have a great
weekend and profitable week!
Sincerely,
Przemyslaw Radomski, CFA
