Gold/Silver Ratio Analysis
Source: Jordan Roy-Byrne, The Daily Gold (9/21/10)
"Breakdowns in the gold/silver ratio lead to big moves. . ."
There are some important points to take away from the gold/silver ratio. We show the gold/silver ratio in silver in the chart below. Take a look and think about what you see.
The positive is that breakdowns in the gold/silver ratio tend to be an accelerant for silver. However, such breakdowns often occur at about the midpoint of a move. Note that silver has made an important top after each major breakdown in the gold/silver ratio. Should we expect that soon? The chart shows there is plenty of room for the ratio to fall. A fair target looks like 57.
Our target of $24–$25 for silver looks well on track after the breakout past $19.50. There is plenty of room ahead in the next few months. However, that target could be the point where the market begins a multimonth pullback. Don't assume that silver will forever outperform gold. It comes in fits and starts. Breakdowns in the gold/silver ratio lead to big moves and also to important interim tops.
The gold/silver ratio can be an economic indicator, as a surge can indicate recession, tightening of credit, etc. The reverse can be true on the downside. However, we are currently in a strong precious metals bull market. For over a year, silver has acted far more like gold than an industrial metal. For a better economic indicator, I would look at the gold/copper ratio. In the chart, we show the gold/copper ratio, commodities and the S&P 500.
We highlight (in yellow) when copper outperformed gold. Stocks were particularly strong during those periods and commodities also performed well. The point is that gold/copper is presently a better economic indicator than the gold/silver ratio. Don't assume that a falling gold/silver ratio is bullish for stocks and commodities. Check the gold/copper ratio for confirmation.
The gold/silver ratio, as applied to precious metals can tell us quite a bit. Typically, a breakdown tells us that a more speculative, momentum-filled run is beginning and the sector is moving closer to a top. This being said, the breakout in silver past $20 will be the most significant breakout to date. We do expect a top at $24–$25, but nothing major.
How does one play the gold/silver ratio? Our recent editorials called for an overweighting in silver stocks as there was more opportunity and better value there. Continue to hold those positions. Realize that a weak gold/silver ratio means the market is in a more speculative mood which means greater volatility, risk and reward. Make sure you are buying a stock for the right reason. If it is a long-term play than look for something that isn't overheated. If you want momentum and short-term gains, make sure to define your risk.
These are all factors we employ in our premium service. It has allowed us and/or subscribers to take advantage of the different opportunities in the changing environment in the precious metals sector. If you are interested in more professional guidance in navigating this bull market, consider a free 14-day trial to our service.
Good luck ahead!
Jordan Roy-Byrne, CMT