By Przemysław Radomski, CFA
Silver moved sharply higher recently along with mining stocks, but unlike the latter, the white metal continued to show strength even on Thursday by holding up well despite gold’s and mining stocks’ decline. What does this tell us?
It tells us that a decline is very likely to be seen shortly. Let’s see why
In yesterday’s alert we wrote the following:
The silver to gold ratio and the indicators plotted on the chart show how often the above signal worked. The RSI close to 70 usually meant that an important top was in or about to be in, especially if the ratio was close to the declining resistance lined and / or the 200-day moving average. This is the case right now and the implications are bearish.
As you can read on the above chart, the signal was even clearer when the RSI moved above 70 and then declined back below it. Based on yesterday’s outperformance of silver relative to gold, the RSI moved above 70 and thus it’s only a matter of time (probably a very short amount of time) when the key sell signal is seen. It seems that one can already view the above situation as very bearish for the upcoming weeks.
Naturally, a question comes to mind: Why would silver’s temporary (!) outperformance be such a bearish sign in most cases? There is no specific fundamental reason for the above . However, in the short term, markets don’t move based on fundamentals, but emotions. The likely reason behind this phenomenon is the popularity of silver among small, individual investors and the relatively small size of the silver market (compared to other markets, like the gold market) and these investors tend to get in the market close to tops. Consequently, extraordinary performance of silver relative to gold may be viewed as a sign of the top. A similar phenomenon sometimes occurs for junior mining stocks (and you will find more details by clicking the above link) but in the past years, silver’s signals have become more meaningful and clearer than those from juniors.
On a side note, we expect silver to outperform gold in the upcoming years, but as far as short-term trading implications are concerned, the above remains to be a very useful trading technique.
What about silver itself?
It moved to our target area – its upper part – and declined. It seems that the top is already in and if it’s not, it seems that silver would not rally far as both resistance levels (the rising blue line and the October 2015 high) are relatively close.
Moving to gold, we saw a decline on relatively big volume (biggest daily volume so far this month), which has bearish implications. It seems that the decline will be continue (especially if gold breaks below the red support line and the February-today head-and-shoulders pattern will be completed) and it appears that entering short positions when gold was at about $1,250 was a good idea.
Summing up, silver’s strong performance in the recent days is not a bullish sign and this – along with a weekly reversal in gold stocks and the breakout in the USD Index – makes the outlook for the precious metals market bearish for the coming weeks. Consequently, we think that a short position (full) in gold, silver and mining stocks is justified from the risk to reward point of view. Moreover, it appears very likely that the profits on the current short trade will become much bigger before this trade is over. We’ll continue to monitor the situation and report daily in our alerts.