Gold is Rallying, is Silver Next?

It’s been a weak start to the month of June for silver (SLV) as the metal is lagging gold by 600 basis points, down just over 5% thus far. This continued underperformance is likely what has contributed to the skimpy demand for the metal among small speculators, with long exposure from this group remaining near 9-month lows.

However, while silver has been underperforming over the short-term, the metal looks like it might be changing its character over the medium-term, as the silver to gold (GLD) ratio has been in a clear uptrend since the mid-March lows.

If true, this is a significant development for the bulls in the metals space, as both gold and silver tend to perform much better when silver is leading. Let’s take a closer look below:

(Source: StockCharts.com)

As we can see from the chart above, showing the silver/gold ratio, silver has made a significant comeback from its worst performance against gold in over a decade, briefly trying to reclaim its key weekly moving average.

Generally, two or more weekly closes above this key moving average have signaled a positive change in trend in the silver/gold ratio, and this has favored silver over the medium-term but has also produced outsized returns for gold.

While silver has yet to reclaim this critical moving average (yellow line), it does look like this ratio is building a new base, and gold’s recent move to new highs is not dislodging this indicator yet.

Therefore, while the indicator has taken a beating for the month of June, it remains intact from a medium-term standpoint, and it could finally turn later this year. The first sign of a positive turn would be two consecutive weekly closes above a 0.012 ratio for the silver/gold ratio.

As shown in the chart below, we’ve seen four signals in the past decade, with the last three bearish. However, the bullish signal in August of 2010 generated exceptional returns for those holding both gold and silver.

(Source: TC2000.com)

If we move over to positioning among small speculators, we can see that they still don’t seem interested in the silver trade, with the 1-month moving average for silver sitting at 36,000 long contracts. This is a stark contrast to the 48,000 to 60,000 plus contracts we saw small speculators holding the last time we were above $18.00/oz, suggesting that the small speculators have either lost interest in this trade or given up after the mid-March meltdown.

This continues to be a positive sign as the last thing investors want to see is small speculators piling into the silver trade on the long side. The previous two times this happened, it was time to start taking profits as silver endured 20% corrections in the following three months.

As long as this indicator remains below 40,000 long contracts, this will remain a minor tailwind for silver and suggest that dips will likely be buying opportunities.

(Source: Author’s Chart, CFTC.com)

Finally, if we look at the technical picture for silver, we can see that silver looks like it might be building a new cup and handle base from its mid-March lows. The key to this thesis remaining intact is for the bulls to defend $16.00/oz on silver at all costs, as a drop below $16.00/oz would put a severe dent in this pattern, making it look quite abnormal.

However, for the time being, this setup remains quite constructive. Therefore, as long as the bulls can defend $16.00/oz on silver, I believe that any 10% pullbacks are likely to be merely noise and an opportunity to add exposure to the best silver miners incrementally.

(Source: TC2000.com)

While we have no confirmation of a turn yet in the silver/gold ratio, the past couple of months are encouraging, suggesting that we could get a turn before the end of the year. This view is corroborated by the fact that silver seems to be giving up ground grudgingly on this recent pullback, and while it’s down 5% for the month of June, this is an entirely normal reaction following a 50% rally in three months.

Currently, I continue to prefer gold to silver given the significant breakout we witnessed last week, but if we could see a pullback towards $16.50/oz on silver, I may look to start a small position in the metal, in anticipation of the silver/gold ratio finally flipping in the next 12 months.

However, this thesis is predicated on the bulls playing defense at $16.00/oz on silver. Any breakdown below here would dampen the likelihood of a bullish signal in the silver/gold ratio considerably.

For now, I remain long gold and a basket of gold miners, including Kirkland Lake Gold (KL), Silvercrest Metals (SILV), and Anglogold Ashanti (AU).

(Disclosure: I am long GLD, KL, SILV, AU)

Disclaimer: Taylor Dart is not a Registered Investment Advisor or Financial Planner. This writing is for informational purposes only. It does not constitute an offer to sell, a solicitation to buy, or a recommendation regarding any securities transaction. The information contained in this writing should not be construed as financial or investment advice on any subject matter. Taylor Dart expressly disclaims all liability in respect to actions taken based on any or all of the information on this writing.

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The iShares Silver Trust (SLV) was trading at $16.55 per share on Thursday afternoon, up $0.27 (+1.66%). Year-to-date, SLV has declined -0.78%, versus a -4.35% rise in the benchmark S&P 500 index during the same period.

SLV currently has an ETF Daily News SMART Grade of B (Buy), and is ranked #20 of 34 ETFs in the Precious Metals ETFs category.