Gold vs. Silver

This post is strictly going to be analyzing the price of gold vs. the price of silver. Is one overvalued vs. the other? Are either of them good investments at the moment, or at they just bubbles? These are some questions I'm going to try to answer very briefly with a few charts that I think tell the tale.

• The first chart I will post is the Gold vs. Silver ratio (Figure 1). This chart goes back to 1982 with monthly prices and show how cyclical the price of gold is vs. the price of silver.
• The two commodities trade in cycles with the economy. Essentially, silver outperforms gold when the economy is improving and gold is a flight to safety when there is economic uncertainty.
• As you can see the ratio bottomed (good time to buy gold) around the year 2000, which was the peak of the Dot.com bubble. The ratio then bottomed again in 2007 which was the peak of the housing bubble that led to the financial crisis. Right now the ratio is in the same zone that it has bottomed at in the past, does this mean that we could be going into another period of tough economic times in the near future? Probably.
• With the current ratio where it is I would be a buyer of gold before I would be buying silver. Historically the time to be buying silver is when gold is trading above 75x the price of silver and the time to be buying gold is when it is trading for less than 48x the price of silver, it is at 40x right now.

Gold vs Silver Ratio Long-Term (Figure 1)

The second round of charts are the long-term monthly prices of gold and silver (Figure 3 &Figure 4). Theses two assets are clearly in bubbles. However, as the old saying goes, "markets can stay irrational longer than you can stay solvent." I wouldn't be a buyer of either of these assets right now, but I also wouldn't even think about shorting them. They can go way higher before they eventually collapse. The problem I have with buying is that when the collapse comes its going to be quick and I don't want to get caught in the rush to the door. Another problem these securities have right now is that hedge fund margin debt is at the highest since July 2007. What this means is that hedge funds are borrowing more money now to buy stocks and other assets than they were before the financial crisis. A drop in the stock market, which is very likely now after the Japan quake, will force liquidations of everything to meet margin calls, including gold and silver. This is similar to what happened during the crash of 08' when gold and silver both fell over 30%. The margin debt chart is shown in Figure 2.

• From Zerohedge:

"Everyone is now purchasing on margin and the level of investor net worth is the lowest in over 3 years. Which means that should the market decline from this week persist and the Fed be unable to stop it, the margin calls will start coming in fast and furious, and unwinds in otherwise stable products like gold and silver are increasingly possible as hedge funds proceed to outright liquidations."

Margin Debt vs Total Net Free Credit (Figure 2)

Here are the charts of gold and silver.

• As you can see in Figure 3, the chart of gold, it is nearing uptrend channel resistance. This area has been a great time to sell and take profits in the past. I would bet it is a great time again too.
• The uptrend has been weakening in strength since the high made back in 2008 during the crisis. Eventually this loss of strength is going to have some effects on price.
• There is no major support underneath the gold price except for the lower channel line until all the way down at $1000/oz. If I wanted to buy gold I would wait till at least a pullback to the lower channel line. If that breaks I would load up the truck with gold near $1000/oz.
• As for silver, it's experiencing the same problems as gold. It's recent run-up has been way stronger than that of gold and it is starting to get overextended. The monthly bar it is painting right now is a reversal candle, bouncing right off of channel resistance. This is setting the stage for a drop in silver.
• The first place to watch for support is near $28/oz, but on the long-term outlook the biggest levels of support will be the lower channel line and support from the 2008 high around $20/oz.

Gold Long-Term Monthly (Figure 3)

Silver Long-Term Monthly (Figure 4)

The last part of my analysis will focus on the major driver of the prices of both gold and silver, the US Dollar. When the dollar falls it spurs inflation worries and drives up the price of both gold and silver because these are seen as safety against the central bankers printing presses. When the dollar rises, as it did in 2008, we experience deflation and the prices of gold and silver fall. However, in a severe deflation like the one experienced in the 1930s gold does in fact act as a safe haven asset. Figure 5 shows the weekly chart of the US Dollar going back to late-2007.

• The dollar has been consolidating for a few years now. It is currently sitting at support from the bottom line of the triangle and from the lows of 2010. Downside momentum has been waning and the dollar is due for at least a moderate bounce to the upside.
• On a fundamental note, Europe is struggling with its debt situation once again. If this comes to a climax sometime soon the Euro is going to get rocked, sending the dollar skyrocketing. I believe this will happen sooner rather than later due to the Japan catalyst. See this, this,this, this, and this for more information on the Euro crisis.
• Also, there is a lot of talk going around about the dollar losing its reserve currency status and how this is going to set the dollar down into oblivion. This is simply not true. Our reserve currency status is secure for the moment. Sure, we will not have the reserve until the end of time, but we will have it for the foreseeable future. Also, losing the reserve status isn't the end of the world. The British pound had the reserve status until we took it from them. Britain didn't get economically "blown" off the face of the Earth when this happened and it won't happen when we lose the reserve status either. See this for more info.

US Dollar Weekly Chart (Figure 5)

In conclusion:

• I would not be a buyer of silver or gold right now, especially silver. Why?
• 1) The gold-silver ratio is suggesting to buy gold rather than silver. It is also suggesting that the economy and stock market are likely going to weaken again rather soon. 2) A fall in the stock market, as suggesting by a number of indicators, will likely trigger margin calls at most hedge funds and force the liquidation of a number of their largest holdings, including gold and silver. 3) The long-term technical picture of gold and silver are both suggesting a pullback. They are both very overextended and overbought and have little support below them. 4) The US Dollar is likely to experience a bounce in the short-term (3-6 months) that will push down the stock market, gold, and silver. This could be caused by a technical bounce in the dollar or the European Union debt crisis heating back up, I think this is very likely.

Anyway, hope you enjoyed the analysis. Good trading.