Gold May Outshine Silver in the Medium Term

By: Przemyslaw Radomski | Tue, Feb 8, 2011
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This essay is based on the Premium Update posted on February 4th, 2011


 

Political as well as economical developments around the globe, especially in the Middle East, have affected the commodity markets during the previous week. Notwithstanding the uncertainty associated with the social illness, a strong demand has supported the precious metals. Talking about the reasons, Chinese New Year celebrations top the discussions. The growth in demand is being attributed in part to Chinese families giving each other gifts of gold instead of traditional red envelopes filled with cash. Fears of inflation have also driven demand for gold.

This year China pulled a rabbit out of the hat and China's gold imports are estimated to have more than doubled from a year ago in the run-up to Chinese New Year. This means that China is on track to overtake India as the world's largest consumer of the yellow metal. China consumes about 527 tons of gold a year, according to the World Gold Council, an industry body representing gold miners. Traders say China will overtake India as the largest consumer of gold this year. The Indian festival of Diwali was once the key driver of seasonal demand patterns because of the large number of weddings taking place during the holidays. But Now Chinese New Year is starting to have a bigger impact.

Ongoing demand surge from China could support the precious metals market significantly in the short-term. Precious metals traders in London and Hong Kong said this week in a Financial Times article that they were stunned by the strength of Chinese buying in the past month. "The demand is unbelievable. The size of the orders is enormous," said one senior banker, who estimated that China had imported about 200 tons in three months. (Just to keep things in perspective, it made headline news around the world when India bought 200 tons of gold from the IMF in November 2009.). There is so much demand that prices for physical gold in Shanghai have been at a premium of about $20 per troy ounce over those in London.

As per the current fundamentals influencing gold price movement, the long-term suggestion would be a definite 'buy'. Moreover, on Jan 25th, 2010, we wrote that we think that speculative capital should be used to bet on higher prices of precious metals in the short run, and we did not change our bullish outlook since that time. However, technical analysis indicates a relative strength in gold movements over silver in the medium-term. To tell you how gold and silver might perform in the near future let's begin this week's technical part with the Correlation Matrix.

Correlation Matrix

We see a relatively strong positive relationship between the precious metals sector and the dollar in the short term (30-day column). In other words, we have a numerical representation of what we mentioned to our Subscribers earlier - namely that the USD Index currently moves along with metals and consequently the fact that USD is likely to rally from here is not necessarily bearish for gold, silver and mining stocks.

There is also a quite interesting phenomenon in the 90-day column, as all assets appear to be positively correlated with each other. Still, there are only a few cases where the strength of the correlation is significant, and that is silver vs. stocks, gold stocks vs. gold, and juniors vs. stocks. While the gold stocks and gold virtually have to be highly correlated (gold mining companies' profits depend on the price of gold), the other two pairs provide us with important insight.

Silver is historically more correlated with stocks than is gold. The implication is that a correction in the general stock market would likely have a greater impact on silver - after all silver, besides being a precious metal, is also a vital industrial metal. A comparison of general stock market moves with silver underscores the analysis based on the correlation analysis. We will start with the short-term chart (charts courtesy by http://stockcharts.com).

$SPX Index

Although there has been a great deal of volatility in the general stock market recently and multiple back and forth movements in closing price levels were seen on daily basis, there is no change seen from the long-term perspective. The overbought situation as indicated by RSI levels continues to be prevalent. Additionally, the general stock market is close to the level of a previous important high seen in 2008. This is as a result of a big and significant rally, which began in mid-2010. Since that time, the rally was paused only one time, and the pause itself was rather insignificant from the long-term point of view.

$TRAN Index

The Dow Jones Transportation Average Index this week reveals some important developments. There has been a great divergence between the transportation sector and the industrials and the transportation:industrial ratio has therefore declined significantly. It has moved down about 5% since the first day of the year and is now below 0.425. Declines of this type are normally followed by significant declines in the industrials and in the general stock market overall. Consequently, the situation is still bearish from the medium-term point of view.

As of today, stocks moved slightly above their August 2011 high, however the breakout has not yet been confirmed, so the situation remains tense.

It is likely that declines back to the highs seen in 2010 will be seen eventually though it may take several weeks to get there. Unless the recent move above August 2011 high is verified, a decline in the market is likely to follow. This development could have a negative impact on the precious metals and especially on silver in the medium-term.

Overall, the sentiment for stocks continues to be bearish for the medium-term and a move to 2010 high is still probable.

Let us have a look into the iShares Silver Trust (SLV) ETF movements in the recent weeks.

$SLV Index

In this week's short-term chart, we see silver's recent breakout. The resistance line formed from previous intra-day highs has been broken and this followed a local bottom which took place right at the cyclical turning point.

Beyond the short-term, however, the picture is not so rosy for the white metal. The risk of a large correction in the general stock market makes medium-term silver investments much riskier than those in gold since silver is historically more correlated with stocks than gold is. For now, the risk-reward ratio for gold is simply better than that for silver right now in the medium term. This may change in the following days, if the breakout in stocks is confirmed. However, that was not the case yet.

Summing up, the outlook is bullish short-term for the white metal as is the case for gold. Higher prices in the short-term appear quite probable, however if a lot of your long-term capital is currently invested in silver, we suggest paying close attention to what happens in the main stock indices in the following days.

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Thank you for reading. Have a great and profitable week!

 


 

Przemyslaw Radomski

Author: Przemyslaw Radomski

Przemyslaw Radomski, CFA
Founder, Editor-in-chief
Gold & Silver Investment & Trading Website - SunshineProfits.com

Przemyslaw Radomski

Przemyslaw Radomski, CFA (PR) is a precious metals investor and analyst who takes advantage of the emotionality on the markets, and invites you to do the same.

His company, Sunshine Profits, publishes analytical software that anyone can use in order to get an accurate and unbiased view on the current situation.

Recognizing that predicting market behavior with 100% accuracy is a problem that may never be solved, PR has changed the world of trading and investing by enabling individuals to get easy access to the level of analysis that was once available only to institutions.

High quality and profitability of analytical tools available at www.SunshineProfits.com are results of time, thorough research and testing on PR's own capital.

PR believes that the greatest potential is currently in the precious metals sector. For that reason it is his main point of interest to help you make the most of that potential.

As a CFA charterholder, Przemyslaw Radomski shares the highest standards for professional excellence and ethics for the ultimate benefit of society.

Sunshine Profits enables anyone to forecast market changes with a level of accuracy that was once only available to closed-door institutions. It provides free trial access to its best investment tools (including lists of best gold stocks and best silver stocks), proprietary gold & silver indicators, buy & sell signals, weekly newsletter, and more. Seeing is believing.

Disclaimer: All essays, research and information found above represent analyses and opinions of Przemyslaw Radomski, CFA and Sunshine Profits' associates only. As such, it may prove wrong and be a subject to change without notice. Opinions and analyses were based on data available to authors of respective essays at the time of writing. Although the information provided above is based on careful research and sources that are believed to be accurate, Przemyslaw Radomski, CFA and his associates do not guarantee the accuracy or thoroughness of the data or information reported. The opinions published above are neither an offer nor a recommendation to purchase or sell any securities. Mr. Radomski is not a Registered Securities Advisor. By reading Przemyslaw Radomski's, CFA reports you fully agree that he will not be held responsible or liable for any decisions you make regarding any information provided in these reports. Investing, trading and speculation in any financial markets may involve high risk of loss. Przemyslaw Radomski, CFA, Sunshine Profits' employees and affiliates as well as members of their families may have a short or long position in any securities, including those mentioned in any of the reports or essays, and may make additional purchases and/or sales of those securities without notice.

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