U.S. Crisis Barometer: The Gold/Silver Ratio

By: Robert McHugh | Sun, Aug 28, 2005
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For the price relationship to remain fixed between Gold and Silver, the following chart should show one thin horizontal line. Instead we see rising and falling patterns that range from 40 to 100. What this means is simply that the price relationship between Gold and Silver is not fixed, varies substantially. Why? Because at different times, in vastly different market environments, the value of Gold is perceived differently than Silver. It is this relationship that speaks volumes to the risks of economic and political upheaval.

From 1990 through 1998, the value of Silver was rising in relationship to the value of Gold. This was due to a booming economy where, because Silver has industrial use, and not just numismatic, it was in greater demand. Gold was not viewed as important as a medium of exchange as there were few perceived going-concern risks to life as we knew it in the United States. No 9/11; no recent 38 percent drops in the Dow, or 80 percent drops in technology stocks; little perceived significant exportation of our manufacturing base (although it had begun); no record Budget, Current Account, or Trade deficits; no Patriot Act threatening our civil liberties, no $67 per barrel oil. Life was good. Silver was valuable relative to Gold.

But that has changed. From 1998 through 2003, starting with the Hedge Fund and Asian crises, through the Y2K scare and the economic collapse of 2000, through the start of the Iraq war, Gold began to be accumulated more than Silver. Suddenly Gold as money was deemed an important crisis commodity. As fear replaced confidence, Gold relative to Silver increased in value, doubling from 40 times Silver in 1998, to 80 times Silver in 2003. Then confidence grew as the War seemed at first to be successful, as the equity market rallied, as 9/11 drifted further back in the minds of people, and Silver once again increased in value relative to Gold - until early 2004. A presidential campaign brought our many problems into focus. Questions about the true state of the union were raised, in private and in public.

From early 2004 through now, the Gold to Silver ratio oscillated between 50 and 70, stabilizing and narrowing toward a mean of 60, which is about where we are now. The ratio's action since early 2004 has been indecisive. Are things getting better or worse? If this ratio rises from 60, this important and correct prognosticator is declaring tough times ahead. If this ratio declines from 60, expect improving times. After its considerable deliberation, it looks like we are about to be rendered the Gold/ Silver verdict, as this ratio looks ready to break out of its trading range - to the north.

Even more than stocks, precious metals factor in political risks as well as financial. They adjudge the welfare of civilization as we know it. They offer stability amidst chaos, have for thousands of years. Kingdoms rise and fall, paper currencies disappear, businesses become obsolete, even the industrial use for Silver is at risk. Ultimately, the choice becomes, which metal would you rather have if the U.S. Constitution is abandoned for marital law?

So what is this ratio telling us on August 26th, 2005? Since June 2005, this ratio has increased 18 percent, from 55 to 65. This is a huge increase in a mere three months. It is telling us it is not happy about prospects. This rapid increase in the value of Gold relative to Silver is warning us of dangerous times ahead. Watch for a breakout above 70. That would start a new intermediate term uptrend, and spell major trouble.

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We have developed buy/sell signals with remarkable correlation to stock market price movements, including the Blue chip stocks, Techs, and HUI Amex Gold Bugs Index. Serious Traders, Investors, Advisors and Market Students should find these buy/sell signals invaluable.

What are these unique signals and why do they work? We have two independent indicators for each of three major equity market indices: The large cap DJIA/S&P 500, the NASDAQ 100 (which mirrors the QQQQs), and the HUI Amex Gold Bugs stocks.

The first indicator is a Stochastic that measures price and breadth momentum. When a Fast measure of this Stochastic crosses decisively above a Slow measure of same, we get a momentum "buy" signal. When the Fast crosses decisively below the Slow, we get a "sell" signal.

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Here's how we like to apply these signals: When both the Stochastic and Purchasing Power Indicators issue new "buy" signals, we like to take a long position in the expectation of a rally. When both generate new "sell" signals, we like to go short, or step out of the market and wait for "buy" signals to reappear, anticipating a correction lower. We recommend always using stop losses.

Unique to these indicators, they have done an amazing job identifying prolonged "sideways" moves in the market. The probability of a "sideways" move occurs when one indicator is on a "buy" and the other is on a "sell." We are not aware of any other market analysis service out there that identifies high probability "sideways" moves. This information is critical for options traders as options lose value during lengthy sideways moves. In the options buying world, Bears win, Bulls win, and Sideways lose.

So how are these signals performing?

First, the blue chip indicators:

On July 8th, 2005, the DJIA 14 Day Stochastic triggered an early "buy" signal. The DJIA closed that day at 10,449.14. The DJIA proceeded to rise 250 points to an intraday high of 10,700.06 before triggering a "sell" on July 21st. This signal found a rising trend that took prices higher by 2.4 percent over two weeks. Its partner indicator, the Purchasing Power Indicator™, generated a confirming "buy" signal three days later, on July 11th. The DJIA rose 181 points from the July 11th close to 10,700.06 before a "sideways" signal was generated. The PPI signal alone, and in combination with the Stochastic, found a rising trend that took prices higher by 1.7 percent over two weeks.

Then, the DJIA 14 Day Stochastic noticed that something was wrong with the rally and issued a "sell" signal on July 21st. But the PPI remained on a "buy" through August 16th. With these signals conflicting, it meant they were telling us a "sideways" pattern was underway. This sideways signal was initiated on July 21st, with the Dow Industrials closing at 1,627.77. When this sideways signal ended on August 16th, three weeks later, the Dow Industrials had opened that day at 10,631.59. In effect we saw prices a measly 4 points apart from the close of the day the "sideways" signal began to the open of the day it ended, when a confirming "sell" signal was generated in the PPI.

On August 16th, 2005, the DJIA/S&P 500 PPI indicator generated a confirming "sell" signal, with the Dow closing at 10,513.45. As of Friday August 26th, the DJIA has declined 129 points since both indicators went on "sells," and the DJIA has declined 243 points since the 14 Day Stochastic Indicator triggered a "sell," a 2.3 percent decline over three weeks.

What is interesting is, these signals have managed to find tradable trends within a three-month lethargic, summer, 200 point trading range (well it was until prices dropped below 10,500 Wednesday).

Now let's examine how the signals for the NASDAQ 100 have performed. On July 8th, both the NDX 14 Day Stochastic and the NDX Purchasing Power Indicator TM generated "buy" signals. The NASDAQ 100 closed at 1,533.27 that night. Prices then rallied to an intraday high of 1,610.84 on July 21st when a key reversal that day triggered a "sell" signal in the Stochastic, unconfirmed by the PPI, ending our "buy" signal. Thus our trendfinder indicators found a rising trend where the NDX rose 77 points, or 5.0 percent from the start of the "buy" signals to the end on July 21st, in just over two weeks. From there we had a "sideways" signal in the NASDAQ 100, where the Stochastic was on a "sell" and the PPI was on a "buy." That "sideways" signal lasted until August 5th. During the signaled sideways period, from July 21st to August 5th, the NASDAQ 100 didn't accomplish anything. The NDX closed at 1,601.89 on July 21st, and closed at the same 1,601.59 two weeks later on August 5th.

Since August 5th, both key indicators have been on a "sell" signal. During that time, so far, the NASDAQ 100 has fallen 48 points, or 3.0 percent, over about a two week period.

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"He who dwells in the shelter of the Most High
Will abide in the shadow of the Almighty.
I will say to the Lord, "My refuge and my fortress,
My God in whom I trust!"
For it is He who delivers you from the snare of the trapper,
And from the deadly pestilence.
He will cover you with His pinions,
And under His wings you may seek refuge;
His faithfulness is a shield and bulwark.
You will not be afraid of the terror by night,
Or of the arrow that flies by day;
Of the pestilence that stalks in darkness,
Or of the destruction that lays waste at noon.
A thousand may fall at your side,
And ten thousand at your right hand;
But it shall not approach you.
For He will give His angels charge concerning you,
To guard you in all your ways."
Psalms 91: 1-7, 11


Robert McHugh

Author: Robert McHugh

Robert D. McHugh, Jr. Ph.D.
Main Line Investors, Inc.

Robert McHugh

Robert McHugh Ph.D. is President and CEO of Main Line Investors, Inc., a registered investment advisor in the Commonwealth of Pennsylvania, and can be reached at www.technicalindicatorindex.com. The statements, opinions and analyses presented in this newsletter are provided as a general information and education service only. Opinions, estimates and probabilities expressed herein constitute the judgment of the author as of the date indicated and are subject to change without notice. Nothing contained in this newsletter is intended to be, nor shall it be construed as, investment advice, nor is it to be relied upon in making any investment or other decision. Prior to making any investment decision, you are advised to consult with your broker, investment advisor or other appropriate tax or financial professional to determine the suitability of any investment. Neither Main Line Investors, Inc. nor Robert D. McHugh, Jr., Ph.D. Editor shall be responsible or have any liability for investment decisions based upon, or the results obtained from, the information provided.

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