Critical Juncture for Silver and Gold

By Michael A. Gayed  DEC 13, 2012 12:31 PM

With the latest iteration of QE, the big question now is if precious metals believe it will work. For silver, the answer appears to be yes.

 


Life is always at some turning point.
--Irwin Edman
 
With the Fed's latest iteration of QE, the question many are asking is whether risk assets continue their bullish move or if the market will once again shrug as it did following QE3.  An an interpreter of price, the question is best answered through relative movement, and by considering what the Fed wants – nominal growth.  What that means is that the Fed wants some combination of actual inflation and actual growth to push the economy into escape velocity mode.  Of course, just because the Fed wants it does not mean it will happen, but that seems to be the goal of monetary policy now.
 
So does price think it's going to work?  It seems plausible, particularly when considering the relative behavior underway in markets.  Take a look below at the price ratio of the iShares Silver Trust ETF (NYSEARCA:SLV) relative to the SPDR Gold Trust Shares (NYSE:GLD).  As a reminder, a rising price ratio means the numerator/SLV is outperforming (up more/down less) the denominator/GLD.
 

 
Silver is often referred to as “poor man's gold,” but the truth is it is an imperfect substitute for the yellow metal.  Silver tends to be much more sensitive to industrial demand, while gold is less so on a relative basis.  As such, when silver outperforms gold, it means money is starting to bet on an increase in industrial production and global reflation.  Note that the ratio rallied in January and February during the best first quarter for equities in a decade, underperformed throughout the corrective period of April-May, bottomed in early June as the melt-up began, and has since fought higher.
 
The ratio now is at a critical juncture given that it has crossed its own 20-day moving average, but is still within what appears to be an uptrend of leadership.  If a breakout in silver's strength occurs, it might mean that further risk-sentiment is likely in markets, which is likely to make gold rally, but not to the same extent as silver and other more industrial-sensitive commodity plays.

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