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What Does the Silver-to-Gold Ratio Tell Us About Silver's Future Moves?

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Silver is acting particularly strong, but it turns out that its performance relative to gold is also in tune with what happened in September 2008.

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In my previous essay, I focused on silver's relationship with the general stock market. Today, I think it would be interesting to revisit the silver-to-gold ratio. However, before I do that, let's check the recent price action in silver and gold.

Yesterday, silver posted biggest six-day gains in two years. Today, in pre-market trading, the white metal climbed up once again and reached the highest level in a month as holdings in the world's largest silver-backed exchange-traded fund, the iShares Silver Trust ETF (NYSEARCA:SLV), rose to a four-month high.

According to Reuters, gold extended gains on Thursday to a three-week high on hopes that the Federal Reserve may not scale back its commodities-friendly bond buying soon, and as holdings at the world's top gold-backed exchange-traded fund, the SPDR Gold Trust ETF (NYSEARCA:GLD), rose for a second time in a week.

US producer prices were flat in July, which could add to worries at the Federal Reserve that inflation is running too low, indicating that the US central bank might not end its stimulus until inflation (taking the official numbers into account) begins to trend higher.

What impact have these things had on the silver-to-gold ratio and on metals themselves? Let's take a closer look at the chart below to see how both precious metals are valued relative to each other. Perhaps this will provide some clues on their future moves (charts courtesy of http://stockcharts.com).


Click to enlarge

Silver's outperformance might be something that you are already wondering about. On one hand, it seems that silver can lead gold higher. On the other hand, the last few times that silver outperformed gold were right before sizable declines. When in doubt, it's usually best to get back to the basics, and simply check what usually happened in situations similar to the one that we have right now.

The rally in the silver-to-gold ratio was significant enough to cause the RSI indicator based on it to rally substantially, moving above the 70 level. This meaningful sign could have some implications -- but it doesn't. I checked each case in the past five years when the RSI moved close to or above 70, and gold rallied in about half of cases and it declined in the other half. Consequently, there's not much that we can infer based on silver's recent outperformance.

I usually don't bother you with things that are not meaningful, but this time, I am making an exception. This is because it seems that there will be a lot of comments on silver's current outperformance, and I want you to be able to compare them with what I wrote above.

There is one thing about the silver-to-gold chart that is indeed meaningful, and that's the comparison of the situation that we have now with what we saw in September 2008 right before the final plunge. Back then, the silver-to-gold ratio moved higher during the corrective upswing (before the decline continued) and the size of the rally was quite similar to what we have seen recently. Consequently, the very recent strength in the white metal does not invalidate the similarity between now and 2008, but rather confirms it.

This means that we shouldn't say that silver's strength is really a sign of a bottom. In fact, the long-term resistance line hasn't been broken, and the trend remains down.

Summing up, the recent move in silver looks promising. However, we saw similar action during the only decline that is similar to the current one – and this action was right before the final, huge plunge. Silver is acting particularly strong, but it turns out that its performance relative to gold is also in tune with what happened in September 2008. Consequently, silver's outperformance does not indicate higher precious metals prices – at least not yet.

For the full version of this essay and more, visit Sunshine Profits' website.

Twitter: @SunshineProfits
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No positions in stocks mentioned.
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