Cinderella Metal or Big Fat Pumpkin?

Since the Federal Reserve announced a third round of Quantitative Easing (QE3) on 12 September, there has been plenty of discussion about what it could do to the gold price.

I’ve spent the last four days writing about exactly that for next Diggers and Drillers newsletter (out soon). The thought of what $40billion worth of ongoing monthly bond purchases could do to the gold price over two, three or four years is mind-boggling.

In fact, I can see it causing the gold price to double over that time.

But you need to keep an eye on silver too.

Because after 15 months in the wilderness — silver has finally exploded…

You may not realise it, but gold (in Aussie dollars) has jumped 12% since the start of August.
But silver (in Aussie dollars) has left gold in the dust and gained 25%.

That’s a huge gain in less than two months. So what’s happening?

Silver Outperforming GoldSilver comprises a very small market. By some estimates there’s only about one billion ounces of silver bullion in circulation. No one knows for sure, but even if there were ten times more than that, the silver market would still be insignificant next to the gold market.And because the silver market is this small, it’s more sensitive than gold to the market liquidity you get when the world’s largest central bank prints more money.

The market had correctly predicted the Fed’s announcement of QE3. The buying started at the start of August in a successful attempt to front run the announcement. After such a big move, we’re seeing a small amount of inevitable selling.

But I’d expect silver to resume its move higher within the next four weeks.

One interesting way to look at silver’s price action is to compare it to gold. The ‘gold to silver ratio’ does this by dividing the gold price by the silver price. And it doesn’t matter whether you’re in US or Australian dollars, it works out the same.

Put simply, when the ratio falls — silver is outperforming gold.

The chart below shows what the ratio has done over the last few years. You can see that it fell in an unnaturally straight line around the time of the second Quantitative Easing program (QE2) in 2010.

The market was expecting QE2 months before it happened. And as traders bought silver in advance, the ratio fell from 65 to 50. And when QE2 started, the gold to silver ratio then fell all the way from 50 to 32.

The big drop in the ratio shows you that silver outperformed gold hands down over this period…

When the Chart is Falling – Silver Rises Faster than Gold

 

Since the end of QE2 of course, some heat has come out of the silver market. While gold has held its ground, silver has fallen from grace. But this reversal of fortunes allows the whole cycle to repeat all over again.

You can see that like last time, the ratio started falling — as investors bought silver — in anticipation of QE3. And, like last time, now that we have the QE3 announcement, the ratio has taken a pause.

So What Happens Next?Well, my bet is that as the effects of the Fed’s $40 billion monthly asset purchases hits the market in coming months, you’ll see the ratio head right back down again as silver rises faster than gold.Without knowing the end date of QE3 (no one knows), it’s impossible to anticipate how far it will go. If normal unemployment is the Fed’s goal, QE3 could last 2-4 years…possibly longer. As such, we’re just at the start of the next big drop for the gold to silver ratio.

Looking at the moving averages in the chart above, you can see that the 50-day moving average (blue line) is close to crossing under the 200-day moving average (red line). This is a powerful signal of a changing trend. You can see it happened before QE2. It heralded the big move down for the ratio, and saw the silver price soar.

It’s the same story for the silver price chart. I wrote to you about silver’s coming move at the end of July this year. The technical chart looked as though the selloff was finally done, and I finished by saying:
‘The trick to profiting from [silver] has been buying on the dips to get these gains – and just maybe we are staring at one of those dips right now’ A few months on and silver is up 25%. And today the Australian dollar silver technical chart looks better still.

We’re about to see the 50-day moving average (blue line) cross the 200-day moving average (red line) on the silver chart too. This is the famous ‘golden cross’. This last happened for Aussie-priced silver at the start of 2010.

This saw the start of a rally that tripled the silver price at its peak, and nearly doubled the price before the 50-day went back under the 200-day…

Silver About to See its Own Golden Cross?

So it’s a very bullish sign to see Aussie silver get close to a golden cross again. And in combination with a similar event for the gold to silver ratio chart, it’s a doubly bullish set up for silver.

How should you play the rising silver price? The easiest way is to own physical silver. There’s a bullion dealer in every city that you can find online, and there are online groups such as Silverstackers too.

Owning shares in silver companies is another way to play this, though over the last few years some Aussie silver stocks didn’t rise much faster than silver metal itself.

Right now I’ve only got one silver stock tip in Diggers and Drillers. It’s an explorer which I expect to outperform the silver price, as it has in the past.

But be warned with silver!

They call it the Cinderella metal. One minute it’s the prettiest girl at the dance, and then the next minute you’re left holding a pumpkin.

The good news is that after spending most of the last 15 months as a pumpkin, it’s turning back into Cinderella again.

How long for — we don’t know yet. That depends on how long the Fed keeps the taps on, and that depends on the unemployment rate.

So if you buy silver now, you’d want to start thinking about selling once the US unemployment rate improves — if that ever happens!

Dr Alex Cowie
Editor, Diggers and Drillers

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