Gold and Silver Update


When Fundamentals clash with Technical Charts who to follow? What role does the Gold-Silver ratio play? What happens if Gold breaks above $1000? What does that mean for Silver? And what should the prudent investor do?

How Intelligent Investors Think

We are approaching another critical point for the Precious Metals Trader. Notice how I say “trader” not “investor”. An investor doesn’t follow a position. He buys low – when demand is virtually non-existent, and sells high – when demand is irrationally justified. A trader on the other hand, may profit from medium term trends. What’s interesting is that more often than not, the investor wins. The reason for this is that generally markets follow trends. “Generally” implies most of the time, however when they do buck the trend they do so with “shock and awe”. Thus, we must approach this current scenario like an investor/long-term trader, and not like a little kid out to make a few dollars.

Many recall the March 2008 highs. Note that Silver is still 20% below its 2008 high and 65% below its all-time. At the time, we did not sell and our reasoning was very clear and even in hindsight “justified”. “If the downside is significant we can always wait it out. Yet if prices pivot to the upside – and they have strong reason to do so – then there will be no way for the investor to re-enter the market”. Basically, you can’t jump onto a moving train. (Well, you could, but its not advised).

One note on the matter: We don’t really “invest” in gold or silver. Gold is the ultimate currency and should be the default holding of any investor. Only an investment of significant upside and strictly limited downside should be wagered for its value.

Outlook

What we see now is similar to March 2008 in the sense that the Technicals look bleak, while the Fundamentals look increasingly resilient. Gold has just broken-out above $1000. This has stood as a significant resistance level and its abolition holds the keys necessary to bring thousands of traders and funds into the market again. These are mostly people who are waiting on the sidelines to see if the rally is sustainable.

Another factor, that will definitely play a key role in the longer-term is the fact that Central Banks are now buying gold, not just selling it. This create a fascinating equilibrium in a once Dollar-dominated monetary system. The game may be up, this time for good. In addition, mining companies, such as Barrick, intend to de-hedge their positions in gold shorts – which were profitable when Gold was falling in the 80s and 90s but with rising prices has now turned against them. These two development are decade changing events and will alter the precious metals market for years to come.

Finally, there is not a lot that the U.S. and the Dollar have to gain from expensive gold. It destroys their credibility and instills fear in the hearts of fiat-borrowers. This being the case, it would be of no surprise if governments make one last-standing effort to contain the gold price. Problem is, that while this was once going with the flow, its now battling an uphill trend – a strong one to say the least.

When Fundamental and Technical indicators clash one must look at Sentiment. This is the one differentiating fact between 2008 and today. While March 2008 was met with great fear and anxiety regarding the future of the economy causing extreme bullishness in precious metals, September 2009 is met with confidence and calm, to the point of skepticism that Gold can old above $1000.

The fact remains, that the precious metals are over-bought and reaching stress levels on the upside, but these factors are merely short term. The overall trend remains up and amidst the strongest buying month of the year, the top may not yet be upon us.

The Gold-Silver Ratio

Many market followers don’t reallize that silver is due to outperform simply due to its recent under-performance and under-valuation relative to gold. Geologists estimate that the in-ground Gold-Silver ratio stands at something between 8-20. This means that there is approximately 8-20 times more silver than gold. Yet above ground reserves have dwindled significantly in recent years as much of the metal has been used industrially or has gone into private hoards and won’t come out until prices increase over-and-above current estimates.

The ratio, now at about 60 as of this writing, is still high relative to its suggested variant. This means that if one could expect a mean ratio of say 45, then with Gold hovering at $1000, Silver can still rally straight up to $22. If Gold rallied to $1650, as many expect within the next 12 months, we can expect to see Silver as high as $36. Again this is all if we revert to a mean ratio. But markets tend to over-extend their pre-defined impacts. Only time will tell.

Summary

There is no question that the bull market is intact. As for corrections, “they’re as predictable as snow storms in winter”. Yet, when it comes to making sound financial decisions, the ones that don’t require much thinking are those that warrant action. The best action is often no action. I saw many people who call themselves “investors” pile out of Gold in 2008. Yet, they did so for the wrong reasons. No one saw the collapse of Lehman Brothers sweeping the market causing a massive full-scale sell-off affecting each and every asset class – precious metals included.

On the flip side, had the market rallied on the COT short-squeeze, or had a major buyer stepped into the market, they’d probably still be locked out of the market forever. This time is no different. Maybe prices will decline, maybe they’ll rally… but its a bull market you know!

A Story

In Reminisces of a Stock Operator, the famed trader Jesse Livermore teaches many valuable lessons about markets and trends. In one event, he was told the following

“When you are as old as I am and you’ve been through as many booms and panics as I have, you’ll know that to lose your position is something nobody can afford; not even John D. Rockefeller. I hope the stock reacts and that you will be able to repurchase your line at a substantial concession, sir. But I myself can only trade in accordance with the experience of many years. I paid a high price for it and I don’t feel like throwing away a second tuition fee. But I am as much obliged to you as if I had the money in the bank. It’s a bull market, you know.”

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