Gold/Silver Spread: Time For a Short Sale

Ready For a Routing In the Ratio

I just finished up a guest post on the gold/silver ratio over at Martin Kronicle. You can view the article here. The gist of it is that the ratio has reached a level where it has made major reversals in the past. If history repeats, the downside potential over the next year or two is significant.

Gold Silver ratio weekly

Gold Silver ratio weekly

With a ratio of nearly 80:1, I am looking at the spread between 8,000 ounces of silver and 100 ounces of gold. A position in the futures market can be created by subtracting the difference between the value of one 100 oz. gold futures contract and a the value of the sum of one 5,000 oz. silver futures contract and three 1,000/oz. ‘mini’ silver futures contracts.

Chart Work

The June-July gold (100 oz.)/silver (x8,000/oz.) spread is trading less than $1,000 away from the August 26th contract high of -$688. This could potentially turn into a double top or, better yet, a Wash & Rinse sell signal. That’s where the spread clears the old high, only to fall back below it and indicate that a breakout attempt was a failure.

June-July Gold (100 oz.) Silver (8,000 oz.) spread daily

June-July Gold (100 oz.) Silver (8,000 oz.) spread daily

Furthermore, the spread has closed above the rising 50-day Moving Average every single day since early November. This constitutes as an uptrend. But a two-day close below the rising 50-day MA (currently around -$4,098) for the first time in over three months would potentially trigger a bearish trend change.

How Aggressive Traders Might Do This

If you were a gun-slinging, gasoline drinking, fly-by-the-seat-of-your-pants commodities trader, you could try to short the June-July gold (100 oz.)/silver (x8,000/oz.) spread somewhere up here and risk a four consecutive closes above ‘even money’.

The reason for the four consecutive days above even money is because the spread only stayed above ‘even money’ more than four days in a row just once during the financial crisis. Therefore, a one or two-day event could be a temporary blip.

Then you could double up once the spread makes a two-day close below the rising 50-day MA. After all, the initial position would be showing a profit and you’d be adding more once price confirms.

If You Are NOT Crazy…

On the other hand, what would a conservative, risk-managing, always solvent trader do?

Probably the exact same trade!

The only difference between the two traders is in the position-sizing. The gunslinger may bet the farm on this trade. The smart trader will put on a position size that only risks a small percentage of his capital. If the trade doesn’t work, the conservative trader gets nicked and the crazy trader gets beheaded. If/when the spread gives a new sell signal, the conservative trader can try again. Not the crazy trader, though. He’s blown out all of his capital.

Sometimes the only difference between a winning trader and a losing trader is the risk management strategy, not the entry/exit signals. Make it a priority to become an expert on risk management and position-sizing. That’s how you get rich. More importantly, that’s how you stay rich.

Trade Strategy:

For tracking purposes, the blog will make a hypothetical trade by selling one 100 oz. June gold contract and simultaneously buying one 5,000 oz. July silver contract and three 1,000/oz. July ‘mini’ silver futures contracts at -$1,500 (premium silver). Initially, the spread will be liquidated on a four-consecutive day close above +$500 (premium gold).

Additionally, the blog will make a hypothetical trade by selling one 100 oz. June gold contract and simultaneously buying one 5,000 oz. July silver contract and three 1,000/oz. July ‘mini’ silver futures contracts if the spread closes below the rising 50-day MA. Initially, the spread will be liquidated on a two-consecutive day close above the August high of -$688.

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