Gold/Silver Spread: Go On, Take the Money and Run!

Book ‘Em, Danno!

The IMC blog is holding a hypothetical short position in the June-July gold (100 oz.)/silver (x8,000/oz.) spread.  It was entered at approximately -$1,890 (premium silver) on St. Patrick’s Day.

At the end of April, the spread nearly matched the multi-month correction low that was established on October 7th.  This was a key support level, so a bounce could be expected.

Gold (100 oz.) Silver (8,000 oz.) spread (nearest-futures) daily

Gold (100 oz.) Silver (8,000 oz.) spread (nearest-futures) daily

The spread bounced, of course.  But the problem is that it has continued to bounce.  If it was a simple bear market rally the spread should have turned over a few days later.  This bounce has lasted for nearly a month now.

Furthermore, the gold (100 oz.)/silver (x8,000/oz.) spread closed below the rising weekly 75-bar Moving Average for the first time in over three years when the month began.  This should have been an acceleration catalyst.  Instead, the spread closed back above the weekly 75-bar MA last week.

Gold (100 oz.) Silver (8,000 oz.) spread (75-bar MA) weekly

Gold (100 oz.) Silver (8,000 oz.) spread (75-bar MA) weekly

Since the blog is positioned on the short side of the spread, the price action over the last few weeks is a concern.

Where’s It End?

Currently, a Fibonacci .618 retracement of the entire decline from the March 1st multi-year high would send the June-July gold (100 oz.)/silver (x8,000/oz.) spread up to -$2,368 (premium silver).  This level would be confluent with the March 21st correction low of -$2,486.  Remember the old technical rule here: Old price support, once it has been broken, becomes new price resistance.

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

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

Now, just because the spread might make it to this resistance level, it doesn’t mean that it is obligated to stop there.  The spread’s been above ‘even money’ before.  Our approach is to react to how the spread behaves at support/resistance levels, not predict how it will behave.

A Golden Sign

A lot of times, the gold/silver spread will trend in the same direction as the underlying metals themselves.  Silver usually moves at a faster clip than gold.  So the gold/silver usually drops when metals rally because silver is moving up faster than gold.  Conversely, the gold/silver usually rallies when metals drop because silver is moving down faster than gold.

In light of this relationship, it can be illuminating to see what the underlying gold and silver markets are doing.

After a multi-year bear market ripped nearly half of the value off the yellow metal, gold staged a huge bull run off the December low.  As a matter of fact, gold started the year with its best quarterly gain –up a whopping 16.4%- since 1986.  A month later, the market was up 22% and hitting the psychological $1,300/oz. level for the first time since January 2015.   This could very well be the start of a new bull market.

But

Markets don’t go all the way up in a straight line.  Well, unless you’re short on margin and don’t have any protective stops or hedges in place.  But Murphy’s Law is a topic for another post, though.

It appears that gold could have finished a first leg higher and is just starting a correction.  Consider the market’s behavior on three timeframes:

On the daily chart, gold hit a short-term peak of $1,287.80 on March 11th.  It then recovered and cleared the March peak at the end of April/start of May.  This only lasted a couple of days and gold slipped back under the March high.  This is appears to be a failed breakout attempt.

Gold (nearest-futures) daily

Gold (nearest-futures) daily

Furthermore, gold pulled back to technical support at the rising 50-day Moving Average a few times in April. It recovered each time.  Today, however, the market is poised to close well below the 50-day MA.

On the weekly chart, gold nearly matched price resistance at the January 2015 top at $1,307.00 at the beginning of the month.  It failed to clear it and has now posted lower weekly lows for three weeks in a row.

Gold (nearest-futures) weekly

Gold (nearest-futures) weekly

On the monthly chart, gold has made higher monthly highs for five consecutive months.  That’s quite a stretch!  Gold has not done this since the end of 2010.  The same thing happened in late 2009 as well.  Breaks to three and four-month lows followed.

Gold (nearest-futures) monthly

Gold (nearest-futures) monthly

As an added bonus, the US dollar undercut the August 2015 correction low at the start of the month and quickly reversed higher.  This Wash & Rinse buy signal is bullish.  The reversal had momentum because the buck is now even above last month’s high.  This created an ‘outside bar’ with an upward reversal on the monthly timeframe.  Since the greenback and gold have a strong inverse relationship, meaning they usually trend in opposite directions, then the recent bullish behavior in the dollar will most likely be a stiff headwind for gold prices.

US Dollar Index (cash) daily

US Dollar Index (cash) daily

All that leads to the conclusion that the gold/silver spread could see significantly more upside over the near-term.

Here’s the Plan, Stan

Near-term, the spread looks poised for more upside.  So it makes sense to cover the position.  Longer-term, however, our studies of the spread and the ratio have led us to believe that the gold (100 oz.)/silver (x8,000/oz.) spread could see a minimum downside target of somewhere around -$80,000 (premium silver) over the coming months and years.

So we’ll do both.  Right now, we’ll exit stage right and take a quick profit.  (Don’t forget, though, that today’s profit will be slightly offset by the ‘add-on’ spread that we took a -$2,352 hit on back in March).  Then we’ll watch the price action closely from the sidelines and look for a setup to reenter a short spread position.

Trade Strategy:

On the hypothetical short position in the June-July gold (100 oz.)/silver (x8,000/oz.) spread entered at -$1,890 (premium silver) on March 17th, exit at the market-on-close on Tuesday, May 24th.  

 

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