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Currencies and Stocks Suggest Improved Returns from Precious Metals

Based on the March 4th, 2011 Premium Update. Visit our archives for more gold & silver analysis.

 

Middle East is still the talk of interest in the commodity markets and the markets have been experiencing substantial volatility over the past weeks. Commodity markets also followed the trend and witnessed highs; Brent traded above US$115 a barrel while gold continues as a safe haven for investors with prices above $1400 per ounce. Apart from geopolitical speculations, precious metals have influenced by currency and stock market moves.

Before talking explicitly on these factors, it would be interesting to have a look at the correlation matrix featuring gold and silver correlations - what it has to say about precious metals and its relationship between currencies/stocks. Based on correlation, strength in relative moves in precious metals market can be foreseen.

From the below correlation matrix, we derive three significant links in the medium term. These are Silver/S&P, CDNX (in USD)/S&P, and HUI/Gold. Gold and Gold stocks being highly correlated is, of course, no surprise. Since the general stock market is verifying a breakout at this point, the implications upon silver and juniors is bullish.

Correlation Matrix

The short-term coefficients (the 10 and 30-day columns) this week are generally positive or negative - they are no longer insignificant, that is, in the range of low correlation (close to 0). The USD has generally moved in the opposite direction of gold, silver and gold and silver mining stocks. Therefore, if there was a slightly bearish sentiment for the dollar it would not automatically lead to analogous outlook for precious metals as a whole. Index levels of the currency markets are not of great concern at this time.

Additionally, please take a look at the 90-day column correlation between stocks and the HUI Index. Would a not-so-likely decline in the main stock indices influence gold stocks to a great extent? Not necessarily.

Speaking of the currency markets and other influences on gold and silver, let's have an explicit overview of currency and stocks markets and its implications on precious metals. Let's start this week's technical part with the analysis of the Euro Index (charts courtesy by http://stockcharts.com.)

$XEU Index

There were some important developments last week which are visible in the short-term Euro Index chart. A significant daily rally was seen on last Thursday, bringing index levels above the early February highs and unless an immediate decline is seen, this will invalidate the head-and-shoulders pattern. A decline from here would keep this pattern development underway.

At this point, the situation is mixed though we feel there is a slightly bullish bias. This is a change from what was seen in the last few weeks. It appears that a continuation of the head-and-shoulders pattern formation is less than 50% likely at this time.

$USD Index

In short-term USD Index chart, the doubts in long-term chart analysis are backed by the influence of a cyclical turning point likely to be seen very soon. There could very well be a rally from what appears to be an impending local bottom. Overall, the situation in the USD Index is overall mixed with a slightly bearish sentiment at this time. Conversely, the situation in the Euro Index appears to be slightly bullish.

The current rally in precious metals was not stopped by the trend in the currency markets. The correlation has been becoming more and more negative in the past days.

What does the stock market have to say in this regard?

$SPX Index

In the very long-term chart, stocks continue to basically move sideways though remaining above the levels of August, 2008 highs in the S&P 500 Index. No other significant developments are seen from a very long-term perspective here. The important implications here are that a resumption of a rally in the general stock market following the current period of sideways price movement could lead to a precious metals rally as well. This is especially true for silver.

That is, stocks appear poised to resume their rally as the current pause builds a foundation for another move up. In other words, the recent sideways price action above the levels of the August, 2008 highs leads us to a bullish outlook for the weeks ahead. The positive situation in the general stock market appears to have carried over to the precious metals sector. Overall, the implications to the precious metals appear bullish from here.

Let's move to the individual gold and silver markets and see what is currently going on there.

$GOLD Index

In the very long-term chart for gold, the $1,600 target level is still valid. Let's switch our attention to two important resistance levels which have recently been touched. These are the previous highs and the upper border of the rising trend channel. A period of consolidation is acceptable in view of this recent move.

Although recent price / volume action may have led to a temptation to get out of gold, analysis of all sides makes this seem to not yet be the right move. Volume levels do not support an overly bearish outlook, and the short-term trend for the yellow metal still appears to be up.

$SILVER Index

In case of silver, in the very long-term chart, we see that white metal has been moving in tune with the dotted-red line analogous to the move seen in 2005-2006. Its price continues to move towards the $38 level, which is still a valid target level (we originally featured this target in the Mid-week Feb 21st, 2011 Update) for this rally.

The breakout above the previous highs is clearly seen here and the RSI is not above the 80 level. Consolidation and a rising RSI level have not yet been seen and there simply are not any obvious bearish implications seen in this week's chart or trends.

The bullish outlook for silver appears strong enough to withstand the lack of a strong rally in the gold market. Silver's recent trend appears strong and it appears likely to continue from here.

Amid the positive outlook for gold and silver, what does the gold:silver ratio suggests? The ratio is quite low now (silver:gold ratio is high), as silver has outperformed significantly recently, however that does not automatically imply that we have turning point right now.

Before the bull market is over, gold:silver ratio is likely to fluctuate as silver is much more volatile than gold is, and its more correlated with the general stock market because of the abundance of its industrial uses. At this point we would not want to provide a detailed target for the ratio because it has just moved above the previous high - a move which has not been confirmed - however, the situation appears bullish as the silver:gold ratio is now back into the rising trend channel.

$SILVER:$GOLD Index

Please note that it may be the case that silver is not really outperforming in terms of its ratio - yet. It's simply catching up, and the true outperformance remains to be seen, as the ratio moves closer to the upper border of the trend channel. The current rally in the ratio appears as an unprecedented event, however if one takes into account that the ratio truly plunged in 2008 when stocks declined, then it becomes more reasonable. The first part of the current upswing was still a correction of the 2008 decline, not really an excessive move to the upside. Consequently, the excessive part could still be ahead, meaning even more significant rally in silver. We don't want to put a number on that yet, but if gold moves to $1,600, then silver might even go above our $38 target level.

Summing up, although the USD Index outlook has changed last week, the influence on the precious metals sector, however, is still bullish. The general stock market had rather lackluster movement last week following its recent breakout. This is still bullish news for silver and the rest of the precious metals sector. There is no change with regards to our feeling on long-term gold and silver investment positions and we continue to believe that long-term positions in precious metals market would definitely result superior returns.

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Thank you for reading. Have a great and profitable week!

 

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