Sunday, September 16, 2007

Silver May Begin to Outperform Gold Part 1

Over the last month, Gold and Gold stocks have done extremely well. In fact, the price of an ounce of gold has risen about $70 in the last month. With such a large move in gold, one would have expected silver to have moved aggressively higher, but, unfortunately, that has not happened. The following ratio chart shows that silver has been lagging behind gold since the beginning of last year:

Let's look at a longer term chart of this ratio to see what the longer term trend is. The following chart is a weekly candle chart of the ratio. The chart at the bottom represents XGD, a gold stocks ETF:

Interestingly, the silver/gold ratio tends to replicate the performance of gold stocks. This means that for the gold stocks bull market to remain healthy, we will need to see silver start to outperform gold. Luckily, that may begin to happen now.

The reason I believe this is due to how the Commitment of Traders Data looks like. In a nutshell, this refers to the data that the US Government collects on futures and options traders every week. Each Friday, a report is compiled and released to the public breaking down the futures and options positions of three categories of traders.

The three categories are: large speculators, commercials, and small speculators. The smart money is considered to be the commercials, since they usually produce the commodity, and have access to more information on business conditions than the general public. The commercials are usually net short when it comes to silver and gold, but it is wise to look for times when they are close to being long, or when their short positions are reduced. When this happens, it is considered a buy signal.

The large speculators are considered the dumb money. When they go extremely long, it is a signal to get out. On the other hand, when they are carrying a very small position, it is considered a buy signal. Large speculators tend to take the opposite position of the commercials.

The small speculators don't matter much, and they rarely give any meaningful signals. For more information on this, I would highly recommend a book called, Trading Stocks and Commodities with the Insiders, by Larry Williams.

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