-- Posted Tuesday, 25 July 2006 | Digg This Article

Below is an extract from a commentary originally posted at www.speculative-investor.com on 23^rd July 2006.

When confidence falls, gold outperforms silver

As noted in many previous commentaries, the trend in the silver/gold ratio can usually be explained by the trend in the broad US stock market. The following chart, for example, illustrates the positive correlation between the NYSE Composite Index (NYA) and the silver/gold ratio since the beginning of 2000. The relationship between the silver/gold ratio and the stock market hasn't always been as 'tight' as it's been over the past 7 years, but as discussed in our 31st May commentary most of the intermediate-term moves in the silver/gold ratio since 1970 appear to be related to what was happening in the stock market at the time. It is therefore our contention that silver generally out-performs gold when confidence in financial assets is rising and under-performs gold when confidence is falling.

Not surprisingly and not coincidentally, the sharp downturn in silver/gold over the past three months has occurred alongside a sharp reduction in the general enthusiasm for equities. At this stage, however, the declines in both the US stock market (as represented by the NYA) and the silver/gold ratio don't appear to be much worse than the declines that occurred during the first half of 2004. In particular, a case could be made that both silver/gold and the NYA are still in the upward trends that began during 2002-2003.

Our view is that the NYSE Composite Index will break its upward trend within the coming 6 months, which means that silver/gold should do the same. In other words, if we are right to remain intermediate-term bearish on the US stock market then we should expect gold to continue moving higher relative to silver with the ultimate bottom in silver/gold likely to roughly coincide with the stock market's ultimate correction low.

We don't, however, have a strong opinion regarding the path that will be taken by the US stock market as it works its way from where it is now to its ultimate correction low. It's possible, for instance, that the stock market will rebound for a few months before resuming its decline, a scenario that would probably result in silver experiencing a counter-trend rebound relative to gold. It's also possible that selling pressure will soon escalate in the stock market, thus bringing forward the ultimate correction lows in both the NYA and the silver/gold ratio.

Current Market Situation

We're expecting the US$ to move higher over the coming months and if significant US$ strength does materialise it will put downward pressure on gold. However, as was the case during the first half of 2005 a strengthening dollar over the next few months won't necessarily cause substantial weakness in the gold price. What we could well see in the gold market over the next few months is what we saw between March and August of last year: back-and-forth movement within a trading range.

We'd be buyers of gold below $600; we'd be enthusiastic buyers of gold at $540-$570; and we'd be mortgaging the final 40 acres and putting the proceeds into gold at $510.

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-- Posted Tuesday, 25 July 2006 | Digg This Article

Regular financial market forecasts and analyses are provided at our web site. One-month free trial available.

E-mail: Steve Saville

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