Precious Metals Update

Fri, Feb 10, 2012 - 3:47pm

After suffering major declines in 2011, precious metals have bottomed and are attempting to breakout of recent consolidations. Given that silver, gold, and precious metal miners remain oversold from a long-term perspective, they are not at risk of a major decline from a purely technical risk point of view. Additionally, we are currently seeing three out of four key relationships in the metals markets that bode well for future performance. There is still yet hope that 2012 may make up for a dismal second half in 2011.

Key Relationships in Metals Market Paint Bullish Picture

When the economy is in full swing and expanding you see it displayed as cyclical sectors like industrials, basic materials, and technology outperform non-cyclical sectors like health care, consumer staples, and utilities. The same is true in the metals market where healthy moves within the space occur where the most risky, most leveraged areas outperform the safer investments. When the metals market is firing on all cylinders you tend to see juniors and small-cap producers outperform large-cap, which then outperform gold and silver bullion, with silver tending to outperform gold given its greater industrial usage. Subsequently, another key metric to keep an eye on for the producers is the relationship between gold/silver bullion and crude oil, which serves as a rough proxy for profit margins.

As things now stand, we are seeing bullish developments in three of the four key relationships: gold is outperforming oil (rising profit margins), juniors are outperforming large-cap producers, and silver is outperforming gold, indicating healthy levels of investor sentiment. The one negative relationship is that large-cap miners are still underperforming gold bullion.

Gold Update

Gold moved from one of the most overbought readings in the middle of 2011 after its parabolic rise to the most oversold reading since the 2008 low as it closed out the year. Gold has since rebounded and currently rests in neutral territory giving it plenty of room to run before becoming at risk of a major decline.

Silver Update

Like gold, silver moved from being significantly overbought in 2011 to an oversold extreme. Currently silver’s rebound has only pushed it into neutral territory and also leaving it plenty of room to run before becoming at risk of a major pullback.

Large Cap Miner Update (HUI Index)

While the large-cap miners (HUI Index) became overbought in 2011, they significantly underperformed both silver and gold bullion and never reached elevated territory (>1.0). Also, the selloff into yearend pushed them into the most oversold level since the 2008 lows. The HUI is still somewhat oversold as it is slightly below neutral levels, giving it even more potential to run than silver or gold bullion before becoming at high risk of a major decline.

Using rate of change to measure mean reversion potential for the HUI, the short-term 20 day rate of change (20d ROC) is back to neutral after becoming overbought last week and its intermediate-term mean reversion potential (60d ROC) is still depressed and at levels of intermediate lows. Taking both the 20d ROC and 60d ROC suggests that we have a short-term pullback after an intermediate-term low was made. Both measures suggest we are closer to a low than a top and the risk for a major selloff remains low.

Summary

For the first time since 2010, we are seeing key relationships within the metals market in a bullish position which indicates precious metals may be setting up for a big first half move, particularly when both gold and silver bullion and the HUI are closer to oversold levels than overbought and would have to rally considerably before risk rises for a major overbought correction.

About the Author

Chief Investment Officer
chris [dot] puplava [at] financialsense [dot] com ()