Note from Louis Basenese: Back in April, I ruffled everyone’s feathers by suggesting that silver was “long overdue for a correction.” Incidentally, my friend and colleague, Marc Lichtenfeld of Investment U, issued a similarly contrarian warning to his readers just two weeks later. And guess what? We were right! In a matter of weeks the precious metal dropped about 30%.
But the price has now stabilized, so with the economy still struggling and debt firestorm still raging in Washington, what’s next for silver and its fellow precious metal – gold? Marc has a compelling and potentially profitable idea below. And since I’m en route to Seattle today, I figured I’d share it with you.
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Our elected officials in Washington are taking the phrase “politics as usual” to a whole new level at the moment.
And if they continue to play partisan games with the debt ceiling issue over the next few weeks, the fear meter will tick ever higher for investors.
In turn, you should see demand rise for traditional safe haven investments. Two of the most prominent, of course, are gold and silver.
But rather than just pile in arbitrarily, we need to zero in, because there’s an anomaly in the precious metals market at the moment.
Simply put, the trade I like most right now is to buy gold and short silver. Let me show you why…
Gold Has History on its Side
While some investors think of both gold and silver as safe havens during times of panic, many more simply think of gold.
After all, gold’s performance is not only more publicized, it’s also better.
For example, during the financial collapse in 2008, while gold and silver tanked along with all other assets, gold held up much better than silver, falling 29% peak-to-trough, compared with silver’s 59% slide.
And once both metals rebounded, gold actually finished 2009 above its 2008 peak, while silver was still 5% below. It wasn’t until things had calmed down in 2010 that silver soared.
Given the debt ceiling issue, I’d expect gold to be the dominant metal. Here’s why…
The Technical Takeaway: Bearish on Silver
Pull up the chart for the SPDR Gold Trust (NYSE: GLD) and you’ll immediately notice that the ETF is sitting at a 52-week high and looks to be trying to trade back above its trendline. It’s set higher lows and after the last low, it bounced right back. That’s a clear sign of strength and an indication that higher prices could be ahead.
On the other hand, the chart for the iShares Silver Trust (NYSE: SLV) isn’t nearly as strong. After the large drop in late April and early May, the ETF has tread water. Furthermore, its 50-day moving average is curving lower. That’s never a good sign, especially given its failed attempts to climb above the 50-day line over the past few months.
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And until this week, SLV had also made lower highs and lower lows, which is another bearish sign. We’ll have to see if these new highs hold. If they don’t, expect to see another lower low.
This is a significant change from the norm in the precious metals market…
Gold and Silver: Locked Together for 10 Years
As you can see in the chart below, aside from the occasional outperformance, gold and silver pretty much moved in tandem for over 10 years. And even when one metal did post a meaningful outperformance, they usually got back in sync relatively soon afterward, or even switched places.
But in late 2010, the relationship changed big-time. The price of silver not only blasted higher, it also did so relative to gold’s performance.
So what do we take from this?
Metals Ready for a Reunion… But Make Sure You Play it Right
Simply put, if the past is any guide, the performance of gold and silver should return to their historical relationship.
The question is: How?
Some think gold will catch up to silver. But given silver’s meteoric rise, I’d expect them to meet halfway, with gold continuing to rise and silver continuing to fall.
Bottom line: If you want more gold in your portfolio, but don’t want to be too heavily weighted toward precious metals, going long gold and short silver is a good hedge that should provide positive results.
And even if I’m wrong about silver going lower, gold looks like it should outperform silver. That would give investors some upside during a price rise for the metals, while lowering the risk of being overly exposed.