by David Brady, Sprott Money:

The GOLD:SILVER RATIO or “GSR”

When Gold falls, the GSR typically rises as Silver falls even further than Gold. Call it a high beta play on Gold. The same happens in reverse, when Gold rises, the GSR typically falls as Silver outperforms Gold to the upside.

From 2001 to 2003, when Gold was rallying off its low of ~250, Silver lagged Gold’s performance during that entire period. The GSR rose from 46 to 82.

Then from May 2003 until Nov 2006, Silver began to outperform Gold and caught up. The GSR fell to 45.

Then Silver weakened before Gold did heading into the 2008 sell-off. The GSR spiked higher in 2008 to 88.

But once the bull market resumed in Oct 2008, it didn’t take long for Silver to catch up to Gold and pass it by. The GSR fell to 32 before Silver again peaked before Gold did in 2011.

So the two takeaways are:

#1 – Gold leads Silver in nascent Bull markets and then Silver catches up and ultimately outperforms Gold.

#2 – Silver tends to lead Gold on the downside, i.e. ahead of major peaks.

Now looking at the current situation, we see something similar going on…

Since the December 2016 bottom in Gold at ~1124, Silver has underperformed its big brother. The GSR has risen from 68 to 93 today.

But now Gold has broken out to the upside, and given its already been 3 years since the bottom in the GSR, it likely won’t be much longer before Silver starts to play catch up in a bag way, and ultimately passes Gold by.

The alternative is that Silver is signaling that this bull market in Gold is about to fail. Gold faces some stiff resistance in the near-term. The following are Fibonacci retracement levels of the entire decline from the peak of 1923 in August 2011 to the bottom at 1045 in December 2015:

Note the 38.2% retracement level at 38.2%. It took a long time and many tests of that level before we broke it. Now we’re within reach of 1485 after a spectacular rally since 1267 and arguably since the bottom last August at 1167. Above there is 1588. Any one of these levels could cap this rally and send Gold lower.

Then there is the XAU/CNY. This has been fused to the hip of Gold in dollar terms since August thanks to the relative stability of USD/CNY since then. It is approaching the psychological level of 10,000. I wouldn’t be surprised to see it test and fail to break it the first time around. It could also be a major top that would coincide with a peak in Gold at ~1450 in dollar terms with USD/CNY ~6.88.

Gold also is extreme overbought at levels not seen since the peak of July 2016, based on the daily RSI and MACD Line, and in the case of the weekly RSI, since the August 2011 peak. Large and small speculators are loading up long while the Bullion Banks are piling on the shorts with open interest only higher in July 2016. As for sentiment, it seems everyone is bullish Gold these days. The data is not on Gold’s side.

That said, the trend is your friend until it isn’t and the trend is clearly up! Since December 2015, I have believed we’re in a new bull market in Gold and we’re heading multiples higher. What could change that? A break of 1350 would be an early warning sign, a drop below 1267 would raise serious doubts, but as I said months ago, unless we go below 1167, I am only looking up.

CONCLUSION

To sum up, to the extent that we believe this bull market has just begun in earnest, and it has in my opinion, everyone should be buying Silver, not Gold. Silver is extremely undervalued relative to Gold and if history is anything to go by, Silver will soon begin to outperform Gold and ultimately pass it by in terms of gains. It did so from 2001-2011 and from 1974-1980, when Gold rose 24x but Silver rose 36x.

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