Gold-silver ratio signals the worse is coming to an end for bullion

Silver could be gearing up for a rally

Gold prices have been fluctuating around $1,200 over the past few weeks. Similarly, silver prices, after tumbling about 20 per cent in the past three months, has managed to sustain above $14 per ounce. The recent sideways consolidation in both silver and gold is increasing the hopes that the prices could bottom. Though it is too early to take a call, a study on the gold-silver ratio signals that the worst could be coming to an end for both silver and gold.

The gold-silver ratio is calculated by dividing the price of gold per ounce by the price of silver per ounce.

Interpretation

Gold and silver tend to move in the same direction most of the time. The movement of the ratio is always the inverse of the gold- and silver-price movements. So when gold and silver prices decline, the ratio increases, and vice-versa. Since silver forms the denominator of the ratio, the volatility in its prices influences the ratio movement the most.

Also, a strong fall in the ratio will mean that silver prices are likely to outperform gold; so silver prices will rally more than gold. Similarly, a surge in the ratio will mean that silver will underperform by falling more than gold.

For instance, the ratio moved higher, from around 75 in June to 85 a couple of weeks ago, due to the sharp fall in the gold and silver prices during the corresponding time.

The gold price tumbled from $1,300 to $1,190 (down 8.5 per cent) and the silver fell from $17 to $14 (down 17.6 per cent) over the same period. So, forecasting how the gold-silver ratio is going to move could give a clue to the direction of bullion prices.

Gold-silver ratio outlook

Gold prices tumbling below $1,200 per ounce and silver falling to $13 per ounce has taken the gold-silver ratio to a high of 85. However, the ratio is struggling to decisively breach 85. Technically, there is a strong resistance for the ratio at 85, and then in between 86 and 87. The ratio moving beyond 87 looks unlikely at the moment. As such, the ratio may start reversing lower, either from the current levels or after a slight rise in the near term to 86 and 87.

On the charts, there is a high possibility of the ratio initially falling to 82. A break below 82 can take the ratio lower to 80 and 78.

If the ratio moves up to 86 and 87, gold and silver prices may fall below $1,200 and $14, respectively, in the near term.

Subsequently, if the ratio reverses lower to the above-mentioned targets of 82 and 80, gold prices have to move higher. A rally in gold to $1,250-1,275 and silver to $15-15.5 will take the ratio lower to 82 and 80.

Take-away

A study of the gold-silver ratio indicates that the possibility of gold and silver prices moving higher from the current levels itself cannot be ruled out.

Also, even if the prices fall, the downside could be limited to $1,160 in gold and $13.5 in silver.

The outlook for both the gold and silver futures contract on the Multi Commodity Exchange (MCX) remains bullish.

The MCX-Gold (₹30,582 per 10 g) contract has a cluster of supports between ₹30,350 and ₹30,270. A strong fall, breaking below this support cluster, is unlikely at the moment. A strong break above ₹31,000 will initially trigger a fresh rally to ₹31,400. A further break above ₹31,400 will pave way for the next targets of ₹32,00 or even higher levels.

The MCX-Silver (₹37,590 per kg) has strong support at ₹37,000, which is likely to limit the downside. Resistance is at ₹37,800. A strong break above it can take the contract higher to ₹38,600 in the short term.

Trading strategy

Traders with a medium-term perspective can go long in MCX-Gold at current levels and also accumulate on dips at ₹30,450. Stop-loss can be placed at ₹30,175 for the target of ₹31,300. Revise the stop-loss higher to ₹30,750 as soon as the contract moves up to ₹31,100.

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