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My System Signals This Precious Metal is Now a 'Buy'

Michael J. Carr

Investors concerned about inflation often invest in precious metals as a hedge. They believe that as the general level of the prices of goods and services rise, metals will increase in value and protect their buying power. There are times when this is true.

For example, in terms of gold, the cost of attending Yale University is about the same now as it was in 1950. At both times, one year's worth of tuition, room and board cost about 53 ounces of gold. This is just one well-selected example from the thousands of possible price comparisons, and it is a misleading example.

Attending Yale has cost as little as 17.6 ounces of gold in the early 1980s and more than 120 ounces in the late 1990s. Like any other commodity, the prices of precious metals fluctuate. Metals actually make a poor substitute for money in the long run since their prices fluctuate so widely.

It is true that an ounce of gold might be used to buy supplies when a crisis is unfolding. However, if things really hit the fan, a bottle of cheap whiskey is also likely to be accepted in place of currency.

Whether or not precious metals actually protect against inflation depends largely on the time period selected for the price comparison. The reality is that precious metals are traded in free markets and their prices reflect factors related to supply and demand in addition to inflation concerns.

Prices of all precious metals, including gold, are actually very volatile, and because of that they are useful for trading. I have included ETFs that track this sector in my 26-week rate of change (ROC) system because their volatility means they can deliver trading gains, or at times trading losses, relatively quickly.

Unfortunately, investing based on relative strength (RS) sometimes will lead to losses. Since mid-March, the system has had a buy signal on ETFS Physical Palladium Shares (PALL), and that ETF is down about 10.5% over that time. This is less than the nearly 14% loss seen in SPDR Gold Shares (GLD) and the close to 20% loss in iShares Silver Trust (SLV) over that same time.

Now, the system is signaling a buy in SLV, the metals ETF that has been leading the way higher since the sector bottomed in June. SLV has delivered almost twice the gains of PALL and GLD since that time, and if the bull market in metals continues, SLV is likely to remain the market leader.

This is a trading signal rather than a long-term buy. On the weekly chart below, SLV seems to be completing a rounding bottom pattern. The objective from the pattern is $28.74, a potential gain of more than 28% from the recent price. The pattern took almost five months to form, so traders should expect any gains from that pattern to develop over a similar time frame.

The chart also shows a gap that could offer significant resistance near $23. The 26-week ROC system is giving a buy signal now, and that system executes all signals with market orders. Conservative investors could consider entering with a limit order near the middle of the gap at $24.15, but that decreases the possible gains from this trade.

The 26-week ROC system is designed to be risk-averse. The system is avoiding fixed-income investments and international stocks for now. It has been bullish on the metals market, and investor sentiment could push metals higher if international stocks fall and interest rates rise. Higher interest rates could indicate that inflation concerns are rising and lower stock market prices could indicate that economic growth is slowing. This would be similar to the economic conditions seen at times like the late 1970s, which have been among the most favorable periods for owning gold and other precious metals.

Recommended Trade Setup:

-- Sell PALL at the market price
-- Buy SLV at the market price

After replacing PALL with SLV, the portfolio will be holding three positions:

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