Where next for the price of Gold and Silver?

A 5% holding in gold has been a consistent part of my own £50k portfolio and remains a long term ‘buy and hold’ allocation because of the diversification benefits it provides. The inclusion of the iShares Physical Gold ETC was inspired by my research article "Should you ever invest in gold? If so how much?" which I published in 2015. I plan to update this article in the coming days to see if the findings remain valid, especially as we've experienced some historic market conditions in recent years.

But it's also been a number of years since I've considered the outlook for precious metals, which included both gold and silver. Recently I published a technical analysis article on the outlook for key equity markets and the value of the pound, so I think it timely to do the same for gold, especially given that it has rallied almost 25% since the autumn of 2022. This move has obviously piqued a lot of people's interest in the precious metal.

What is technical analysis? - A recap

First of all for those new to the idea of technical analysis here is a quick recap of what it is.

Trying to predict the future of the stock market or the price of any asset (including gold or silver) is akin to reading tea leaves. Personal predictions are almost always clouded by prejudices which reaffirm what we ‘want’ to happen rather than what is ‘most likely’ to happen. In addition, the narrative of why the price may go up or down is highly subjective but also prone to confirmation bias.

One objective method is to use technical analysis to try and judge the likely future outcomes. So what is technical analysis? One line of thinking is that asset prices (such as the price of stocks or the price of gold) are driven largely by human behaviour. At the simplest level you could argue that fear and greed drive a lot of investors’ actions. Let’s say that an opportunity presents itself and some investors jump on it and buy the shares in question. The demand then drives up the price. More investors jump on the bandwagon looking to profit. Then at some point the tide turns (fear sets in) as people think the price for the shares (or whatever asset you are looking at) is looking expensive and so people start selling. More and more people start selling to take profits and the price falls. At some point the price falls until others think the shares look cheap and start buying, outnumbering the number of sellers. Again demand outstrips supply and the price goes back up.

This see-sawing explains the movement you see in investment markets. The prices at which investors start bailing and selling the shares are called lines of resistance while the prices at which they pile in are called lines of support.

As such there is a surprising level of predictability to human behaviour. In terms of the stock market that means when the price goes through historic points of resistance or support it can indicate a new unfolding market rally or collapse. Why does it do this? Part of it will be because traders trading in millions of pounds will use these lines of resistance and support to trigger trades. Yet for a lot of investors they might not even be aware of these inflexion points. They simply are reacting to how other people in the market are behaving. Put it this way, when stock markets fall you feel tempted to sell, right? Also once it starts to rally, you are tempted to jump in? That’s why these patterns have a tendency to repeat.

Some investors and traders swear by it and trade solely using technical analysis. I don’t fall into that camp. I view technical analysis like a road map drawn by someone who has already completed a journey to somewhere near where you are planning to drive to. The road map won’t take you exactly to your intended destination, nor will it be entirely accurate. However, it will give you a better sense of what to expect.

One of the benefits of technical analysis is that it only considers the price of the asset. So the reasons why an asset, such as gold, may have risen/fallen in value or might do so in the future is irrelevant. It cuts through the noise to give you some insight into future possibilities. But like a weather forecast, it is not a guarantee of what will happen.

Gold

I recommend reading the last gold technical analysis piece which I wrote in August 2020, because it is a great example of when technical analysis can accurately highlight short and long term trends.

In summary, last time I discussed how the price of gold broke above $2,000 per ounce after the US Federal Reserve restarted its Quantitative Easing (QE) programme. I then suggested that such parabolic moves are not usually sustainable and highlighted the possibility of a 20% pullback in the price of gold to $1,680. It was a bold call but as the updated chart below shows, that is EXACTLY what happened. I even got the low of the initial pullback almost spot-on at $1,680. Technical analysis doesn’t always work so beautifully, but when it does it reinforces its usefulness as a tool.

Following that initial pullback we did see a lower low of $1,626 in November 2022, after a new multi-year high was achieved in the wake of Russia’s invasion of Ukraine. Interestingly in 2020 I highlighted the potential formation of a bullish cup and handle pattern that began in 2012. At that time the handle hadn’t formed, but I speculated that if it did it could prove bullish for the price of gold with a target price of $2,500. Here is an updated long-term chart for gold on which I’ve highlighted the potential cup and handle pattern which has now formed.

Have we finally seen the completion of a decade-long set-up? If the price of gold is to break higher, towards $2,500 then the $2,050 resistance line will prove problematic in the short term. At present the price of gold is testing the bottom of an uptrend channel (shown in the first chart) that began in November 2022 and the $1,950 level will prove crucial. A significant move below this could see a fairly swift move towards the 200 day moving average at $1,860 (not shown on the chart).

Gold also typically moves inversely to the strength of the US dollar, although the relationship does change. At present, the recent dollar strength (shown in the chart of the US dollar index below) has certainly hurt the rally in gold. The recent rally in the US dollar index has been driven by concerns surrounding the US debt ceiling, which when combined with rising bond yields and interest rates, has proved a drag on the price of gold. So in summary, gold's short term outlook is in the balance, but long term there remain positive signs.

 

Silver

Back in 2020 I highlighted how silver rallied alongside gold but the parabolic move in 2020 fizzled out as shown in the chart below. Interestingly the critical $23 support level I wrote about was tested on a number of occasions before we saw a decisive break lower in the spring of 2022.

Silver remains the more volatile cousin of gold but it has been caught in a downtrend (shown above) since early 2021. It has since tried to break out of that downtrend and is currently retesting its upper trend line. How it behaves at this juncture is key to the short term outlook. Should it break back into the downtrend then keep an eye on $22.3 which is the 200 day moving average. A break below there would be very bearish for silver and we'd likely quickly revisit $20, which would represent an almost 15% decline from current levels. While some of the recent weakness in gold will have bled over into the silver market, much of the weakness is a result of the deteriorating economic outlook, certainly in the face of a possible US debt default. Silver has industrial uses, unlike gold, so economic fundamentals also impact its price movements.

Looking higher, $25 and $26 resistance levels are likely to prove a challenge to overcome, but a rally to $26 would still represent a 10% rise from current levels.

Gold/silver Index

As a closing thought, the gold/silver index is again worth highlighting. It is calculated by dividing the current gold price by the price of silver. So currently the gold/silver index is 121, while the historical average is somewhere between 50 and 70. Therefore a number of 121 suggests that gold is overvalued versus silver and that silver is likely to perform better (on a relative basis) than gold in the near term.