It’s been a solid start to Q1 for the precious metals space, with silver up (SLV) up more than 6% for the month, erasing most of its year-to-date gain. This rally in the metal has come at the same time as we’ve finally seen sentiment begin to cool off with readings below 30% bulls, and while the Silver/Gold ratio continues to hold up very well in the face of recent weakness. Generally, a violent correction in the metals space can be differentiated as healthy or dangerous based on how this simple ratio is acting. Given its recent strength, the odds suggest the pullback has merely been a shakeout, and new highs could be on deck before year-end. Let’s take a closer look below:

(Source: TC2000.com)

As shown in the chart above, the silver/gold ratio has had a tremendous year, continuing to make higher lows and making new highs in January. This powerful uptrend in this ratio with minimal giveback is a very healthy sign for the precious metals sector because it’s very rare that we see a new bear market in the metals complex while silver is leading. Instead, when a new bear market is on the horizon, silver typically breaks down and starts to underperform gold in an obvious manner.

The fact that this ratio has held up and continued to make new highs despite the weakness in gold and silver to start the year has increased the probability that we are still in the earlier innings of a new bull market for the metal, meaning it’s time to accumulate the best silver miners like GoGold Resources (GLGDF). For reference, the 2011 top is shown below, which shows that this ratio was breaking down at the same time as gold was printing new highs above $1,900/oz.

(Source: TC2000.com)

So, how is sentiment looking?

(Source: Daily Sentiment Index Data, Author’s Chart)

As shown above, while silver is not near a buy signal yet (below 10% bulls), it has dropped to much more interesting levels, with the bear camp outweighing the bull camp for the first time this year. Just because we didn’t get a buy signal in silver does not mean that the market can’t bottom out near $24.00/oz where it found support last week, but it does suggest that there is the possibility for a lower low closer to $22.00 to $23.00/oz ahead.

However, with sentiment near 20% bulls despite silver being above its 200-day moving average, it’s certainly possible that the lows are already in, and it’s great news that sentiment has finally reset for the most part. This is the opposite of the setup we had in February when I warned that the trade looked a little too crowded for the metal to make new highs in the short term. Let’s look at the technical picture:

(Source: TC2000.com)

It’s easy to get caught up in the day-to-day noise, but the long-term chart for silver suggests that we have a healthy breakout with not even a back-test of the multi-year breakout level. This is a very bullish development over the long run, suggesting that higher prices are ahead as long as the $22.00/oz level is defended.

Besides, unlike gold, silver did not break down below its breakout level for the time being, which also confirms that it’s leading the metal. The best-case scenario here (even if it would frustrate the bulls) would be for the metal to continue consolidating for a few more months to complete wash-out sentiment before attempting to make new highs later this year. There’s no reason that the market has to act this way, but this would allow silver to re-fuel for a significant breakout above $30.00/oz. For now, as long as silver is above $22.00/oz, the benefit of the doubt will go to the bulls.

So, what’s the best course of action?

I continue to prefer gold miners over silver miners simply because they can be bought at 15% plus free cash flow yields in many cases, but it’s difficult to find any silver miners above 8% free cash flow yields. However, one name that’s a standout in the silver is GoGold Resources. This ~$500MM market cap silver mine has a small operation in Mexico that generates free cash flow to spend drilling out its massive Los Ricos Discovery without diluting shareholders. Based on the past 18 months of drilling, it’s looking like Los Ricos could hold 200MM ounces of medium-grade silver, which gives the company a very reasonable valuation of barely $3.00/oz if it can prove this up in the next 12 months. Given that there’s a dearth of silver projects of this size in North America, I see the stock as a potential takeover target, and I would view any pullbacks below US$1.80 as low-risk buying opportunities. If I were looking to stick to the metal and stay away from leverage, any dips below $24.00/oz would be ideal spots to add exposure.

Disclosure: I am long GLD, GLGDF

Disclaimer: Taylor Dart is not a Registered Investment Advisor or Financial Planner. This writing is for informational purposes only. It does not constitute an offer to sell, a solicitation to buy, or a recommendation regarding any securities transaction. The information contained in this writing should not be construed as financial or investment advice on any subject matter. Taylor Dart expressly disclaims all liability in respect to actions taken based on any or all of the information on this writing.

SLV shares were trading at $24.06 per share on Thursday afternoon, up $0.47 (+1.99%). Year-to-date, SLV has declined -2.08%, versus a 11.43% rise in the benchmark S&P 500 index during the same period.

About the Author: Taylor Dart

Taylor has over a decade of investing experience, with a special focus on the precious metals sector. In addition to working with ETFDailyNews, he is a prominent writer on Seeking Alpha. Learn more about Taylor’s background, along with links to his most recent articles. More...

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