Why Relative Strength Analysis is Important

Relative Strength is a simple concept in technical analysis. Its essentially the comparison between two different securities or markets. In most cases, its the comparison between one stock to its sector or the market averages. With respect to precious metals, there are numerous comparisons one can make. These include comparing a stock to the sector, a stock to the metals and a stock to the broad market. Often times we like to compare the gold stocks to gold and the silver stocks to silver. We can also compare gold and silver to the market averages, bonds or commodities. There is no limit to the comparisons one can make. Relative strength should be important to investors and traders because one wants to be invested in the leaders while avoiding the laggards and losers.

Let me provide a few examples with respect to precious metals. Silver stocks were a strong leader in 2010 and into spring 2011 while many gold stocks peaked at the end of 2010. Conversely, silver stocks were a disaster for the rest of 2011 and remained well off their highs in 2012. Yet, more than a handful of gold stocks reached new highs in late 2011 and a year ago when Gold rebounded to $1800. Junior exploration stocks performed fantastically in 2009 and 2010. Yet, even when Gold hit $1800 last year and some gold stocks reached new highs, the Canadian Venture exchange was 45% off its highs.

Relative strength is always important but its especially important now for two reasons.

First, the precious metals complex has arguably been in a long bottoming process for more than five months. We’ve argued that we can expect some type of retest this month and possibly a rebound into the end of the year. Whether it takes one month or three months, it doesn’t change that we are in a bottoming process. One wants to own the strongest stocks. Try to identify the stocks that have shown strength and outperformed during the past five months. The key is to buy those types of stocks on weakness (such as a sector retest of the lows). These stocks have a strong chance to accelerate first when the sector completes its bottom.

Second, use relative strength to identify and avoid the laggards. This is extremely important as many mining and exploration stocks can decline continuously and precipitously. Remember, these are not real businesses. Buying a weak stock on the dip is not a good strategy. Individual gold and silver stocks can fall 95% or even to 100%. Also, relative weakness can portend to a future problem or negative event.

On Wednesday, a highly-regarded NYSE listed development company plunged about 30%. This is a company we liked but called a sell weeks ago. The stock had started to perform badly (after being a leader) and the weekly chart showed heavy distribution. Also, highly-regarded geologists (legitimate and credentialed I’d add) voiced some skepticism about the project. I don’t know how this situation plays out but relative strength analysis gave us a clear warning of what was to come.

If you haven’t already, please incorporate relative strength analysis into your repertoire. It’s only one tool but its a useful tool. It will help you avoid laggards and losers and keep you in companies that are market leaders. This is true for precious metals and for any sector. As this bottoming process in precious metals moves to its final stages, readers are advised to identify the companies with the best fundamentals and growth potential that are showing relative strength. Focus on the leaders and avoid the laggards. If you’d be interested in our analysis on the companies poised to lead this new bull market, we invite you to learn more about our service.

Good Luck!

Jordan Roy-Byrne, CMT