A Metals Trade Hedge Funds May Take

04/04/2012 11:25 am EST

Focus: COMMODITIES

Steady underperformance by gold mining stocks relative to physical gold and an opposite scenario playing out for silver is creating a long/short opportunity contrarians and hedge funds will like, writes Willem Weytjens.

Although gold prices are off their highs of 2011, they still remain at a reasonably high level.

From the chart below, we can see that gold and silver are highly correlated:

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With high gold prices and the fact that the stock markets are near their highs, it would make one assume that gold stocks did well too, right? Wrong!

When we measure gold stocks (using the Market Vectors Gold Miners ETF (GDX) as a proxy) versus gold (using the SPDR Gold Trust (GLD) as a proxy), we can see that they are setting new lows.

This is in contrast with silver stocks (using Global X Silver Miners ETF (SIL) as a proxy) versus silver (using the iShares Silver Trust (SLV) as a proxy), which are still well above the low:

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It gets even more interesting to see that this underperformance of gold stocks measured in gold relative to silver stocks measured in silver occurred at a time when the gold-to-silver ratio was flat (which means that gold and silver moved in line with each other):

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The fact that gold stocks measured in gold have underperformed silver stocks measured in silver can be seen in the following chart, as the ratio of GLD/SLV drops to new lows.

The spike in early 2011 in the chart below can be attributed to the fact that silver prices outperformed silver stocks dramatically when silver shot up towards $50 per ounce:

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What is the reason for this recent anomaly? Well, as always, I think sentiment explains a lot.

NEXT: Latest Sentiment Readings for Gold and Silver

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As we can see in the charts below (courtesy of Sentimentrader.com), sentiment for gold (first chart) is reaching an extreme low, as it has pushed through the lower band of the standard deviations, while sentiment for silver (second chart) is neutral, and thus, far from reaching extreme lows:

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No wonder the sentiment for gold bugs is also extremely low:

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From this perspective, I like gold stocks better than silver stocks at the moment.

Wouldn’t it be a nice trade for hedge funds to go long gold stocks and short gold, and long silver and short silver stocks now? Time will tell!

By Willem Weytjens of Profitimes.com

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