Charting Asia

Playing gold? Keep an eye on silver

Getty Images

Gold prices fell to a near-three-week low on Monday amid sharp exchange traded fund outflows, continuing to erode mild gains posted in the first quarter of 2014. For those with an eye on silver the erosion of gold's recent gains should come as no surprise.

Comex silver has led gold prices since 2011 and it's not about to give up that leadership role. The lag between silver and gold prices has been reduced but silver continues to lead price developments. Looking at silver gives traders a leading advantage when it comes to anticipating the behavior of gold.

Read More Gold extends losses to fourth session; fund outflows continue

I offer no explanation as to why this relationship exists. What is more important is the trading advantage conferred by the relationship.

The peak price in Silver in April 2011 appeared before the peak in Gold in September 2011. The collapse following these price peaks showed the same behavior for silver and gold. Traders who followed silver had clear warning of how gold would behave once the peak price was established.

The silver price-leadership advantage was reduced in 2012 and again in 2013; the price lead is now a matter of days rather than weeks or months. However, a lead of several days is enough to give gold traders an advantage. They watch developments in sliver prices and then wait for confirmation of the behavior in gold prices.

The key feature in the silver chart is the retreat and retest of the support level near $18.70 (note this chart scale is in cents). A successful retest of support near $18.70 confirms a long-term sideways consolidation. Silver is constrained by strong resistance near $26.00. Traders have seen weak rallies and strong retreats within this trading band. The upper edge of the trading band is at long-term support at $26.00 was not tested in 2013. There is limited rebound strength in this market, which suggests the probability of an uptrend reversal is low. This is also bearish for gold.

Failure of support near $18.70 has a downside target near $11.30. This is calculated by taking the width of the trading band and projecting it downwards below support near $18.70.

A break below $18.70 support is bearish for silver. It is also very bearish for gold.

Read More Gold bear takes on bug: 'You're miles off base'

The key features of the trend weakness are shown with the Guppy Multiple Moving Average (GMMA) indicators, which track the behavior of traders and investors.

The long-term GMMA (in red) is widely separated, which confirms continued selling pressure. When the price rises investors enter the market as sellers, pushing the price down and reducing the probability of the rally developing into a trend change. The long-term GMMA is widely separated; this absorbs the upward price momentum. The rally in silver in March 2014 was defeated by the wide GMMA separation.

What is important is that the behavior of silver prices will provide a guide to the behavior of gold prices. The retest of support near $18.70 for silver suggests gold will retest support near $1,180. How silver behaves near $18.70 will provide a guide for the expected price activity for gold and that's a significant trading advantage.

Daryl Guppy is a trader and author of Trend Trading, The 36 Strategies of the Chinese for Financial Traders – He is a regular guest on CNBCAsia Squawk Box. He is a speaker at trading conferences in China, Asia, Australia and Europe.