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Adam Hamilton

Adam Hamilton

Mr. Hamilton, a private investor and contrarian analyst, publishes Zeal Intelligence, an in-depth monthly strategic and tactical analysis of markets, geopolitics, economics, finance, and investing…

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Trading the Silver Bull

Unfortunately silver never seems to garner as much press as gold or the general equity markets, so there are probably lots of contrarians out there not yet fully aware of all the wonderful things afoot in the other precious metal.

In just the past few months or so, the technical character of the silver market has changed dramatically. Silver's major long-term resistance has been decisively blown out of the water, the upslopes of its key moving averages are accelerating, and what may very well prove to be the first major upleg of a long bull market has just been witnessed.

Last time I wrote about silver back in October, in "Silver Technicals", we launched some initial explorations into adapting some technical speculation tools that have proven very useful in gold and gold-stock trading into the realm of silver. I had to conclude that essay with an important caveat, however.

As silver carved a strong long-term bottom just above $4 in late November 2001, I pointed out that the silver bull market wasn't even two years old yet at the time. As such, we really needed to analyze and digest more silver price data in order to try and define potential high-probability-of-success entry and exit points for silver-related speculations.

Speculation, which literally means guessing, is heavily dependent on the art of observing current financial-market conditions and comparing them with similar episodes in the past. If we can identify major turning points in historical data, then we can be ready and discerning to recognize similar tradable conditions as they develop in the future.

If we perceive a familiar pattern today that corresponds with a technical signature that we witnessed near a major turning point in the past, we can then consider trading on it in anticipation of a potentially major move. Of course sometimes comparing the present to the past works dazzlingly well and sometimes it does not, but market history really has proven that more often than not technical patterns, fundamental episodes, and emotional psychologies really do echo down and rhyme throughout all of market history.

So, with the benefit of several more months of silver data under our belts, today we can farther refine and recalibrate our technical tools. While the silver bull remains young and almost certainly has many years left to run yet, it is not too early to analyze the data available to date and define some potential technical signals and trading ranges to be vigilant for.

Before we delve into some of the proprietary indicators that we have developed and are adapting for silver, it is important to take a quick technical overview of the glorious recent breakout and upleg in silver. After examining a silver chart, there can be absolutely no doubt that the character of the silver bull has changed dramatically in recent months. What a wonderful sight to see!

My earlier "Silver Technicals" essay has longer-term graphs which highlight silver's late 2001 secular bottom, but this shorter chart really underlines both the deep frustration felt by silver speculators and investors in the past couple years along with their hard-earned joyous elation of recent months. The technical nature of the silver bull has just changed dramatically!

As usual, the black 200-day moving average line above does a beautiful and mathematically precise job of summarizing silver's long-term trend. Prior to the beginning of Q4 2003, silver's 200dma was generally drifting modestly higher, although at a snail's pace. In fact, if you isolate the region of this graph between mid-2002 and mid-2003, silver was essentially flat for an entire year.

During this same time frame gold enjoyed a magnificent rally from under $325 to over $375, but silver remained stubbornly rangebound much to the immense frustration of the silver faithful. In my experience most silver speculators game gold and gold-stocks as well, so they were not totally locked out of gains, but it was still a tough time psychologically. Silver is well-known to have vastly higher appreciation potential than gold historically, so it was troubling that silver wasn't behaving well and rallying strongly with gold.

All of these silver-investor tears were washed away in the second half of 2003 though, in two distinct stages. In Q3 of last year, silver finally broke decisively above its long-time oppressive $5.00 overhead resistance. This exciting development rekindled some hope amongst silver's legions of diehard fans, but was merely a small foretaste of the splendid feast to come.

After a minor retreat back under $5.00, silver exploded towards the heavens in Q4 of 2003, as the chart above nicely illustrates. After touching $4.80 for a couple days in early October, silver started rocketing higher and kissed $5.00 goodbye, perhaps for good this time. As you can see in this chart, silver's 200dma is now above $5.00, and in secular bull markets the 200dma line almost always provides rock-solid support for the uptrend. I would be very surprised to see silver fall significantly below its 200dma again in this particular bull market.

Since its last 200dma kiss in early October, silver has exploded nearly parabolic from a short-term perspective, rocketing up 38% between early October and mid-January! Naturally silver stocks leveraged these gains tremendously as well, providing high-double and even triple-digit returns for those fortunate enough to have been deployed in elite unhedged silver stocks in the past quarter or so.

I think it is quite fair to say that this spectacular recent silver action sure looks like the first major upleg in a glorious new silver bull. This chart action over the past few months is so different from anything witnessed in many years that it just demands special consideration. And if this silver bull ends up acting like the already galloping gold bull, which it ought to, then there will be many more much larger uplegs to come.

While these are certainly exciting times worthy of celebration, it is still important that we remain sober in our analysis of this silver rally's possible causes. Truly legendary gains won't arrive until silver becomes thoroughly invaded and dominated by pure speculation, as opposed to standard industrial demand and dollar revaluation issues. While industrial demand is difficult to quantity, we can thankfully isolate the plunging dollar's potential impact quite easily.

During the same early October to mid-January period that silver soared 37.8%, the US Dollar Index fell by about 8.7% and gold rose by 15.1%. So, we could estimate that the ongoing dollar devaluation accounted for about 9/38th of the recent silver upleg, roughly one quarter of its gains. This modest fraction is definitely exciting though, because it leaves three quarters of silver's recent gains to industrial, investment, and speculation demand.

While it is probably impossible to precisely break down silver's industrial, investment, and speculation demand on a global basis, I really suspect that the dominating force of these three, at least over such an incredibly short time period since October, has to be pure speculation. This is great news for everyone bullish on silver, as it's always the speculators that ultimately drive bull markets and create the excitement that eventually entices in long-term investors and their vast capital war chests.

Even when the horrific Greenspanian destruction of the US dollar is considered, silver's recent upleg still shines brilliantly and exhibits a totally new technical signature for this particular bull market. As such, it is very appropriate to revisit our technical tools and refine and recalibrate them based on this important new technical price information.

We'll begin with the Silver 50/200 MACD, the concept of which was explained in October's "Silver Technicals" essay. This technical tool divides silver's 50dma (the white line) by its 200dma (the black line), and expresses the quotient in terms of a percentage. It tells us how far above or below the 200dma that the 50dma happens to be at any given moment in time in perfectly comparable percentage terms.

In my last essay, written before this first major upleg in silver, I suggested that speculators should watch for a Silver 50/200 MACD range between -1% on the bottom to 6% on the top. The idea was to throw long silver whenever this indicator traded under -1%, and then raise stops and/or exit outright when it shot above 6% or so. As this first major silver rally clearly proved though, these ranges definitely need to be adjusted in light of silver's strengthening technical character.

In both mid-2002 and most of the way through Q3 2003, silver did indeed correct back down to its 200dma shortly after the 6% Silver 50/200 MACD line was crossed to the upside. After the recent 6% upside cross though, silver almost immediately recovered and rocketed higher, ultimately blasting the Silver 50/200 MACD well above 12%, which is amazingly double our old pre-major-upleg topping range. Wow!

So there is no doubt that this indicator needs recalibrating, but it is still a challenging exercise. For about a month now I have been pondering over where to set these limits to alert me in my own speculations, but so far I haven't reached any definitive conclusions. Due to the nature of this indicator, there is a built-in lag from using two longer moving averages which compound the difficulties involved in defining an excellent tradable range.

Early last year while defining the spiritual predecessor of this indicator, the Gold 50/200 MACD, we had two complete major gold uplegs and their subsequent pullbacks to use to calibrate it. Today in silver, all we have is an unresolved initial upleg with no major pullback yet. Silver could certainly shoot higher from here or it could just as easily correct back down to its 200dma, but until it does either we really don't have any rock-solid basis for recalibrating this technical tool yet.

Nevertheless, fully realizing that this will almost certainly change as more new silver-bull data pours in during the months ahead, I am going to take a stab at Silver 50/200 MACD recalibration. Starting at the bottom, you will note in the middle of 2003 that silver's current major upleg began when the red Silver 50/200 MACD line was significantly above our earlier -1% pre-major-rally trading-range threshold.

The actual numbers recorded around the halfway mark of 2003 were a bit under +1%, in the +0.5% range when silver bottomed. When this observation is combined with the fact that in bull markets raw prices, let alone 50dmas, rarely trade below their 200dmas, I believe that we ought to raise the lower end of the Silver 50/200 MACD indicator from -1% to +1% or so. Thus, going forward, I am going to be very interested in deploying long silver speculations (silver stocks, options, futures) when the Silver 50/200 MACD breaches +1% on the way down.

On the top side of this indicator, our original pre-major-rally 6% caution level is quite obviously far too conservative as speculators are finally coming to play in the silver markets. The latest interim top in silver, just achieved in January, occurred three trading days after the Silver 50/200 MACD crossed 10% and eight trading days after it crossed 9%.

While silver certainly may run higher from here and drag the Silver 50/200 MACD up even farther, I am going to tentatively reset our silver neutrality level at +9% for now. Thus when silver's 50dma trades more than 9% above its 200dma after a major future silver rally has been soaring higher for a couple months or so, I will treat it as a cautionary signal. On this signal we can either raise our trailing stop losses in anticipation of a pullback or sell outright, depending on the prevailing sentiment conditions at the time.

Since we don't even have one complete major silver rally and pullback cycle yet, let alone two, I am sure this range will change, but for now I am recalibrating this silver speculation indicator to less than +1% on the low side to greater than +9% on the high side. These changes will be reflected immediately in our Zeal Intelligence monthly newsletter and Zeal Speculator alert/update service for our subscribers, where we track our various technical indicators of choice in every published issue.

No mere mortal can see the future, and speculation is simply the art of guessing about the markets and trading your own capital based on these conjectures, but using good technical tools can still be quite valuable. We can use concepts like the Silver 50/200 MACD to keep us abreast of crucial mathematical relationships behind the scenes that are not readily apparent to the naked eye when examining normal price charts.

When extremes in these indicators are reached, they can alert us to high-potential-for-success long or short opportunities that could otherwise escape our notice.

A second, and potentially superior, technical silver indicator involves dividing the silver price by its 200-day moving average. I call this Relative Silver, as it tells us how far silver happens to be above its all-important 200dma in percentage terms at any given moment in time. Remember that long-term bull and bear markets alike inevitably periodically advance beyond and retreat back to their 200dmas as they ebb and flow, so keeping track of this relative relationship is very important. This was also explained in "Silver Technicals" if you seek more background.

The farther along and deeper that I research this relatively concept, the more impressed I become with its utility and efficacy for speculators. In long-term bull markets 200dmas really do provide the strongest and most likely long-term support, so any time that a price in a secular bull trend nears its 200dma, odds are that a nearly ideal time to go long has finally arrived.

Relativity also has another big advantage over the 50/200 MACDs, it has a lot less time lag to contend with. In a 50/200 MACD, both the 50dma and 200dma inputs lag the actual price significantly, complicating interpretation and indicator calibration. A relative price to its 200dma, however, only has one lagging component, its denominator. Its numerator, the current market price, is rock-solid and immediate, probably rendering it easier to interpret in real-time.

Just as silver's first major upleg pushed bold new 50/200 MACD extremes, it also vastly expanded our horizons on what is possible in relativity terms. While this indicator is easier to recalibrate, the same caveat that I articulated above certainly still applies here. We have not even seen a single complete major rally and subsequent pullback yet, so the target Relative Silver levels of interest will certainly continue to evolve along with the silver bull.

We had been running with a Relative Silver long-to-neutral range of less than 0.98 to greater than 1.10. The recent months' trading actions redefine this range significantly, however. On the bottom end, note in early October on the chart above how silver almost, but not quite, kissed its 200dma before rocketing higher. This is very typical bull-market behavior that is very familiar for gold and gold-stock speculators of recent years. There is no stronger long-term support in major bull markets than their own 200dmas!

So, with silver now demonstrably in full-on bull mode, it doesn't make much sense to wait until Relative Silver goes under 1.00, meaning that silver trades under its 200dma, in order to go long again. We ought to get interested in redeploying silver-related speculations or buying long-term silver-related investments as soon as silver merely approaches its key 200dma.

In October, Relative Silver hit 1.01 for a couple days before silver catapulted towards the heavens. In Relative Gold terms we look for levels under 1.02 for a strong buy, but in the far more volatile HUI gold-stock index, our long target in the Relative HUI is a far looser 1.05. Silver is significantly more volatile than gold but will probably remain much less volatile than gold stocks, so a Relative Silver level of 1.03 for a new long signal seems appropriate for this recalibration exercise.

Thus, next time silver meanders within 3% or less of its 200dma, it will probably be an awesome moment to deploy aggressive long silver speculations in anticipation of the next major silver upleg. We will certainly continue to track this indicator and recommend actual trades based on it when appropriate in our subscription-only Zeal Intelligence monthly and Zeal Speculator anytime publications.

Incidentally, the current January issue of Zeal Intelligence fundamentally analyzes some of the best elite blue-chip silver miners, companies that we will be buying and recommending once the technical fortunes of silver give us a bright green light once again. These indicators discussed in this essay will help me determine when this highly-sought-after opportune moment in time will be upon us. Please subscribe today to stay abreast!

Defining the topside zone of interest for Relative Silver, the cautionary zone used to ratchet up trailing stops, is much more challenging, especially at this very early stage in the silver bull market. A 1.10 level is far too conservative, as silver soared above 1.31, or 31% above its 200dma in early January. At this point I am thinking about splitting this difference and running a new Relative Silver neutrality watch zone above 1.20 or so, for the following reasons.

While I do expect silver's future uplegs to be larger, its 200dma will also be heading up faster as long as its bull trend continues. Silver's 200dma was pretty low during this first major rally since the silver price had essentially been flatlined for an entire year before it launched. In the next major silver rally, its 200dma will probably be already trending up at a good clip similar to gold, so it will probably be harder for silver to extend 30%+ above its already rising 200dma again, barring a full-on silver speculative mania like the late 1970s.

Second, the whole idea of the top-end of this indicator is defining a cautionary neutral zone, not necessarily a moment to sell but a moment to be vigilant. If we get too aggressive and raise this Relative Silver topping zone too high, the chance grows that we will miss the next interim top and lose the opportunity to raise stops ahead of it. It is much better to err on the side of caution and raise stops early before a major interim top than to totally miss it because we were waiting for too aggressive of a level that ultimately failed to arrive.

In light of these concerns, a Relative Silver reading of greater than 1.20 seems to be an appropriate neutrality recalibration level for now, although this will almost certainly change as more silver-bull data becomes available in the months ahead.

So in Relative Silver terms, I will be looking to redeploy aggressively long in silver-related speculations when Relative Silver trades under 1.03 after a major correction. On the back side of this trade, I will be raising my stops and recommending the same when Relative Silver trades above 1.20 after a major silver upleg. I will probably not sell outright at Relative Silver 1.20 since upside surprises are far more probable in bull markets than downside ones, but I will raise my stops and tread cautiously when silver extends this far above its key 200dma.

One more quick point this week, which I will have to save for a future essay to discuss thoroughly, is to examine the yellow Bollinger Bands of silver relative to the metal's price itself and the Silver 50/200 MACD and Relative Silver technical tools.

These proprietary moving-average-based technical tools that we have been developing at Zeal for trading the metals bulls are not only useful in isolation, but dovetail nicely with more conventional tools like Bollinger Bands. On the graph above, note how Relative Silver extremes, both to the upside and downside, tend to almost always correspond with silver hitting one of its yellow Bollinger Bands. Bollinger Band bounces can be used to confirm Relative Silver signals, or vice versa. A prudent speculator always cross-checks many indicators before layering in extensive new trading positions!

The bottom line is that silver has entered a new bullish phase with what appears to be its first major upleg in its young bull market! In these exciting times, technical tools are useful to refine speculation guesses, define probability ranges, and help speculators and even long-term investors decide when they appear to have the highest chances of earning big gains by deploying their scarce capital in silver-related vehicles.

While technical tools are not some magical window into the future, they do help us maintain patience and discipline by precisely quantifying important mathematical relationships that are not readily apparent visually on a simple price graph. They help illuminate the rare moments for us speculators when the probabilities of success swing vastly in our favor.

And timing is everything in speculation.

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