The following is commentary that originally appeared at Treasure Chests for the benefit of subscribers on Tuesday, September 7th, 2010.

The first thing I want you to do this week is to read this past article from the spring entitled 'Smoke and Mirrors Markets to Sponsor Precious Metals Mania', which will benefit new and exiting subscribers alike for several reasons. (Apologies to non-subscribers as this article cannot be opened to the public.) First and foremost, and reflecting the title, it discusses market sentiment in detail - it's importance and how sentiment is a primary driver in any market. Secondly, it discusses this with respect to silver as a focus, which makes for a good comparison with present circumstances. What's more along these lines, it also discusses aspects of the bullish fundamentals that are now driving silver (i.e. seasonals, fractional reserves finally drying up, etc.) that are contributing to silver's long awaited breakout higher, which is occurring as we speak in my opinion.

Why do I think silver is finally breaking out to the upside moving forward? Because of important developments not present back in the spring. First, in terms of the paper markets, not only does the likelihood of position limits on COMEX finally have JP Morgan and the banking cartel rethinking their situation; but also, sentiment has gone bearish on silver as measured by rising open interest put / call ratios on the primary silver ETF known as SLV, fostering a short squeeze higher just like this condition does for stocks; again, both aspects discussed in the above attached article. We would be amiss not mentioning how inter-market relationships play a role here too (i.e. money from a popping bond bubble looking for a new home will be drawn to precious metals), which is also discussed above, however we will not expand on this point today.

Instead we continue to focus on sentiment, as it's appears to have been an important missing link in terms getting a long overdue move higher underway once again, where we would like to bring your attention to the logic loops used by speculators when placing bets, bets in the derivatives (primarily options) market. Where are we now in this respect? An increasing percentage (still low) of speculators think deflation is immanent, which is causing gold and silver to rise (because of a short squeeze), which in turn has the larger population seeing an inflation signal, which is keeping open interest put / call ratios on US stock indices generally low. Here, unlike previous instances that witnessed low and falling put / call ratios on precious metals and their related equities (think GDX and XAU), now we have the opposite (hence the higher prices due to squeezing); and, we also have the opposite in stock indices ratios as well, which is why they have had trouble catching a bid. So you see what goes around has come around for both silver and gold in the paper market pricing mechanisms, which is a large part of the reason they are rising.

And the second reason silver is breaking out in my opinion is a physical supply squeeze is also now finally underway, which is not discussed above, and is essentially new from this perspective then, however we always knew this was coming, we just didn't know when. Here, I can tell you from my own experience in buying physical in Canada, where one would assume supplies to be plentiful until a genuine supply problem emerges, wait times, especially with larger quantities, are getting longer, which supports this thinking. Things are nowhere near as bad as in the States, with silver eagle sales suspended regularly (and are still unavailable today) amidst record demand, however this could happen in Canada too, which would be telling in my opinion.

What's more, this would also be another example of what goes around comes around in that in perpetuating paper markets and the dollar ($) all these years at the expense of the silver market (because this aided in controlling the gold price), now, we will have a buoyant silver market pushing gold higher, which would hopefully see both finally return to not just some semblance of reasonable inflation adjusted pricing, but more, as the currencies they have been for thousands of years. Of course if Egon von Greyerz is correct, and gold (and silver) is entering a virtuous cycle, then this brand of thinking is far too conservative, with prospects for the metals potentially into the multi tens of thousands.

Where are we right now? With silver at $20 and looking to test more recent highs at $21; and gold just under nominal all time highs at $1260, we may be knocking at the door of entering such a virtuous cycle, however both of the metals are short-term overbought as can be seen on daily measures (gold and silver), so corrections could come at anytime. In bull markets like this however, you don't want to make the mistake of looking at a daily chart in gauging potentials (or even weeklies sometimes [not with silver and gold now however]), where under present conditions, which are potentially explosive for the metals, prices can keep moving higher despite overbought conditions that would normally stop a move. This, is what manias are all about, where it imperative to watch the monthlies, with silver featured first below. (See Figure 1)

Figure 1

Moreover, in manias such as this you don't attempt to trade lower degree swings, allowing the momentum to work in your favor. If you wish to look at such a strategy (short-term swing trading) then one must use a system (like put / call ratios, sentiment, technicals, etc.) or identify trade signatures, such as the one that appears dominant right now, with the cartel attempting to push prices down every night, only to see new highs daily as cash market / ETF trade overwhelms such efforts. Here then, a short-term top in silver would be apparent with a strong overnight performance possibly leading to a gap opening in daily COMEX / ETF trade. This is the signal I would be watching for to mark a short-term top in both silver and gold, which as suggested above, with the former takingthe lead these days. (See Figure 2)

Figure 2

Further to this, and as you can see in both charts above, technically both gold and silver have further room to run, with the latter still playing catch-up from a technical (and fundamental) perspective. (i.e. gold is more over extended than silver.) With both gold and silver approaching overbought conditions on the monthlies what is the primary reason they would continue higher then? Answer, because the Fed (Bernanke) will likely need to start monetizing stocks and real estate, which could lead to asset hyperinflation. It's either this or the US government will eventually be forced to devalue the $ Roosevelt style, meaning by declaration, making technicals moot with such a move. This is of course why it's a very good idea to have healthy core holdings in physical gold and silver.

Aside from such a development however, if precious metals are to continue advancing on a more natural basis, the shares will need to participate too, meaning we should look at the health of the indexes as well. Here, with broad index health important to precious metals shares, it makes sense to look at the Philadelphia Gold And Silver Index (XAU) because it has a tighter correlation to the broad measures of stocks compared to the Amex Gold Bugs Index (HUI) or Amex Gold Miners Index (GDM). And in looking at the long-term weekly print from the Chart Room we see quite a constructive picture, with indicators well supported and positioned to move higher. The potentially exciting part of this chart comes in the observation a channel recapture is being attempted right now (as has been the case off and on for some time), this accompanied by an important time line turn right now, allowing for volatility to re-emerge with a bullish impulse higher. (See Figure 3)

Figure 3

Unfortunately we cannot carry on past this point, as the remainder of this analysis is reserved for our subscribers. Of course if the above is the kind of analysis you are looking for this is easily remedied by visiting our web site to discover more about how our service can help you in not only this regard, but also in achieving your financial goals. As you will find, our recently reconstructed site includes such improvements as automated subscriptions, improvements to trend identifying / professionally annotated charts, to the more detailed quote pages exclusively designed for independent investors who like to stay on top of things. Here, in addition to improving our advisory service, our aim is to also provide a resource center, one where you have access to well presented 'key' information concerning the markets we cover.

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Good investing all.