Originally published July 22nd, 2012.
Silver investors and speculators are amongst the manic-depressive you can possibly find in the investment world. When they are playing maximum credits on the slots and passing round boxes of cuban cigars and taking out massive loans to buy Ferraris and Lambos you know it's time to watch out. When they retreat into the shadows, only coming out to hurl themselves off bridges and other tall structures, mumbling about the "cartel" as they plummet earthwards, you know it's getting time to buy - and that is the situation we now find ourselves in. In this update we are going to examine evidence which suggests that, despite the fragile looking price pattern, silver is going to turn surprisingly strong in short order, or alternatively, if it does break down, it turns out to be a false move that is swiftly followed by a dramatic recovery.
On its 3-year chart we can see that silver has been severely testing its key support at and above its September and December lows in recent weeks, and with its falling moving averages bearing down on the price overhead, and this being the 3rd major test of this key support, clearly there is some risk that it could crash it and plunge, yet while this is certainly true, various indicators are telling a story of gathering internal strength, and we will examine these a little later.
Staying with the 3-year chart a very important point to note is the current unbeatable risk/reward ratio. With the price hard down on support after a long period of retreat, those buying here have the opportunity to get in right at the start of a major uptrend if it does start higher from here, and can guard against serious loss by the simple expedient of placing close stops beneath the support. If this is obvious to us, then you can bet that Big Money is aware of it, and by Big Money we mean those with sufficient clout to muscle the market around to their own advantage. So what might they do here to make even more money? - crash the support, and run the little guy out of his remaining positions before a dramatic reversal back above the support leading to the major uptrend starting that we are anticipating. This is why it is so important to be ready to jump back in if, after failure of the support, the price then reverses back above it again, accepting the modest whipsaw loss as the possible cost of this strategy. Given the unusually bullish COTs and sentiment indicators for silver, it does not look likely that failure of the support would lead to more than a brief plunge that is quickly reversed, the only exception to this being if we see a 2008 style market wide total meltdown, and while this of course possible it does not look likely over the short to medium-term. The Accum-Distrib line shown at the top of the chart looks remarkably positive and is in itself a good omen, although we know from past experience that this indicator cannot always be relied upon. The current very low volume, about the lowest since the 2010 and 2011 Christmas holidays, is another positive sign. A new uptrend in silver will really gain traction and accelerate once the price succeeds in breaking above the red downtrend line shown on the chart.
The 6-month chart for silver shows a downtrend in force from March that parallels the one in gold. With the price approaching and then backing off from the upper boundary of this downtrend about 8 times now, it is clearly valid and very important, and while for various reasons we are thought to be at an optimum entry point here, the safer approach for would be buyers is to wait for the price to break out upside from this downtrend boundary, which as it is now close by above, would not involve missing much in the way of gains - unless that is the price takes off like a rocket upon breaking out - which is quite likely given how obviously important this downtrend is. There are several other lesser but still important points to note on this chart, which are the run of "doji" candlesticks that appeared last week that are indicative of a situation of extreme indecision - total standoff, but coming as they have after a drop they indicate a higher chance of a resolution to the upside, especially given that upside volume last week was predominant, which we can see reflected in the rising Accum-Distrib line shown at the top of the chart (On-balance Volume, not shown, also rose). Lastly the Bollinger Bands also pulled in tightly, signifying that pressure is building for a big move.
From what is set out above it will be clear to more sophisticated traders that we now have a near perfect setup for playing it both ways - a raft of straddles (Calls and Puts with the same strike price) or "strangles" (Calls and Puts whose strikes are both out of the money, and which are thus cheap) - and the current low volatility, if it persists into tomorrow, will mean you can get these on board cheaply. If the support fails and the price plunges you quickly ditch the Puts for a whacking great profit and hang on to the Calls. If, as we suspect, the breakdown is the result of Big Money running the little guy out of his positions by triggering his stops, then we can look forward to a rapid reversal back above the support enabling the trader to at least recoup the cost of the Calls and very possibly make a profit on them too. If the new uptrend develops from here, then you simply hang on to the Calls and write off the Puts, and you should end up with big gains.
A big reason that we are believed to be at or very close to a bottom here is the latest silver COT, which looks exceptionally bullish, with the Commercial short positions being close to record lows for this bullmarket, and the Large and Small Spec long positions being close to record lows. Unless we are just entering an era when things are suddenly very different, this is a classic indication of a major low in silver. The rationale behind the bullish implication of this is that the Large and Small specs' interest in silver is at a very low ebb, so their long contracts, which the Commercials counterparty, are a very low level reflecting this lack of interest.
Chart courtesy of www.sentimentrader.com
The silver public opinion chart shown below is such a reliable barometer of the foolishness of most silver speculators and traders that it is almost comical. Why don't they refer to it? - just too stupid, I guess. It's a good thing they don't because it means that people like us can use it to our advantage. As we can see the "great unwashed" have a low opinion of silver at this time, and that has to be bullish.
Chart courtesy of www.sentimentrader.com
Finally, the long-term 15-year chart of silver relative to gold is interesting as it shows several interesting things. The first is that during the early days of the Precious Metals bullmarket silver underperformed gold, and it got treated as almost worthless trash during the 2008 market crash. Then, after a period of recovery, it really went nuts in a big way for the first time ever in late 2010 and early 2011, with silver speculators becoming totally manic before being overcome by blind panic and exiting their positions just as fast or even faster. Now silver bugs are licking their wounds and feeling decidedly timid after the severe kicking they have received since May of last year - it's kind of sad really considering how attractive silver is now compared to those earlier heady days - but we can surely count on them getting interested again - once the new uptrend has become well established.
