Where Gold And Silver Are Headed Next

As we come closer to the end of the year, precious metals are leading the equities markets and are living up to the standard that has been expected of them. 2010 has been nothing short of eventful and I expect 2011 to be even more exciting as the next leg of the bull market in gold and silver begins to unfold. Silver is up over 60% in the last 4 months and has stolen some of the attention that gold has enjoyed throughout the year. Gold is up nearly $300/oz for the year and has recently peaked around the $1425/oz level. So the question is, what’s next for gold and silver?

There are a few key items that can be taken from the 1 year chart of spot gold, one is that the price increased roughly the same amount in the second half of the year as the first half and a similar pattern in price activity may occur next year. More importantly however, the divergences on the oscillators indicate that we may be on the edge of another consolidation. The divergences from price activity between May and July were indicators of an overbought condition which is likely what caused the correction that lasted for a few months and had analysts calling a top in gold prices. Most of us had known better, and sure enough, the correction led to a breakout that has only just begun to show signs of slowing down. I believe that we will correct again very shortly, and then make a run on $1500 in early 2011. It may appear that gold has already been consolidating over the last month or two, but by using the 2 year weekly chart below, we can see how we are overextended from our 20 day SMA.

A few months ago I used this chart to point out how that since the end of 2008 every time gold has hit the 20 day SMA it has either bounced off of it, or traded below it for a brief period before rejecting the lows and closing back above the trend. There are now 7 instances where we have rejected breaks of the 20 day SMA and I believe the 8th one is coming up shortly. You will definitely want to be a buyer when that happens because when it does, $1400 gold may be a thing of the past. Another thing that supports the notion that we are on the verge of a correction followed by a breakout is that the gold market at the end of 2009 traded in the same pattern as we have been trading in over the last several weeks. In July of 2009, we bounced off of the 20 Day SMA, then had a very steep run which lasted through December before turning over into a healthy retracement. The same pattern seems to be forming right now. In February 2010 when gold was on its way down from that overbought peak, the Full Stochastics tapped the 25 level, indicating an oversold condition. At the same time, price activity touched the 20 Day SMA. Look for the Full Stochastics (14,3,3) to match up with the 20 SMA as extra confirmation to time your entry point.

I would hope that by now some people are beginning to take the name “poor man’s gold” and throw it away. Perhaps the people still calling silver poor man’s gold are bitter because they missed out when it was still under $20/oz. The good news for those people and anyone else is that silver has a long way to go and unlike gold, it is currently in position to blast off to new highs once again.

Oscillators are great for technical analysis. They provide relatively accurate information in forecasting momentum, which is a valuable commodity for anyone using technical analysis to make investment decisions. However, the problem with oscillators is that they tend to lie from time to time. Oscillators don’t lie as often as CNBC, MSNBC, CNN, or FOX, but they have been known to lose people lots of money based on the information they have provided. In some cases, one oscillator is wrong and the others correct it, however, currently in the silver market, they are all lying to you. The kicker is, the chart is not broken- see volume. Volume is second only to price activity and despite the obvious bearish divergences on the RSI, MACD, and Stochastics, volume is backing up price activity in the silver market. I’m using iShares Silver Trust to show volume where spot futures can not. Someone looking at silver futures where volume is not listed, may interpret the chart as overextended.

In addition to the volume supporting the short squeeze, silver, like gold, has recently been bouncing off of its 20 day SMA. When a security continues to bounce off of the bottom of a trendline such as an rising moving average, the trend becomes stronger. No doubt J.P. Morgan’s short covering has a lot to do with what’s going on. The COT reports have shown that the 4 largest commercials have been cutting back shorts, and just yesterday, J.P. Morgan admitted to holding and in fact cutting back their short position in silver. I think that this is a clever move by them. There’s no way that they could have actually covered all of the shorts, otherwise the price would have gone much higher already, but they have admitted to having those contracts and have stated that they have covered a certain portion of them. I believe that the idea behind them admitting to some of it is to get people to think that they are no longer “manipulating” the price, which of course, I’m sure they would never dream of in the first place. In any case, I stand by what I had predicted last week, silver should hit $32 and perhaps higher by the end of January. With the parabolic run in share prices since August, earnings for Q4 should be staggering.

Regarding exposure to gold and silver outside of bullion, the HUI still makes a strong case as to how gold is still not yet in a craze as some on TV are suggesting. The HUI or Arca Gold Bugs, has slowly caught up in terms of spot gold price, but is still well behind which signals that gold and silver mining companies are not yet overvalued in terms of the sector as a whole.

The HUI has only just taken out its 2008 highs, two years after the financial crisis. Gold on the other hand managed to take out it’s 2008 highs in just one year. Silver only eclipsed it’s 2008 high a few months ago. Based on this information, both gold and silver mining companies are still extremely undervalued. It may seem however that they have had quite a run since last July, but it’s literally only because they have been lagging for almost 2 years and only now are they beginning to catch up. The HUI is following a nice bottom trendline that formed in August which it is currently overextended from. The fact that it is extended from that trendline lines up with the analysis of gold I gave, as the HUI is much more heavily weighted in gold producers than silver producers.

With the Fed Chairman publicly stating that he “wouldn’t rule out” the use of another quantitative easing program which would be the third in under 3 years with ZIRP still in place, I can’t make a case against being long bullion or precious metals producers. Bernanke has made it clear that he intends to live up to his nickname and along with the FOMC, arbitrarily decide the fate of the financial system by adding zero’s and commas to the balance sheet’s of major US banks. In short, more volume should pick up in the metals markets as prices rise from centrally planned policies. I would expect gold to hit $1700 by at least Q4 of 2011, that forecast would allow gold to have one good correction in the middle of winter and perhaps one in the middle of summer while still allowing it to maintain a steady ascent higher. As for silver, we are in uncharted territory and currently, the reason for the higher prices is the significant amount of short covering over the last month. As more volume picks up, silver will gain more momentum but it is unclear as to when the next consolidation may be. Until then, continue to accumulate long exposure to producers.


About Aaron Basile
Market Technician, Equity/Commodity Trader, Austrian Economist, Contrarian Investor

One Response to Where Gold And Silver Are Headed Next

  1. Pingback: Gold & Silver Snap Trends – Correction Confirmed « Aaron Basile

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