Silver Closing In On Phase Three?

A YouTube search for “CNBC Silver” yields a total of 10 segments from CNBC on silver within the last month. Personally I remember just a month or more ago where there were no segments on silver at all. Mad Money’s Jim Cramer says to “buy the physical”. In one clip from last week, CNBC covered traders of physical metals from coin shows who would “buy it in the morning and sell it in the afternoon”. Of course, none of the examples provided can be used as concrete evidence that silver is “topping” nor am I suggesting to anyone to liquidate their silver equity, but my point is that I am hearing more noise from outside of the sector and from within that is disturbingly bullish. We do know the fundamentals are strong, but the big story in the silver market has always been the eye-opening misvaluation by the market as the price had been suppressed for years.

With more and more traders getting on board in the last 1-2 months, the valuation story has significantly lost it’s luster. Silver bears and silver bulls previously conceded that the price had been extremely overbought at $25. At that time, I agreed but I still saw tons of value there as it had not literally gone straight up yet. From August 2010 to December 2010 silver gained $13 dollars in roughly 5 months. It appears now that they are even less silver bears out there and the silver bulls are awestruck of the recent $16 move from $26 to $42 in 2 and a half months. If I’m wrong, that’s fine with me because I’ll still on board for the ride, but since I don’t see too many others who are willing to go on record and say that silver is dangerously overbought here, I’m going to go ahead and make the case.

Tekoa Da Silva from Contrary Investors Cafe recently suggested that people buy uranium stocks instead of silver at least until it is clear where silver may be headed next. Any why not? Everyone hates uranium stocks right now and just about everyone wants to be in silver.

The simplest, most spot-on, yet sometimes difficult advice for traders is to buy low, sell high. Do you want to be to trader that buys silver when it is worth less or equal to uranium? Or would you rather buy when it has gained 100% versus uranium in the last year with 84% of it being in just the last 2 months? If the gold silver ratio falls another 20x, silver could go to $140 or $150/oz. That would be roughly about a 350% increase. Uranium, thorium, and rare earth oxides are other examples of assets that can do the same or more but have not come even close to performing the way silver has and are largely undervalued and underreported. In fairness, we’re not talking about nuclear and alternative energy assets, we’re talking about silver. However, my point is that silver bulls started by being contrarian and now it seems as if most of us are wearing the blinders when it comes to what’s been happening. Of course, these things can go on for a while and if the mania phase is set to happen now, then, as popular YouTuber and silver guru StellaConcepts recently said, so be it. Be prepared to hear all of your friends who wouldn’t listen to you at all become experts on precious metals and start telling you about the P/E on silver companies as if price to earnings is an effective way to value resource stocks. And most importantly, enjoy the profits.

The ECB rate hike

Though it’s my belief that a large reason for the increase in the price of silver is driven by consumption in emerging markets, investment demand, which is still by far the largest source, is driven by traders in the US who use commodities as a hedge vs the dollar index – which brings me to my next point – the euro, which makes of 58% of the dollar index weighting, is overvalued versus the dollar.

The interest rate hike by European Union has been a major catalyst for higher equity and commodity prices over the last week. The question is, why did it gap higher after the news came out if all economists in a Bloomberg survey predicted the move months in advance as well as it largely being the consensus on Wall Street that it would in fact happen? Let’s delve even further… how is does interest rate increase make for a strengthening euro if it’s already the consensus that Portugal, Greece, Spain, and Ireland will need one or more, or many more bailouts in the future? If this increase in interest rates does indeed become the “first in a series” then the cost to service the bailouts rises and ultimately it will create a debt spiral for the EU. Riots continue across Europe because governments can no longer afford to make good in the benefits and handout packages that they once promised. Luckily for those in the US, we don’t have that problem here quite yet. I can say with complete certainty that the countries in Europe will have to deal with more rioting and more defaulting by inflation in the future, well before the US will have those problems.

On the other side of the coin, the dollar is everyone’s favorite currency to sell.

From Yahoo:

US Dollar sentiment and positioning shows that large speculators continue to bet on weakness, warning against taking aggressive bullish positions in the downtrodden US currency. Yet the potential for material reversal is growing amidst high leverage on Greenback-bearish bets.

Risk reversal is as follows –

1 week 61.69%
1 month 68.39%
3 month 64.33%
1 year 77.78%

Commercials are largely still betting on dollar weakness which explains the smaller short term spreads, but the 13.45% spread between the 3 month and 1 year reversal is triple the size of the other spreads which means that the dollar can continue to show weakness in the short term, but institutional bets may change dramatically over the next 6-12 months. Inflation in the US has moderately outpaced EU inflation over the last 12 month by about a tenth of a percent per month. However based on CPI, EU inflation rose in March to 1.1% compared to .5% in February. Also, inflation in the euro area rose 1% from .4% in February to 1.4% in March. Meanwhile, yields on Greek debt are over 13% and yields on Portuguese debt are pushing 9%. This too has yet to translate into the market.

Speaking of Greece and Portugal, another thing that has been questionably excluded is the Portuguese bailout. The Greek debt crisis last year was more than enough to drive to DJIA back below 10,000 after QE 1 expired. We’re getting close to the end of QE 2 as Portugal nears a $100B+ bailout package to stop their government from shutting down.

So, what happens if some catalyst takes place like the exchange rate failing to break the pivot top at $1.45 as QE 2 runs out and no immediate program is publicly announced? Does the euro rally forever as the dollar falls below 70 and commodities skyrocket? From a fundamental point of view I seriously doubt it. But, if we are reaching mania phase then certainly silver can go higher as retail volume increases regardless of other measures. I’m still very sold on the long term fundamentals but for me to be a strong buyer again, I’d have to see silver hit a top as soon as possible, retrace about 15-20% and sit in a trading range for several months until the pundits stop promoting it and the talking heads begin bashing it once again. Until then, I’ll remain in silver with a trader’s strategy and not risk any long term capital that I cannot liquidate should I need to.

About Aaron Basile
Day Trading and Swing Trading Ideas, Certified Personal Trainer, Power Bodybuilding, Avid Sports Fan (NBA, NFL)

3 Responses to Silver Closing In On Phase Three?

  1. Aaron says:

    Another brilliant article.

    I’m kind of with you, now, that sticking to a rapid-fire trading strategy on silver and miners is the best bet for us. Since I’ve started doing this, my profits have greatly increased and nearly matched volatility in the space. When I first spoke to you, I was setting up for a long play on EXK, as you likely remember. I sold prematurely, but it still paid off about 6-7%. When silver neared $43/oz, I started smelling a pullback…the technicals of mining stocks, as I showed on my page, were suggesting strengthening resistance and a dwindling supply of buyers even with silver at that high level. I reverted to a short play at that point. I was a little early on going short, and silver and miners rallied in my face the next day about 2-3%…but after sticking with it, the stocks began to sink intra-day. AG actually totally reversed and fell about 2-3%. Today, it touched a low point of -10%. I got the big drop I was looking for, and covered my shorts, right at the intra-day low thus far (I was close to it on EXK short…I covered at $11.11, right as it reversed from the bottom — I went short Friday, at about $11.90). Another 6-7% profit on that. Had I just stuck to being long or short on the long-term, I’d have made basically nothing so far. But playing the near-term technicals and analyzing the macro-economic factors and commodities markets, making intra-day and intra-weekly plays, has given me exposure to every move in price. With a bit of finese and luck, I’ve been able to strike right near the pinnacle of peaks and troughs. Your articles have also been most helpful in my research, gathering of information and weighing sentiment.

    I’m still trying to come to a decision on my next play. However, I’m strongly leaning towards the idea of another short. I think we may have another day or two or three of wobbly silver prices. We touched a -25 cent drop today, sending miners to the bottom of the trough (where I covered). We’ve come up from those lows now though. Silver is at $43.13 right now, as I type… So if it doesn’t close down today, I think we haven’t seen any real correction yet, and short is the place to be. I think support has come up from my $40-ish/oz estimate, and is probably around $41.50 – $42/oz now on the near-term. So I tend to believe it’s time for it to really come in, knock down the miners, and find support. That’s where I get crazy bullish again for another big long play. But I’ve still got some homework to do here.

    I think this S&P downgrade of US credit, despite how serious or silly one thinks it, is a big factor to consider. The US Dollar Index is stronger today too. On the other hand, there is huge investor demand in the US and China for the metal, and continuing fears of inflation. I haven’t really factored these things into my equations yet. Maybe you can provide some insight…

    So what do you think this S&P downgrade means for silver? Brings it higher or lower? Will continued uber-Keynesianism and rising inflation fears continue to push silver near-term? How about the end of QE? Will they do it again, and push more liquidity into the market and drive commodities? In other words, how do you think these longer-term factors will influence the short-term technicals for silver?

    • aaronbasile says:

      Thanks for taking the time to comment,

      I am beginning to see more and more now that the swing trading strategy that you described is the best possible way to play this market. We’re in a situation where it’s damned if you do. damned if you don’t. If you buy long term growth/valuation gold and silver stocks, at some point you may make money but if the Chinese housing bubble pops, all of your profits could be wiped out and you constantly would have to keep one eye out for that. On the other hand, if you don’t do something to hedge yourself against the fed’s policy, inflation wipes out your savings.

      I think trading is the safest and most profitable right now. You never stay in a position for a long time and keep smart stop losses to hedge yourself against volatility and potential sovereign debt defaults which will drive the market. I am holding a few long term valuation/growth plays but the majority of my capital is being put to work via trading. I just don’t feel safe in this environment with all my money in several stocks, it’s not safe in the event of a market meltdown.

      If you are shorting silver, just be careful as it has defied any type of sane price movement over the last 2 months or so. I really want it to fall 15-20% and get stuck in a trading range for a while so that all the pundits stop harping on it. With the current momentum it has, it really loses it’s valuation appeal to me and I don’t want to be a the guy who buys at the precipice of a multi-month top.

      As for the dollar/gold relationship you described… read my article “The dollar index vs. gold & commodities” and the follow up one to that “dollar sentiment is weaker than ever, the market is telling you to buy”. I have a contrarian approach to precious metals investing and I think that the dollar despite all it’s flaws is still the most stable currency.

      The S&P downgrade is very interesting. The not so smart investor might think that debt default = deflation. But the astute investor will see debt default = inflation because the Fed/Treasury/Congress won’t allow for a real default and will print their way out of it. The market sold the euro and bought the dollar yesterday on the news. I think that may just be partly due to an oversold dollar as the dollar still lost vs. the yen. Still, regardless of the fundamentals, silver is overbought and I’m not attracted to it from the buy side at all right now.

  2. Rene from Cape Cod says:

    Aaron, have you seen the gigantic cup from 30 years. Don’t you think that will break out to a handle with an unbelievable bull run?

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