Silver's New Upleg

By: Adam Hamilton | Fri, Aug 6, 2004
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It has been somewhat of an anticlimactic summer in the precious-metals arena. Following sharp corrections and/or long consolidations, gold, silver, and the HUI unhedged PM-stock index have all traded largely sideways in recent months.

Early on during these consolidations, in the first couple months of 2004, PM speculators remained very gung ho and excited about the near-term prospects for their PM speculations. As this year marched on however, the lack of thrilling breakouts to the upside and the increasing negativity began to weigh on psyches.

Today the metals markets seem to be racked with ambivalence at best and festering pessimism at worst. The intellectual justification for this rampant negativity runs the gamut from election-year manipulation theories to the perceived risk of PM stocks cratering along with overvalued general stocks. Whatever the specific reasons advanced though, the radical shift in prevailing metals psychology throughout 2004 has been quite dramatic.

The best proxy for the lackluster PM sentiment is certainly the sideways drifting HUI. Since the final weeks of its sharp correction in late April, this flagship index has drifted rather aimlessly between about 170 and 200 for over three months now. As a homogenous herd PM speculators have vacillated all summer, neither willing to ante up fresh capital to plow into PM stocks nor willing to pull their existing capital and crash the index.

As always the best way to dispel this persistent funk is to witness rising prices, the early evidence of enormously profitable major new uplegs approaching. Gold and the HUI were both up modestly since their early May lows, achieving early July upleg-to-date gains of 8.8% and 19.4% respectively. Unfortunately the dollar surge in July pared these gains considerably, knocking them back to 3.2% and 3.7% late in the month and rekindling popular fears of an impending PM crisis. Is the end of metals as we know them upon us?

Galloping to the rescue there is a bright ray of sunshine piercing through all the precious-metals gloom and doom these days. Largely overshadowed by the perpetual tussle between gold and its arch nemesis the dollar, silver has been relentlessly advancing under the radar. Just this week silver was up a fantastic 21.8% from its early May correction lows!

This week I would like to discuss this strong early recovery in silver prices and its important implications for the metals world in general. Silver's summer price signature appears to be that of the early months of a major new upleg. If this interpretation proves correct in the months ahead, then silver is leading the way and gold and the PM stocks will certainly follow sooner or later here. Silver's new upleg is the great news that PM speculators have been increasingly desperately seeking!

The technical case for this new silver upleg is readily apparent in the price charts. This week we are examining a couple silver charts, a strategic one detailing the past year or so and a more tactical one zooming into the last six months. The picture that silver is painting is looking better with each passing day and it is a shame that the dollar-rally-induced gold weakness in recent weeks has overshadowed these important silver developments.

Silver has certainly lived up to its volatile reputation and has granted speculators one wild ride in the last year or so. From hovering under $5 to powering above $8 to collapsing under $6 to once again challenging $7 today, it has really been a fascinating year to watch long-slumbering silver starting to wake up and flex its muscles.

The impressive 72% trading range captured in this chart may seem extreme, but in light of silver's explosive history it is really quite tame. When silver really gets cracking, it has the potential to soar by hundreds of percent a year and dwarf the moves highlighted above. Silver is almost certainly the most volatile popularly-traded commodity in existence over the long-term and it is very exciting to see it once again spinning up and getting ready for action.

To understand today's dreary psychological scene, we really have to consider the entire past year's silver action in context. Last summer silver was extraordinarily dull and uninspiring. Between early 2002 and autumn 2003 silver seemed hopelessly mired in an oppressive trading range bouncing between roughly $4.25 to $5.25. Silver bulls were certainly out there, but they were a very rare, and much maligned, breed. I think even tax collectors may have been more popular than silver bulls back then!

Then, seemingly out of nowhere as Q3 2003 began, silver kissed its 200-day moving average goodbye and took a decisive turn northward. For the next six months or so silver seemed nigh unstoppable, clawing its way higher month after month and more or less continuously hitting new bull-to-date highs. As this first major upleg gloriously announced the new bull market in silver to the world, naturally speculators grew very excited about silver's prospects. Those were darned fun months!

Silver is an extremely small market in the grand scheme of things, an infinitesimal fraction of stocks and even vastly smaller than gold. It doesn't take a great deal of capital, relatively speaking, to move silver quite dramatically. As more capital than usual started chasing the new upleg in silver, silver prices kept going up and up along with general sentiment among silver speculators. By the time silver approached $8 in March most players were convinced that the fabled $10 level couldn't be far behind.

But the markets have an uncanny knack for executing a short-term turn-one-eight just as the majority of speculators are convinced that an existing trend will accelerate indefinitely. By March the increasing level of silver bullishness was making me nervous over the short-term since silver was getting stretched much too far above its major bull-market support at its 200-day moving average.

On April 1st just before silver crossed $8 I wrote the following in the April issue of our Zeal Intelligence newsletter for our subscribers, "Stretched 42% above its 200dma bull-market support, a major correction is due in silver. It makes no sense to buy silver stocks or physical silver today. A typical bull-market pullback would drag the metal back down near its 200dma, and I am sure that silver stocks would be hit hard in a silver retreat back down under $6."

The red Relative Silver line above, rSilver, quantifies silver relative to its 200dma in absolute constant percentage terms over time. In early January rSilver had exceeded 1.30, silver traded 30%+ above its 200dma, and the charging metal began retreating. It was able to hold the line and recover though, shooting up to 45%+ above its 200dma before finally giving up its ghost.

To put this extreme degree of overextension into perspective, gold tends to retreat into a correction once it stretches only 15% above its own 200dma, so silver's 1.45 rSilver reading at its latest interim top was really extraordinary and quite ominous from a short-term perspective.

All of the financial markets inevitably flow and ebb, advancing and retreating over time. They usually take two steps forward within their primary trend before taking one step back in a countertrend move. Graphically these uplegs and corrections become evident as a bull market advances far above and then retreats back down to its primary bull-market support at its 200dma. The red rSilver line above traces these very typical tactical sentiment waves oscillating within silver's primary trend.

These short-term swings are necessary to bleed off temporary speculative excesses that result when too great a percentage of traders pile on to one side of a trade, long or short. Silver was short-term overbought early this spring and it needed to correct, period. And correct it did, with something of a wicked vengeance.

Silver plummeted like a millstone in April, ultimately plunging by a gut-wrenching 32.8% by early May. Ouch. Unlike the HUI, which took a long time to consolidate back down towards its own 200dma, silver decided to take the express elevator down and correct viciously fast. This correction, while very painful at the time for long silver speculators, accomplished a couple key things.

First, when silver was topping in early April bullish sentiment was just too crazy over the short term. There were too many longs and there was too much greed to be sustainable. Silver's sharp correction deftly obliterated both the excessive longs and the greedy speculative fury that was swirling around silver. The great sentiment pendulum swung back from greed through neutrality and slammed into naked fear by the time the early May bounce occurred.

Second, silver retreating back down to its 200dma cleared the way for its next major upleg. All primary bull markets retreat back to their 200dma support periodically, and silver had not made the visit for almost seven months. By descending back down to get reacquainted with its 200dma, silver once again flashed the technical green light alerting technicians that it was reloading and that its next major upleg could launch at anytime.

Technical go signals aside, the long speculators who got caught in silver's sharp correction were understandably extremely bitter and negative after the dust settled. They promulgated all kinds of manipulation theories explaining why various shady groups had set out to target them directly. Even a century ago Jesse Livermore commented extensively on the natural human tendency of speculators to want to blame anyone but themselves for their own losses.

Looking back though, there was really no need for manipulation theories since silver had been unarguably overbought over the short-term and just needed to correct. Periodic corrections within bull markets are inevitable and no big deal, they will happen and we just have to deal with them. Manipulations do undoubtedly happen often in the financial markets, but the Occam's Razor principle demands that speculators always consider the simplest possible explanation for a given price movement before adding complications like malicious unseen parties directly gunning for them.

Regardless of whether the silver correction's cause was natural or artificial, the lingering fear from this steep slide coupled with the grumbling over losses set a very negative precious-metals mood heading into the summer. Gold and the HUI had been consolidating too but I think the silver plunge was the straw that broke the camel's back in sentiment terms. Once silver plummeted, the perceived popular allure of the whole precious-metals sector shrunk dramatically.

I believe this negative sentiment carried through most of the summer and is the primary reason why speculators remain unwilling to buy PM stocks despite the new uptrends in gold and silver alike. This strikes me as really ironic.

The only reason to buy PM stocks is because one expects gold and silver prices to rise. Well, gold and silver prices are rising since their expected corrections ran their courses earlier this year! As gold and silver prices rise, PM miners' profits grow dramatically rendering their stocks much more valuable. Yet, today PM speculators remain stubbornly reluctant to commit capital and the HUI drifts aimlessly in some sort of surreal market purgatory.

While you couldn't tell by talking to an average depressed PM speculator or watching the HUI's excruciating lethargy, gold and especially silver are actually looking up since their spring weakness. As the trendlines above and below illustrate, silver is carving a definite uptrend since its May lows. I suspect that this uptrend will grow into a full-blown upleg in the coming months and silver prices will catapult much higher.

When we zoom into the last six months or so the precision and strength of this new silver upleg becomes very apparent. Why would any speculator owning silver stocks want to sell them when silver is marching higher? Provocatively, there are a handful of elite unhedged silver miners that are actually trading lower now than they were in early May! This rare and unsustainable disconnect is providing stellar opportunities for fearless contrarian speculators.

An uptrend, or a longer upleg, is simply defined technically by a series of higher lows and higher highs. The blue silver line rendered above fits these requirements perfectly. Each subsequent interim low that silver carves near its support line seems to be higher while each subsequent interim high exceeds its immediate predecessor as well. This beautiful chart, an unmistakable uptrend, looks exactly like the early months of a major new bull-market upleg.

Even in relative terms silver's advance in recent months is textbook perfect. The red rSilver line shows silver first flirting with its 200dma in May and June and then pulling away from it and heading higher in July. I consider any rSilver level under 1.03 to be a strong buy signal and we have been blessed to have this coveted green light to buy silver all summer.

As long as silver remains in a primary bull market, as it ought to based on growing world demand and flat supplies, silver should continue running higher until it stretches at least 30% above its 200dma. Based on today's 200dma, an rSilver 1.30 neutral zone won't occur until silver trades above $8 again, right near its early April highs. And as silver's 200dma rises in the months ahead, the absolute silver price 30% above it will continue to rise higher as well, so our neutral target will gradually migrate upward.

In addition to its crystal-clear uptrend, there are other bullish technical developments on this chart as well. Silver's white 50dma is about to cross back over its black 200dma to the upside. A 50/200 moving average cross is a big deal to a lot of silver futures traders and they will probably consider it a bullish omen. Silver buying could accelerate considerably once silver's 50dma meanders decisively above its 200dma in the weeks ahead.

And since silver is such a tiny market, even a relatively small amount of buying will push its price up and entice in even more buying, creating a virtuous circle. Silver is also nowhere near its upper Bollinger Band at the moment, its top yellow line, so it can't be considered technically overbought even over the ultra-short-term. Yes, it certainly could retreat back to its lower support line around $6 and bounce anytime, but it could just as easily power higher until its hits that upper Bollinger Band two-and-a-half standard deviations above its 50dma before regrouping.

Any way you want to slice it, silver is carving a gorgeous new uptrend! And for a lot of fundamental and technical reasons I suspect that this particular uptrend will ultimately blossom into the second full-blown bull-market upleg in silver. If the markets prove me right in the months ahead, then silver investors and speculators alike will earn excellent returns in the metal itself and in all of its related speculations including silver-mining stocks along with futures options and equity options.

If you are interested in silver and how to trade this new upleg, you may wish to check out the hot-off-the-presses August issue of our acclaimed monthly Zeal Intelligence newsletter just published. My partners and I are actively playing and constantly evaluating and gaming this increasingly powerful new uptrend in silver.

For long-term silver investors, I outlined a couple brilliant new strategies designed by legendary metals analyst Franklin Sanders for trading bullion with the goal of at least doubling the bull-market returns obtainable on a buy-and-hold physical silver investment. For very little risk it is possible to strategically trade silver bullion during a silver bull and come out with far more silver at the end than from conventional buying and holding. These investment ideas are very powerful and innovative and every metals investor needs to be aware of them.

For silver speculators I recommended a new buy in one of the world's best silver miners. This elite unhedged silver company has been grinding lower during the silver uptrend of recent months creating an unsustainable and potentially quite profitable divergence. Either the stock is right and silver fails and plummets or silver is right and the stock will have to soar in the months ahead to catch up. Obviously I think silver is right this time and this stock will rebound with a vengeance once the markets realize this. When silver is up but one of the best pure silver plays on the planet is down, it seems negligent not to seize this incredible opportunity!

As always, brand new e-mail PDF edition subscribers will receive a complimentary copy of this current August Zeal Intelligence as our way of saying thanks for honoring us with your business. Your paid subscription will start with next month's new issue. I am very grateful for your support and I could not analyze and write about the markets without it. Please consider subscribing today!

So, as we plunge into this last full month of summer, please try not to get caught up in the overwhelming negativity permeating precious-metals land. Sure, PM stocks have largely traded sideways and the dollar's strength in recent weeks has hurt gold a little. But regardless of these short-term events, gold remains in a modest new uptrend as it carves higher lows and higher highs.

Far more impressive is silver's fantastic performance this summer. Just a year ago if silver had done this people would be yelling about it from the rooftops, but after silver's sharp correction earlier this year sentiment just remains unnaturally dreary and depressed. This won't last forever though. The higher the silver price moves, the more the scales of fear will fall from speculators' eyes and the more enthusiastic they will grow in bidding up its price.

Silver's new upleg sure looks like it is already underway and odds are it will prove to be one of the key catalysts that leads gold and the HUI way higher in their own next major uplegs. Silver's strength is providing tons of evidence suggesting that the precious-metals bulls are far from dead but are on the very verge of powering higher yet again.


 

Adam Hamilton

Author: Adam Hamilton

Adam Hamilton, CPA
Zeal LLC.com

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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 delivered from an explicitly pro-free market and laissez faire perspective. Please visit www.ZealLLC.com for more information, www.zealllc.com/samples.htm for a free sample, and www.zealllc.com/subscribe.htm to subscribe.

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