Silver Market Update
Originally published September 3rd, 2007.
A week or so ago some financial reporters went on a quest to find silver bulls and gave up and went looking for lottery winners instead.
At first glance the silver chart looks terrible, with last month's dramatic breakdown below an important support level causing its moving averages to roll over and momentum to break to an 11-month low, and appears to confirm a Double Top with last year's highs, with the price accelerating away to the downside. So the pullback of the past couple of weeks towards what is now resistance is understandably regarded by many disenchanted bulls as an opportunity to quit in disgust at a slightly better price. However, as we shall see, there is now strong evidence that the August plunge was a final capitulative flushout, and that sophisticated traders have been gleefully mopping up the abundant supply in recent weeks from the disillusioned habitual losers, principally the Large Spec traders.
Before going any further it is worth considering the general background. The "end of the world is nigh" crowd had a field day in August, getting high on the convulsions in the broad market, and their dire predictions have been given a good airing due to a sudden surge in media and public interest. This is not to deride the doom and gloomers or their work - there is a strong basis to their arguments, but according to the indicators we follow the wheel is not going to come off just yet. On the August selling climax the Put - Call ratio rose to an extreme normally associated with a market bottom. Volume indicators for the broad stockmarket remain decidedly bullish with Accumulation-Distribution and On-balance Volume pushing new highs over the past week or two, which given that the market is still well off its highs is quite an accomplishment. Insider buying has been running at a 4-year high, again hardly what you expect to see at the start of a bear market. Finally, the plethora of alarming articles in the mainstream media is what you expect to see at a market bottom. From all this we must conclude that the market is on its way up again and is likely to make new highs, even if some sectors such as house building and home improvement in the US continue to suffer the fallout from the fenced off mortgage crisis. An important point to grasp is that the reasons for the markets being able to recover stability and advance also happen to be bullish for gold and silver - the massive infusions of liquidity required to put the markets back on an upward path are of course inflationary, and thus good news for gold and silver, and the renewed prospect of falling interest rates makes gold and silver more competitive investments, and in addition the lurking risk of a major dollar breakdown perhaps brought on by falling rates would be a powerful additional driver for the Precious Metals. Thus we should see both the broad market and gold and silver advance in unison.
We will now turn to consider the reasons why the plunge last month is regarded as having been a final capitulative flushout. One big reason is the current COT profile for silver, which is viewed as being VERY BULLISH. On the latest COT chart presented above, we can see how the Large Spec long positions, represented by the blue bars, have dropped to an extraordinarily low level, demonstrating that they have finally "thrown in the towel" in disgust and walked away. The Large Specs are the clowns of the marketplace, the fall guys who are always wrong and their unusually low level of interest in silver at this time is one of the surest signs you could hope for that silver is going up soon, and probably substantially. Conversely, the Commercials, who are never normally long silver, have greatly reduced their short positions as shown by the purple bars on the chart, to levels that suggest that a major rally is brewing. If you doubt the importance of these observations, then simply take a look at the latest Oil Market update, which utilized COT data to accurately predict the latest upturn in oil and oil shares on the basis of which we bought BP and Conoco Phillips before they turned up, and earlier on we used COT data to accurately predict the early August breakdown in crude.
Another important indication of a bottom is that the all important MSI, the Maund Subscriber Index, has dropped to a very low level consistent with us being near to a sector low - people just love to buy stocks - and to subscribe - at the top. Sentiment in the sector has been TERRIBLE these past few weeks, and this in itself is a powerful indication that a major rally in silver - and gold - is close at hand.
Finally, referring again to the 2-year silver chart, we must keep in mind that the resistance at the red resistance zone shown is strong, especially as it is reinforced by the Dome resistance boundary now dropping into it from above. Thus, despite the overwhelmingly bullish indications highlighted in this update, we may see a little more backing and filling before silver can break above the resistance zone and the Dome, and it may dip back towards $11.50 near-term which would be a major buying opportunity. Nevertheless, because of the psychological importance of the resistance between the current level and $12.60, if silver should succeed in breaking through it as expected a powerful rally is likely, as many player will want back in once that happens.