Big Autumn Silver Rally 2
Source: Adam Hamilton, Zeal Research (8/20/10)
"Despite silver's recent sojourn, it actually has excellent potential."
The primary reason is gold. Since the early 1970s, silver has closely followed, and sometimes amplified, the price moves of the granddaddy of precious metals. Over the vast majority of this decades-long span, silver has been nearly perfectly statistically correlated with gold. When gold is strong, traders flock to silver. And when gold is weak, they abandon its smaller cousin. In hard technical price-chart terms, there is no doubt at all that silver is a derivative play on gold.
Of course autumn is typically an excellent time of the year for gold, and thus the whole precious metals complex. Big seasonal factors converge, which tend to seriously ramp up global gold demand and hence gold prices. These include income-cycle drivers like Asian harvest, after which farmers invest some of their year's surplus income in gold. They also include cultural drivers like Indian wedding season where brides are adorned with intricate and expensive gold jewelry dowries.
While the usual autumn gold rally is very bullish for silver, it certainly isn't the only thing silver has going for it right now. This essay will explore those other factors, including silver technicals coiled like a spring and ready to launch, as well as silver's continuing undervaluation relative to gold. Even if gold somehow managed to languish and flat lined this autumn, silver's own intrinsic merits are exceptionally bullish today.
This first chart looks at silver's impressive technicals. Silver and its key moving averages (MAs) are tied to the right axis, while relative silver is rendered in red on the left. Relativity is a measure of oversoldness and overboughtness, helping traders understand when prices are exceptionally low (the time to buy) or exceptionally high (the time to sell). Rsilver is computed by dividing the close in silver by its 200-day moving average (dma). The result charted over time creates a horizontal constant-percentage trading range.
In order to understand why silver looks exceptionally bullish emerging out of this year's typical summer doldrums, we need some technical perspective. Back in the summer of 2008, silver was consolidating high after a massive rally in late 2007 (which started in autumn) and early 2008. Then the brutal stock panic hit like an F5 tornado, destroying the global appetite for all risky assets including silver. In just 4 months, this metal plummeted a sickening 53%!
Ever since that epic panic anomaly, silver has been relentlessly recovering. This recovery provides the critical strategic lens through which all recent price action must be considered. Silver had already stubbornly returned to its pre-panic price levels last autumn. It averaged $18.07 in July 2008 before the panic, and $17.90 in November 2009 after last year's autumn rally. Since then, it has generally consolidated sideways.
Provocatively, this high consolidation over most of the past year occurred within the old pre-panic high-consolidation range. Silver did fall out of this range once, when it plunged 20% in 3 weeks in late January and early February 2010 in response to sharp gold and stock-market retreats. But that correction was quickly erased, silver rapidly climbed back up into this high-consolidation trend less than a month later.
High consolidations are basing events, very important technically. After any fast rally to new price levels not yet seen in a bull, traders are nervous about whether those seemingly stellar prices are sustainable. Some traders, looking for a correction, sell. Meanwhile other traders, excited because the price has rallied so far, buy to ride the momentum. The net result is a high consolidation, prices grind sideways not far off their new highs while traders digest their implications.
The longer a high consolidation lasts, the more comfortable traders get with those new price levels. Back in early 2008, $18 silver seemed pretty high and overbought. While the silver-to-the-moon zealots loved it, more prudent traders were concerned since silver often plunges even faster than it rallies. Yet today, since we've seen $18 silver on and off for a few years now, it seems perfectly normal. Silver doesn't feel overbought at all at $18, we've been conditioned to accept this level.
This base has been established over a long time, either since late 2009 or early 2008 depending on your perspective. The longer that a particular price level bases in a fundamentally driven secular bull, the more powerful the inevitable rally out of that base. Since the stock panic was an ultra-rare once-in-a-century anomaly, silver's base extends back to 2008 in my book. But if you want to be more conservative and consider it only relevant since late 2009, that is still a long basing period.
Remember, silver follows gold. Back in February 2008 when silver pierced $18 initially in this bull, gold averaged $926. Last month (July 2010) when silver averaged $18, gold averaged $1192 (29% higher). So as I'll discuss after the next chart, silver's high basing in the face of strong gold prices makes it look even cheaper today. This high base is the perfect springboard for a major silver rally.
There are some other bullish technical developments beyond this long high consolidation to note. First, silver's key support zones are converging today. Its recent recovery-support line since the panic has just hit its old pre-panic high-consolidation support line. For technically oriented traders who pay attention to these things, and most silver-futures traders do, a convergence of major support lines is a powerful incentive to buy. Right in time for the autumn rally!
More importantly, check out rsilver's position in its horizontal range. Considered as a multiple of its 200 dma, over the past six years or so silver has tended to run between 0.96x its 200 dma when it is oversold and 1.40x when it is overbought. The last time rsilver traveled in the upper half of its long trading range was way back last autumn. Languishing at an average less than 1.04x so far this month, silver is low in its range and near-oversold today. It's been a long time since silver has seen any excitement.
The best time to buy anything is when traders aren't excited about it, when it is low relative to its 200 dma. And thanks to this year's summer doldrums, rsilver has been grinding ever lower on balance since spring. To see silver mired in bearish sentiment, and hence low technically, right before the usual strong autumn seasonal factors kick in is exceptionally bullish. If silver was overbought instead, stretched well above its 200 dma, too much greed could lead to a correction fighting against autumn seasonals.
But this isn't the case today. As we exit the summer doldrums and head into gold's strong autumn, rsilver is near the oversold end of its secular trading range and traders aren't excited at all about this metal. Meanwhile silver has been consolidating high for at least a year and building a strong base from which to launch its next big rally to new bull highs. On top of all this, the recovery support line has converged with silver's high-consolidation support. Together these facts create a great environment to be long silver.
Way back in the heart of the stock panic, we bought silver stocks aggressively and encouraged our subscribers to do the same. Why? Silver was radically undervalued relative to gold. Since then, I've advanced this argument several times using the silver/gold ratio. Prior to the panic silver traded in a definite range relative to gold. The panic anomaly blew that apart as risky silver plummeted much faster than much-safer gold; but, ever since that panic, silver has been gradually recovering relative to gold.
This next chart highlights the state of the silver/gold ratio today, another powerfully bullish driver for silver this autumn. Because the silver price divided by the gold price yields a difficult-to-parse small decimal, I prefer dividing gold by silver and then inverting the axis to get an easier-to-understand proxy for the SGR. This SGR is rendered in blue on the right axis, while the raw silver price is slaved to the left in red.
For years prior to that stock-panic anomaly, the SGR was actually climbing higher in a secular uptrend. And this makes sense. Strong gold prices get traders interested in leveraging the precious-metals bull in silver. So the longer a gold bull persists, and the higher it runs, the more traders want silver exposure. And the more traders bidding silver higher, the faster its price rises. Since silver is such a tiny market compared to gold, as a gold bull matures silver gradually gains ground relative to the gold price.
Between January 2005 and August 2008—the time of normalcy before all the wild dislocations the panic spawned—the SGR averaged 54.9x. An ounce of silver traded for about 1/55th the price of an ounce of gold. In addition, silver had a correlation r-square with gold of 95% over this span! In other words, 95% of the daily price action in silver was directly explainable statistically by gold's own price action. This was the normal precious metals secular-bull environment.
But, when highly speculative silver plunged far faster than gold during the panic, this relationship was blown apart. Between September and December 2008 when the extreme the-sky-is-falling panic psychology reigned, the SGR averaged a dismal 75.8x. At worst at the panic's nadir, it easily hit its lowest point of the entire secular bull (1/84th the price of gold!). And in correlation terms silver started following the U.S. stock markets rather than gold, its r-square with the yellow metal fell to an unbelievable 53%.
Now if you've studied silver's historical relationship with gold, even in the bowels of the panic it was crystal-clear this anomaly couldn't be sustained. It was the best opportunity of this entire secular bull to buy silver stocks, so we and our subscribers did aggressively. And time has vindicated our hardcore contrarian stance then, as silver has indeed been recovering relative to gold since.
From January 2009 to today, the SGR has regained a 66.4x average. And silver's correlation r-square with gold is back up to 89%, nicely returning towards historic norms. But I don't believe this post-panic recovery is over yet. Remember that silver is highly speculative, and thus exceptionally sensitive to prevailing sentiment in the financial markets. And ever since the panic, widespread fear and anxiety have continued to dominate. This ugly environment has slowed silver's recovery relative to gold, but not stopped it.
Depending on where you want to measure it from, silver's undervaluation relative to gold today runs somewhere from substantial to enormous. Ever since this post-panic recovery got underway in earnest in early 2009, the SGR has been recovering in the uptrend rendered above. Today the SGR is down low near its support, silver is unloved thanks to the summer doldrums. But if the SGR merely climbs back up to resistance, we are looking at an SGR of 58x or so.
At $1,200 gold, this yields a silver price of $20.70. But gold tends to rally in the autumn, and is set up beautifully this year (low in its relative trading range, near its 200 dma). At $1,300 gold, a 58x SGR yields a silver price approaching $22.50. But for a variety of reasons, I think merely using this SGR recovery uptrend's resistance line is far too conservative. Ever since the panic, I've argued that silver ought to at least regain its old secular pre-panic average SGR near 55x.
At $1,200 and $1,300 gold, this yields “fairly valued” silver prices around $21.75 and $23.50. Of course these are well into new-bull-high territory, as silver achieved its best level of this secular bull ($20.77) back in March 2008. And you better believe that as soon as silver surges to new bull highs, interest in buying silver stocks is going to soar. Probabilities are high that we'll see new bull highs in silver this autumn.
For me, a return to the old pre-panic average SGR is plenty bullish enough. But for some investors, silver is a religion. They hold nothing but physical silver and silver stocks, and their whole financial future revolves around a silver moon shot. While not being diversified is extremely risky, this all-or-nothing bet on silver is common enough to throw out some optimistic projections for these silver zealots.
Check out the SGR's old pre-panic secular uptrend rendered above. Today its support extends to 46x and its resistance to 35x. Remember the longer a precious-metals bull persists, the more traders get interested in silver and the higher it is bid relative to the gold price. So it is probable at some point, though almost certainly not this autumn, that the SGR will re-enter this pre-panic trend. If you plug a 46x or 35x SGR into a reasonable gold price in the coming years, you get some silver-price projections that will make even the raging bulls smile.
Back to a more reasonable 55x in the near term, $1,200 and $1,300 gold projections are conservative. On average seasonally, gold rallies about 5% between mid-August and late September and then another 12% between late October and late February. Together, these rallies average around 14% in the autumn and winter buying season. If gold rallies 14% this year from its recent late-July low, we'd be looking at $1325 before next spring.
Heck in last year's autumn rally, which was admittedly quite exceptional, gold soared 31% between late July and early December. A similar rally this year, which I'm not betting on since its odds aren't great, would push gold up above $1,500! Even at the pre-panic average 55x SGR, this would yield a silver price around $27.25. And even if we don't see this until autumn 2011, the appreciation potential of silver stocks is vast thanks to silver's continuing post-panic recovery relative to gold.
So while gold, and hence silver seasonals, are always bullish in autumn, this year looks like it has greater potential than normal. Silver has been basing for a long time getting traders comfortable with $18ish levels. It looks cheap technically trading near its 200 dma and sentiment, while not exactly rotten, is certainly still totally bereft of any greed or excitement. On top of all this, silver remains very undervalued relative to gold, and is even trading near support in its post-panic-recovery SGR uptrend. What an explosive setup heading into autumn!
At Zeal we are riding this big-autumn-silver-rally potential in investments and speculations in elite silver stocks. You ought to join us. We sold many of our short-term silver-stock trades near highs before the summer doldrums hit, then we started redeploying for autumn this week in our weekly Zeal Speculator newsletter. It should be a very profitable campaign.
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The bottom line is—silver looks very bullish heading into autumn 2010. Big seasonal gold-demand spikes are approaching, and rising gold prices get traders excited about silver. After consolidating high and forming a strong base for at least a year, silver has the perfect springboard from which to launch to new bull highs. Couple this with converging major support lines, near-oversold technicals, and little enthusiasm today, and silver is perfectly positioned for a fast ride higher in the coming months.
Overarching all these bullish silver technicals is this metal's continuing panic-driven undervaluation relative to gold. Until this valuation gap is fully closed, silver has a lot of ground to regain and thus should rally faster on balance to catch up. Thanks to all these bullish influences, this year's big autumn silver rally certainly has the potential to surprise on the upside. And silver stocks will naturally soar if all this comes to pass, creating a great opportunity for traders today.
Adam Hamilton, CPA
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