"When misguided public opinion honors what is despicable and despises what is honorable, punishes virtue and rewards vice, encourages what is harmful and discourages what is useful, applauds falsehood and smothers truth under indifference or insult, a nation turns its back on progress and can be restored only by the terrible lessons of catastrophe." … Frederic Bastiat

Evil talks about tolerance only when it’s weak. When it gains the upper hand, its vanity always requires the destruction of the good and the innocent, because the example of good and innocent lives is an ongoing witness against it. So it always has been. So it always will be. And America has no special immunity to becoming an enemy of its own founding beliefs about human freedom, human dignity, the limited power of the state, and the sovereignty of God. – Archbishop Chaput

Trader Dan's free work will soon be available at www.traderdan.biz

Thursday, August 18, 2011

Silver Stuff

I wanted to post a few comments about the Silver market for some of those who have been asking me to do so. As mentioned in previous posts here, silver is finding itself caught in a war between those running out of risk trades who are selling commodities and equities, and those who are buying it as a safe haven metal.

That tug of war has prevented it from surging alongside of gold but nonetheless, even in the face of such selling, it has been attracting enough buyers that its technical chart picture is slowly but steadily improving.

I want to first note that it has regained its footing above the 50 day moving averaage having bounced firmly off of that key technical level last week. Since then it has established a nice little uptrend which has taken it back to the region where it has encountered selling resistance over the last month or so. I am speaking specifically about the region near and just above the $40 level.

If you will also note, all four of the major moving averages that I use in tracking this market, are now moving higher with the silver price ABOVE those ma's. That is bullish. What I would like to see and what it appears that we are likely to soon get, is for the 10 day moving average (blue line) to move up and crossover the 20 day moving average (red line). That would put the market solidly in an uptrend as it will take some stability at these current price levels for such an event in the moving averages to occur.

If, and this is an important "IF" from a technical perspective, silver can close out the week tomorrow on a firm note, preferably with a push through the $41.30 - $41.50 level, it will enter the following week on very solid technical ground and set up a run to the $44 level for starters.

It still has some downside support first near $39.50 which is followed by another level of support near the $38 level. It would have to breach that latter level for a move towards $35 again.

At some point, as gold continues to move sharply higher, silver will become increasingly attractive to value-based buyers as it is still very affordable if one considers the current options in what can be termed "precious metals", platinum ($1845), palladium( $758), and gold ($1835). None of these metals are cheap any longer ( in the sense that the common man on the street can plunk down some loose change for an ounce) making the little grey metal, "poor man's gold", likely to outperform on a percentage basis in the coming months.

Mining Share ratio to gold back at pre QE1 levels

The following ratio chart says in a picture just how severely undervalued the gold stocks are in relation to the price of bullion.

You might recall that as the credit crisis erupted in the summer of 2008 with the failure of Lehman Brothers and subsequent meltdown of other large financial firms, stocks and commodities plummeted as the Yen carry trade unwound and deflationary fears escalated.

The rumors began to circulate as the crisis deepened that the Federal Reserve was getting ready to implement some unorthodox policies in an attempt to stave off the deflation and prevent a credit market lockup. That was when the phrase, "Quantitative Easing" first began making the rounds in the markets.

So confident were traders that the Fed was not going to sit idly by while the entire US financial system imploded that they began covering shorts and bidding up the price of equities and commodities ahead of what was then announced with certainty in November of that year.

Look at the chart and you can see that while the HUI/Gold ratio is not at the depths it reached during the peak of the credit crisis, after today, it is now at levels last seen just before the QE1 was actually implemented.

If you look across the chart to the left and note the blue line reaching back to the end of 2001, you can see that the mining shares relation to gold had actually plummeted to levels last seen near the VERY BEGINNING of the now decade + long bull market in gold. That is how cheap the shares had become to gold bullion in the third quarter of 2008.

Quite frankly, we are not all that far off from levels seen at that time with today's round of selling across many of the mining shares. This has occured in spite of the fact that we have spent more than $2.5 TRILLION between QE1 and QE2 and seen the gold price leap from $700 in November 2008 to over $1800 as of today's close.

Based on this fact alone, either the price of gold is going to have to plummet quite sharply from current levels or the shares are going to be at levels last seen in relation to the price of gold bullion when the bull market in gold began and that was at a price level of $270-$290 gold. While gold may correct at any time from its strong rally, why in the world would the gold price be the one moving lower given the current state of the global economy and particularly with all the implications regarding the integrity of the currencies of many nations in the West? The only way to correct this glaring imbalance is for a very sharp and incredibly swift rally in the mining sector.

I have been detailing the ratio-spread trade being employed by the hedge funds across the mining sector for some years now. As a trader I understood the rationale behind that trade - why risk issues related to mines such as management changes, labor disputes, environmental lawsuits, hostile laws and regulations, aging mines, etc. when you can get leveraged exposure to gold by using the ETF's instead. One could buy the ETF or Comex gold and sell short some of the weaker gold shares and laugh all the way to the bank. As an investor myself in the gold shares, I was not happy to see this trade but I could understand it.

I must say that it has now reached a point where those who ply the trade are treading on very thin ice. There is no longer a fundamental case that can be made to justify the trade at current levels of the shares in relation to the price of gold. Smart traders will run a trade as long as they can but they will leave the last 20% for the foolhardy and the novices who think that they are clever enough to pick exact tops or bottoms in markets. The pros do not practice such stunts - if they do, they do not remain pros for much longer but soon become, "EX" traders.

The first hedge funds out the door of this trade are the ones who are going to make the money in it. They will take their profits and they begin looking for another golden goose that may lay yellow eggs for them. The ones that stick around and think they are quick enough to exit before getting run over by all the rest of the funds in such a crowded, lop-sided trade will be the ones who overstayed their welcome and end up losing big when they could have retired the trade with decent profits had they not been so mindlessly greedy.

The first inkling we get of any acquistions by a major gold mining outfit of a quality junior and it is game over for this trade.

Wake up hedgies - the trade to have been in for the last few months was to be long the miners and short the broader markets. There was your money maker. How many times on this site did we mention this trade and urge you to get out of the wrong one? Stop relying on your damned computers and do some thinking and analysis on your own.