How to Play the Next Hand in Silver

By Joshua Enomoto, Founder of and contributor

The breach of the vaunted $26 dollar level in the silver market couldn’t have come at a more desperate time in the alternative investment community. So many trades, positions, and personal vaults took a hefty haircut that even the most hardened of precious metal bugs were left questioning their will to remain in this most volatile of sectors. Many people that saw the COMEX sell-off on April 12th reasoned that it couldn’t get much worse and bought in…the only problem? It did get worse, to the tune of over ten percent of valuation flushed down the fiat toilet. We believed that through it all, the 26 dollar level would hold, and it failed.

There was a time when I sat on the opposite end of the computer screen, reading literature upon literature of silver’s “under-valuedness” and waiting with intense anticipation for the final stage of the bull market, possibly the greatest bull market in human history, according to David Morgan. The rewards came early and often, but in recent years, the market has failed to capture the jubilant sentiment of 2011. The lingering doubt amidst the collective conscience of the silver bull is whether we have instead entered into a new secular bear market in commodities.

Of course, in the short-term, anything is possible, including more volatility. However, bull markets rarely ascend to their zenith without prolonged periods of correction: consider the last bull market in the precious metals that began in the early 1970’s, which saw both gold and silver make tremendous gains before a “fake-out” decline, and ultimately culminating in a massive parabolic move, achieving a price point that was unimaginable at the time, and would be so for the next thirty years.

Given the backdrop of global debt monetization and the collapse of European member states, is $2,000 gold and $60 silver really that difficult to envision? Some would argue that those figures are conservative and they would likely be proven correct.

Let’s take a look at the technical chart (3-year daily) for the iShares Silver Trust, or ticker symbol SLV:

Gap days of substantial variance, or differences between the opening price of the current session and the closing price of the prior session, are few and far apart in the silver market, with the most notable occurrence appearing in September of 2011, when two gap down days of over 5% chopped the white metal from $37 to $32. This makes what happened on April 15th, 2013 even more momentous, as the opening bell saw the SLV lose nearly 9% of valuation from the previous session! Oddly, the sharp decline in price came on 50 million trades, half the selling volume witnessed in September 2011. If there was ever a time to cry manipulation, this would be it.

While such charges are going to be hard to prove, thus invoking more than a fair share of controversy, the dual nature of silver demand got the better of the precious metal. Silver is heavily used for industrial purposes, but a great portion of demand comes from the investment sector, with many of the participants exercising little faith in “silver conspiracy theories.” These are the folks that mitigate downside risk by no longer holding dead weight, rather than average costing long positions by buying the dips. The aggregation of stop-losses compounded the mass psychology of fear and the end result was $23 silver.

Those that bought in at this price (yours truly) were expecting a short-squeeze to spike the price to $24, helping to close off some deep-seated portfolio wounds, but even at this level, there was disappointment. Silver’s price action following the 15th has been lethargic at best, with a lack of directional vigor placing derivative instruments in trading purgatory.

Have we truly woken up an ugly bear market?

Although the current technicals are beyond hideous, there are some interesting historical points to consider:

Above is a chart comparing the SLV (gray line) to the USD index (green line). As can be expected using standard financial logic, as the dollar weakened (inflation) through the execution of QE2, silver experienced a dramatic spike top (nearly $50 in the futures market) in April 2011, but the failure to build upon that success signaled a return of strength in the greenback (deflation). This deflationary cycle, evident by the rising index rating, continued to cap silver’s peak gains throughout 2012. The dollar made one more surge between February and April of 2013, where the index rose over 5%.

Since that move, the dollar has failed to clear the 83 level, and weak jobs numbers are suggestive of a more accommodating Fed with regards to monetary loosening. We also saw a spike bottom occur in the silver market, which leads me to believe that a cycle reversal in the FOREX sector is in play here. If so, we could see the inverse of 2012, meaning higher silver prices within the context of an inflationary cycle.

The bottom line is this: commodities often overshoot the mean during periods of monetary transition. While no one in the long-side of the trade was happy about the events earlier this week, we could take comfort in the fact that the worst may be behind us. Reflation is the hot topic of the central banking community so now is not the time to panic!