By Adam Hamilton
Silver has certainly enjoyed an impressive run of late, catapulting nearly a third higher since mid-summer. Because this surge looks nearly vertical on short-term charts, some traders are getting nervous about this rally’s staying power. While silver may indeed be temporarily overbought, its recent strength actually looks like the vanguard of a major new upleg. Silver’s advance is likely just getting started.
Skepticism of silver’s potential continues to run rampant among speculators and investors. But this is par for the course after a major correction. Back in the spring of 2011, silver rocketed parabolic in a gargantuan upleg. But it became wildly overbought, hitting the most extreme greed levels of its entire secular bull. So over the subsequent 14 months, silver corrected dramatically by a staggering 45.5%!
Remember that the job of any correction is to rebalance sentiment, to eradicate the greed and euphoria that necessitated that correction in the first place. So the bigger the upleg leading into a major topping, the bigger the subsequent correction will have to be. Thus it shouldn’t be the least-bit surprising that silver’s biggest upleg by far of its entire bull was followed by its biggest and longest correction.
Silver finally bottomed in this past summer’s precious-metals doldrums, and as always after a major correction sentiment was rotten. Fear and apathy reigned supreme in late June and early July as silver languished near 19-month lows. This metal was largely left for dead, with bearish commentary abounding. But out of just such major sentiment ebbs is when major new bull-market uplegs are stealthily born.
While powering nearly a third higher in the less than 3 months since then may seem excessive, it is really nothing special for silver. This hyper-volatile metal has always been a speculators’ playground. The relatively small size of the silver market means it doesn’t take much capital sloshing in or out to ignite big and fast moves. Considered within the context of its own bull, silver’s latest advance is actually minor.
Perspective is everything in the markets, so we’ll start with a long-term silver chart. Most sizable moves look excessive on short-term charts, and silver’s latest is certainly no exception. But traders worried that silver’s latest surge is too big and sharp to be sustainable are trapped in the tyranny of the present. From a broader strategic perspective, silver’s recent strength simply looks like a young new major upleg.
Let’s start with silver itself, rendered in blue here and slaved to the right axis. In the context of its broader secular bull, the recent 31.9% rally in 2.7 months doesn’t even stand out. In the final month alone leading into its last upleg’s top in April 2011, silver saw a similar gain in far less time. But that surge happened from highs as greed waxed extreme, the polar-opposite sentiment environment from last summer’s lows.
And out of major lows after major corrections, major new uplegs are born. Silver has enjoyed 5 of these since 2003, all marked above. Leading into early April 2004, silver climbed 71.5% higher in 6.0 months in its first real upleg of this bull. After that silver consolidated for the next year and a half or so to eradicate the excessive greed seen at that first topping. And then speculators finally returned and silver soared again.
Over 8.5 months climaxing in mid-May 2006, silver blasted 124.0% higher in this bull’s second major upleg! Then once again after being bathed in such greed and euphoria, silver corrected and consolidated for well over a year. Finally in the summer of 2007 silver sentiment was bad enough to spawn its third major upleg, which crested at an 80.5% gain 6.5 months later in early March 2008.
As a hyper-speculative metal, silver was naturally ripped to shreds in the subsequent once-in-a-century stock panic. Between July and November 2008 at that panic’s climax, silver plummeted a gut-wrenching 53.4%! Talk about a bloodbath. But while most traders succumbed to that epic fear superstorm, we stuck to our contrarian guns and bought into it. If you want to buy cheap, there’s no better time than a panic!
Deep in its dark heart, we bought and recommended a long-term investment in an elite silver stock to our subscribers. The brave contrarians who followed us into the breach are now sitting on 1007% unrealized gains. The only way to earn big money in the markets is to be brave when others are afraid and afraid when others are brave. Buy low when no one else wants to, and then sell high when everyone else wants to buy.
As I expected after seeing such insane levels of fear, silver indeed recovered rapidly after the panic. It powered 115.4% higher over the subsequent 12.4 months, nearly regaining its pre-panic highs. Since that stock panic was such an extremely rare event that will never be repeated in our lifetimes, silver’s post-panic upleg was certainly not typical. So to be conservative it can be excluded from our analysis.
After this secular bull’s fourth major upleg, once again silver drifted sideways for the better part of a year. Finally in late July 2010, in out-of-favor sentiment conditions much like this latest July’s, silver’s fifth major upleg was stealthily born. And it would prove a monster, ultimately skyrocketing a staggering 176.6% higher over the next 9.0 months! Whenever silver regains favor among traders, it just flies higher.
For our purposes this week, consider the average gain and duration of silver’s major uplegs so far in its secular bull. Excluding that anomalous post-panic recovery, silver’s normal four major uplegs have averaged gains of 113.2% over 7.5 months each. And even including that post-panic upleg doesn’t change things much, the averages merely shift to 113.6% over 8.5 months. Compare these to silver’s recent gains.
Rallying merely 31.9% higher over just 2.7 months is truly nothing for silver. I actually find these numbers very interesting. If you triple both of them, it would take silver to a little under an average upleg’s gains in just over an average upleg’s duration. In other words, since its latest mid-summer lows silver is nearly perfectly on pace with what you’d expect in a major new upleg running in line with the averages!
While technicals (price action) measure uplegs’ progress, sentiment governs their staying power. When any price rallies too far too fast, it generates too much greed and becomes unsustainably overbought. The excitement convinces all traders interested in buying anytime soon to hurry up and deploy. This pulls all near-future buying forward, leaving nothing but sellers. So the overbought price soon corrects.
Has silver rallied too far too fast in the past few months? Is it overbought with greed growing excessive? No, as most sentiment indicators will reveal. My personal favorite is one I developed many years ago to trade gold stocks in gold’s secular bull. It is called Relativity trading. It recasts a price like silver’s as a multiple of its own 200-day moving average. Charted over time, this metric reveals sentiment extremes.
Relative silver, or silver’s daily close divided by its 200dma, is charted above in red off the left axis. As is usually the case within ongoing secular bulls, rSilver has formed a very definite horizontal trading range. We currently define this as support at 0.95x and resistance at 1.40x. In other words, when the silver price slumps under 95% of its 200dma it is oversold and fear and pessimism reign. That is the ideal time to buy.
Note that during silver’s recent correction after its stunning parabolic fifth upleg, rSilver plunged well under this support zone. Silver got so beaten down and unloved over the year or so leading into this past summer that rSilver was trading near panic levels. There was absolutely no reason for silver traders to be as scared and depressed as they were during the stock panic, so this fear anomaly simply couldn’t last.
And it didn’t. By late June when silver finally bottomed, rSilver was way down near 0.83x. That was one reason we started aggressively buying silver stocks and recommending them to our subscribers this past summer when few others would touch them. Today the unrealized gains on these young short-term silver-stock trades are already running as high as 87%! It pays big to walk the contrarian walk with us.
While uplegs are naturally born when silver is very oversold, they give up their ghosts when silver gets very overbought. We currently define this danger zone in rSilver terms at 1.40x. Once silver rallies far enough and fast enough to climb more than 40% above its trailing 200-day-moving-average baseline, greed and euphoria are so excessive that the probabilities favor an imminent correction. That is when to sell high.
In April 2004 as silver’s first major upleg peaked, rSilver was running 1.448x. This secular bull’s second major upleg topping in May 2006 was radically more extreme, briefly stretching rSilver to 1.651x when that upleg finally crested. A couple years later as silver’s third major upleg peaked, rSilver was running at 1.465x. Before that epic stock-panic discontinuity, major silver toppings were consistent in rSilver terms.
But since the post-panic recovery took longer than a typical silver upleg, rSilver only hit 1.294x in early December 2009. Speculators were so heavily scarred from the stock panic’s huge losses that they weren’t particularly enthusiastic about anything including silver for years after. Once again this post-panic upleg wasn’t normal, and can certainly be excluded from the averages in order to stay conservative.
Later on the first normal post-panic upleg that went parabolic at its climax certainly did rekindle euphoric greed in speculators. rSilver shot up to a staggering 1.747x at its April 2011 topping! If you average all these past major upleg toppings, they show an average rSilver crest of 1.578x not including the initial post-panic-recovery upleg. Even including it doesn’t change things much, the topping average merely shifts to 1.521x.
At Zeal we start looking to exit our silver-upleg silver-stock positions whenever silver stretches 40% above its 200dma, it has simply rallied too far too fast to be sustainable. And the average upleg topping that marks the greed and euphoria climaxes is a bit higher still, let’s call it 55% above silver’s 200dma. Why is this relevant today? Look where rSilver was trading this week even after its recent sharp surge.
At best, rSilver merely hit 1.141x! Silver was only 14% above its 200-day moving average this week. As the chart above shows, this is simply nowhere close to being overbought in the context of silver’s own secular bull. With rSilver so low in its secular trading range, there is probably effectively zero chance that silver is carving or will soon carve a major interim high. Its upleg is probably just getting started.
And provocatively even this 14% read is somewhat overstated. Since my Relativity trading tool is based off of 200dmas, whenever a price crosses back over a falling 200dma after a particularly large correction the readings look higher than normal for a new upleg. We saw a similar sharp surge in rSilver after the stock panic and the falling silver 200dma it generated. Then, like now, rSilver overstated greed growth.
Silver considered in proper secular context today looks exactly like a young new upleg. Its gains in the past few months have not been excessive by bull-to-date upleg standards, in fact they are tracking perfectly with what you’d expect in the first third of any major upleg. And these benign technicals are confirmed by sentiment reads like rSilver. Silver sentiment is actually still closer to fear than greed, just emerging from deeply-oversold panic-like fear-laden levels.
So while silver might need to weather a minor pullback in the near term, it is nowhere near major topping levels. On a weekly basis silver may indeed be a little overbought, and this metal tends to exhibit a seasonal pullback over the next couple weeks anyway. But on a monthly basis, the context that matters for gaming its major uplegs, silver is nowhere near being overbought. Greed has yet to wax extreme.
While the technical and sentimental cases for a new silver upleg being underway are compelling, there is another major reason why silver ought to continue rallying a lot higher. Silver remains pretty undervalued relative to gold, its primary driver. This next chart revisits the Silver/Gold Ratio, which reveals silver still has huge potential to run higher in the months ahead even if the best gold can do is grind sideways.
Fully explaining this chart here is beyond the scope of this essay, but I did discuss it in depth in late July when silver remained quite undervalued relative to gold. This was one of the main reasons we added cheap silver-stock positions and advised our subscribers to do the same last summer. And interestingly despite silver’s strong surge in recent months, this white metal still remains undervalued compared to the yellow.
Prior to that epic panic anomaly, the SGR averaged 54.9. In other words, it took 54.9 ounces of silver to equal the value of a single ounce of gold. But like any secular relationship, the Silver/Gold Ratio exhibited a trading range that is shaded in blue above. It ran from 60 ounces of silver per ounce of gold on the low side to 45 on the high side. The latter was seen whenever silver regained favor among traders.
This week the SGR was trading around 51, still well below the 45 pre-panic resistance. Even if gold stalled right here, the growing speculator and investor interest in silver thanks to its recent rally ought to push it back up to a favorable SGR again in the coming months. At $1775 gold, a 45 SGR implies a silver price near $39.50. But gold’s seasonal strong period is now underway, so it is likely to head higher.
And there’s nothing like strong gold prices to get traders interested in aggressively buying silver to leverage gold’s gains. And if silver really starts regaining favor again in a big way, the SGR can certainly go a lot lower (silver gets more valuable relative to gold). In addition to the pre-panic horizontal trading range, there is also a strong SGR uptrend that came into play again in early 2011 as silver surged.
The midpoint of this uptrend is now around 33 in SGR terms, silver worth so much that only 33 ounces are necessary to equal the price of an ounce of gold. And if gold merely enjoys an average seasonal rally between this past July and May, which is very conservative in light of the Fed’s new QE3 campaign, it will be near $1875 by spring. Plug a 33 SGR into this, and you get an impressive silver price near $57!
I find this target very interesting because it dovetails in perfectly with an average silver upleg. From silver’s recent late-June major low, a 113% upleg would carry it over $56 by next spring. While only God can see the future, there is certainly no doubt that silver has great potential today. After such a massive correction, the odds definitely favor silver’s recent advance growing into a major new upleg.
The bottom line is silver looks to be in a young new upleg today. While its recent gains appear outsized on short-term charts, they are right in line with those seen in the first third of this silver bull’s past major uplegs. Silver only recently bottomed after a massive correction, the perfect breeding ground for its next major upleg. And despite its latest surge, silver remains far from overbought levels while greed is low.
On top of this, we are still early in silver’s usual seasonal strong period between autumn and spring. And this metal remains undervalued relative to gold, the primary driver of silver speculation. So as gold continues higher on central-bank inflation, silver should easily leverage its gains as it races to catch up. And naturally elite silver stocks, which are still largely unloved, will further amplify silver’s coming rally.
Adam Hamilton, CPA
September 21, 2012