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Tactical Silver Trends 3

Adam Hamilton
March 4, 2005

Silver's performance was excellent in February, up more than 9%. Since its latest major interim low on January 4th, it has rallied a very impressive 17%. To put this into perspective, it is interesting to realize that the market-darling NASDAQ actually fell by 4% over the same period of time. Silver is really starting to shine again.

As an active silver investor and speculator, I am certainly grateful for silver's recent performance. As a lifelong student of the markets however, I am even more pleased with silver's latest behavior from an academic perspective. Silver's extraordinary volatility has reinforced priceless speculation lessons that seldom play out over such a short timeline.

One of the greatest obstacles to learning the art of speculation is time. The longer the time between a technical signal and a market response, the more difficult it is to perceive the efficacy of the signal. If I touch a hot stove and get burned instantly, I learn pretty darned quick not to do it again. But if I touch a hot stove and my flesh doesn't start sizzling until six months later, my mind won't properly link the effect with the original cause.

In silver's case, in just two short months we have gone from a major technical buy signal to substantial gains. Eight weeks ago when silver languished at $6.41 I wrote, "If silver remains in a long-term bull market for fundamental supply-and-demand reasons, then there is no better time to throw long than when it falls to or under its 200dma, like today. Carpe diem silver speculators!"

Thankfully the tactical silver trends have already proved this earlier technical signal correct. Silver has indeed thrived since it fell below its 200-day moving average to bounce off of its major bull-market support line. The metal is now carving a typical technical fingerprint that we'd expect to see in the initial months of a major new upleg.

This week I would like to update the tactical silver trends from two perspectives, both learning from the past and attempting to divine the highest-probability course of action for the future. Silver can move so fast that it deftly illustrates major speculation principles over a couple months rather than the generally longer timespans of other markets.

There are few, if any, major markets other than silver that have enough inherent volatility to react so quickly and aggressively to major technical buy signals triggering. And silver's well-behaved following of bull-to-date precedent on these latest technical buy signals certainly bodes well for its near-future course of action in this new apparent upleg.

Both of our charts this week are updates from early January's "Tactical Silver Trends 2" essay. If you compare these latest versions to the charts from two months ago, the accuracy of silver's technical buy signals of early January is nothing short of outstanding.

While investing is concerned with long-term supply and demand trends, speculation is concerned with relative pricing. Speculators strive to throw long silver when it is "relatively" cheap and go short or neutral when it gets "relatively" expensive. Sentiment, or the prevailing popular attitude on silver in any given week, is what ultimately drives these short-term pricing extremes. And while sentiment cannot be directly measured, a technical price chart certainly captures its essence.

In nicely trending bull markets like silver's shown above, several factors contribute to a price being relatively cheap and signaling the time to go long. First, bull markets tend to surge ahead before periodically retreating back to their 200-day moving averages in healthy corrections. Second, these corrections also tend to end at long-term linear support lines. Finally, these periodic corrections are often similar in duration and magnitude.

Back in early January, I was really excited about silver because it met all three criteria. Silver had not only fallen below its key 200dma, but it had also just hit its linear support line drawn above. Bull to date it had never fallen far below its 200dma nor had it ever decisively broken its major support. Silver was relatively low and looked like a great buy as long as its core supply-and-demand fundamentals remained intact.

Silver's wickedly sharp correction in December was in character as well. Silver is probably the most volatile major metal on the planet, and it can rise and fall with blistering speed. Its corrections, in particular, tend to be lightning fast. Last spring silver plummeted like a skydiver with a parachute failure for about a month in correction 1 rendered above. December's correction 2 also plunged for about a month.

As students of the markets, it is our duty to understand the character of any market before we place our capital at risk. Silver's extreme volatility should surprise no one. It always amazes me that after any sharp silver correction I get a flood of e-mails from folks who are shocked that silver plummeted so fast. Some wonder if the bull is over, some blame a consortium of powerful players arrayed against them, and others wander around in stunned disbelief.

Yet, like the vicious hailstorms I remember while growing up in the plains, silver's corrections are violent but very short-lived. While gold corrections can take over four months for sentiment to shift from euphoric to neutral to pessimistic, silver's extraordinary volatility accelerates this cycle into a compressed timespan running about a month.

If silver corrects hard for a month, plunges by 20%+, then odds are that particular correction is essentially finished. Silver did just this in December, falling by 20% and eviscerating unprepared longs before it tunneled under its 200dma and slammed into its bull-market support. And with a sharp correction, sub-200dma plunge, and major support approach in place, January just looked like the perfect time to throw aggressively long again.

So if you are a silver speculator, remember these simple technical clues for the next time silver inevitably corrects. Whenever one of silver's periodic corrections in the future returns it to this technical position, the odds are very favorable that it will soon claw back higher and start carving its next major upleg, as long as its core bullish fundamentals remain intact.

This next major upleg, which I suspect is already underway this very day, brings us to the reason I find these latest silver chart updates so fascinating. Just as silver's corrections 1 and 2 were so similar in duration and magnitude, the initial couple months of uplegs 2 and 3 are also uncanny birds of a feather. 2005's silver price action is a virtual carbon copy of that of late spring/early summer 2004 which ultimately led to awesome 45% gains in silver!

In both cases, silver tended to drift around its 200dma and gradually consolidate its way higher after its sharp corrections. Both of these episodes are highlighted above with the blue ovals. This technical behavior does make sense from a sentiment perspective. Following such brutal and unforgiving corrections, some leveraged speculators are unceremoniously booted out of the game and the surviving ones understandably grow very cautious.

Buy-side commitment after a 20%+ drop in merely a month is low since no one at the time can be certain that silver's correction has ended. And sell-side fervor also fades dramatically since speculators don't want to sell short at major support. Whether you think technical analysis has inherent validity or not, you cannot deny that it is widely followed in the futures world and that countless speculators trade based on these support and resistance lines.

As these modestly uptrending consolidation zones near support mature, gradually the terror of the recent sharp correction fades and more longs return to test the waters. The long-term bull-market support continues to hold after repeated tests and silver supply-and-demand fundamentals remain bullish. Capital returns to the relatively tiny silver market and soon demand for the metal outstrips supply at relatively low support-zone prices. Then an interesting event happens.

In both uplegs 2 and 3 above, after consolidating near support for a month or two silver suddenly shoots higher in a sharp initial spike. These spikes are labeled in this chart, and the recent February spike looks a great deal like what we witnessed early last July. Interestingly, even two years ago in July 2003 a similar phenomenon occurred before the utterly massive upleg 1 that ended in a speculative anomaly far above silver's probable bull resistance line.

I am not sure why these early-upleg spikes occur, why all of a sudden after a 200dma consolidation speculators suddenly flood into silver as a flock after eyeing it warily for a month or two. Nevertheless, these spike events tend to herald the unofficial beginning of the season of serious silver gains in each new bull-market upleg. The fact that we saw one in February in line with precedent certainly increases the probability that silver's third major upleg in this bull to date is now underway.

Before we explore the actual technical long and short silver signals in more detail in our final chart, there are a couple of miscellaneous technical observations that I would like to share on silver.

First, in January silver's 200dma was declining which spooked many technically oriented silver players. While it is true that 200dmas tend to run parallel with an asset's primary trend, it is not true that 200dmas are always ascending in bull markets. A temporarily descending 200dma, taken in isolation, is not conclusive enough to sweat about a bull market possibly being over.

200dmas are just mathematical constructs of course, and with every month having roughly 20 trading days a 200dma can be thought of as a ten-month moving average. In silver's case, its lofty speculative anomaly of early 2004 dragged its prices up so high that its 200dma was skewed to the upside for most of 2004. While not yet witnessed in silver until recent months, the HUI gold-stock index has already seen this phenomenon.

In both early 2003 and late 2004 the HUI's 200dma slope moderated. After this event in the former case its bull market continued higher unabated, and I suspect today's case will end the same way. If any particular upleg in a bull market shoots parabolic and carries prices far over trend, it is possible for its 200dma's slope to moderate or even go negative for a spell in the ensuing ten months of consolidation without jeopardizing the viability of the bull in any way.

Just as 50dmas rise and fall throughout a secular bull, the 200dmas can do it too with the right conditions. Interestingly silver's 50dma turned up again in February, another strong technical clue that a major new silver upleg is already underway.

Second, note silver's probable bull-market resistance line rendered above. While silver temporarily spiked above it during the climaxes of both major uplegs 1 and 2, I suspect this is where resistance lies since both of these previous uplegs initially had trouble breaking through before speculative fervor finally broke them over this line. Extended to today this probable resistance is currently hovering near $8.

Thus, silver's current upleg should hit at least $8.00, and this linear resistance is rising at about $0.50 every four months. So if silver generally runs higher for five more months following its initial spike as it did back in late 2004, then we have a conservative upleg target above $8.50 this time around. And, given silver's proclivity to temporarily rocket above resistance at the climax of each upleg, it could certainly spike above its resistance again before this latest upleg gives up its ghost. Silver probably has a ways to run yet in this new upleg 3.

And, amazingly enough, an entirely different technical approach based off of the distance silver stretches away from its 200dma during its major uplegs yields similar target regions. Relative Silver (rSilver) uses Relativity, the idea of dividing a price by its 200dma as a baseline to define high-probability turning points. We have been using an rSilver band of 0.99 to 1.25 to analyze the probabilities of silver being near major interim turning points.

On the buy side, whenever silver trades under 0.99x its 200dma it has been a fantastic time to throw long. Last spring, last September, and this latest January all witnessed silver trading significantly lower than 0.99x its 200dma. It was this very technical buy signal that led me to write my bullish silver essay in early January as well as start layering in actual real-world silver-related speculations in our newsletters.

During a bull market speculators have the highest probability of launching successful long trades when silver languishes under its 200dma. Conversely, the farther silver stretches above its 200dma the higher the probability that a major correction looms. Depending on speculative fervor surrounding each individual upleg however, these terminal stretch distances can vary greatly between individual uplegs.

Back in early April 2004, silver stretched a stupendous 1.45x above its 200dma before its blistering correction 1. But in December it only approached 1.20x its 200dma before plunging in major correction 2. While relative targets evolve along with a bull market, for now we are using a conservative middle point of 1.25x to define our moments in time when it looks like silver is due for a major correction. As additional silver uplegs unfold, we will be able to more precisely tailor this technical signal to the character of this particular silver bull.

If silver marches above 1.25x its 200dma, the time to be neutral or short has arrived. You can sell your longs and throw short or at least ratchet up the trailing stops on your longs if you are a speculator. If you are an investor, it is not prudent to add new long positions when silver stretches 1.25x above its 200dma. Every bull market claws two steps higher before retreating one step back so corrections are totally normal and should be expected. It is futile to fight them.

So with silver's 200dma currently running near $6.70, our next neutral signal in silver should occur about 1.25x above this level, or near $8.40. This target level for a merely average silver upleg is very close to the $8.50 mentioned above from conventional technical analysis. And, of course, as silver rises in the months ahead its 200dma will also rise pushing up the absolute silver price at this next 1.25x neutral signal.

During major upleg 2 last year silver's 200dma rose 14% from May to December. If this current silver upleg runs for a similar duration and sees a similar arc, another 14% gain in silver's 200dma from January's low would put it at $7.50 at the climax of this upleg. The Relativity band's neutral signal for silver, 1.25x, with this kind of 200dma would put it up at $9.40 or so. Thus, even though silver's latest upleg is probably already underway we ought to still have plenty of room to run yet.

Speaking of room to run, in the shiny new March issue of our acclaimed Zeal Intelligence newsletter just published this week I recommended two new primary silver stock trades that ought to thrive in this new upleg. This is the third layer of new silver trades we have launched in as many months. One of our layer-one picks from early January already has 32% unrealized gains and our early February trade is already up 15%.

If you are interested in playing this upleg using leveraged silver stocks, please subscribe today because it is probably not too late to deploy capital yet at this early stage. As an added bonus, our subscribers gain exclusive web access to a large long-term version of this Relative Silver chart that we update twice a week or so. You can easily follow the silver upleg's progress through its relative trading band with your own eyes.

The bottom line is since silver behaved so well relative to precedent in its latest sharp correction and interim low, odds are it will continue to generally follow precedent in what looks to be its third major upleg. These technicals are confirmed by outstanding silver fundamentals where global industrial and investment demand continues to far exceed world mined supplies.

Since silver is such a volatile and relatively tiny market, ultimately its gains will probably vastly dwarf those of the ongoing secular gold bull. If you can stomach silver's extreme volatility and enjoy a good speculative roller-coaster ride, the best of this third major upleg still looks like it is yet to come.

March 4, 2005
Adam Hamilton, CPA

Thoughts, comments, or flames? Fire away at zelotes@zealllc.com. Due to my staggering and perpetually increasing e-mail load, I regret that I am not able to respond to comments personally. I will read all messages though and really appreciate your feedback!

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