Silver had/has become a driving force in the precious metal market, overtaking gold in terms of upside and downside momentum. The Gold/Silver Ratio Chart below shows that this ratio had moved dramatically in silver’s favor this year, as that ratio dropped from a high of 50 down to 32 just days ago. Today it is back to 40.

Gold’s role in holding value against falling currencies, inflation and financial uncertainty has not changed. Silver’s role has, in large part due to the high price of gold, which caused investors looking for an alternative to gold that is still considered a precious metal, into silver. I and others have referred to silver as the “poor man’s gold”. While I consider it a quasi-precious metal, some look beyond that to its precious metal status. In looking back it seems that the creation of silver ETFs went a long way in helping silver gain in popularity as a precious metal.

Silver has topped out; at least that’s my opinion for now. Part of the reason has to do with The Comex Exchange announcement that silver margins will move up to $21,900 per 5000 ounce contract as of May 9^th.  The margin increase in and of itself was very important, but adding to its importance was the exchange announcement in advance that two margin increases were taking place. Silver margins have gone up 4 times in but a couple of weeks. The initial margin has gotten so high that the only ones left to trade silver are right now the very well healed investor or fund traders.

So the question is how this impacts gold.

My analysis is that other than creating “lots of volatility” around gold, it doesn’t have a long lasting material price impact. Yes outside forces like margins or spreading one market against another can and do have short term impact. But the key words here are “short term”.

As I see it nothing has materially changed to alter gold’s role or longer term price direction. That doesn’t mean that outside forces can’t pull down gold in the near term and change the short term trend. Both occurred today. However, given that the US has not changed its monetary policy, things really haven’t changed. US economic numbers still look weak and job growth is at best anemic. According to the Case-Schiller Index, home values in most US large cities continue to lose value. Home values in my opinion impact directly the largest investment US citizens have.

Don’t get me wrong, there are investments that have and are continuing to do well. Stock market indices have moved up sharply this year, creating wealth for those in stocks and for corporate balance sheets. Bonds continue to rise in value as well.

Food and energy prices soared, at least until today. How much they fall is anyone’s guess given how overbought they became.

Due to a falling Dollar, China and Russia have announced that they have been increasing the amount of gold they are buying and holding in their reserves as a replacement to foreign currency reserves. That doesn’t mean they are giving up on foreign currencies. They aren’t, but at the same time they are increasing their exposure to gold.

I see gold moving to new highs later this year. However, the whole commodity run to the upside seems to have entered a corrective mode, exactly as Goldman Sachs warned about recently. Keep in mind that funds that trade commodities tend to move their investment in waves. The wave that carried commodity prices up to new all-time highs has temporarily peaked and prices are now moving down across the whole commodity spectrum. in unison. What this means to me is that gold prices will probably get oversold fairly quickly and embark on building a new trading range to work from. I expect that base to be much higher than the last base.

The best way to describe what is taking place is by me making an analogy by using a step of stairs. Typically one climbs up, a step at a time, except when in a hurry. When in a hurry you might jump two steps at a time. That’s the analogy I want to make as to what recently occurred in silver, gold and a host of other commodities. I think that those who felt that silver prices were leaving them behind bought almost blindly into silver, which in turn helped to drive gold higher. When you go down the stairs you probably take it a step at a time, except when in a hurry, when you might may leap two at a time. If you go too fast you end up tripping and fall a bit further.  That’s what I think commodities are now doing. They’ve been tripped up on the way down and are looking for a place to land.

Exacerbating the break in silver are ETF holdings that as they are being liquidated are impacting futures prices given that some ETFs deal in silver futures, not physical silver.

I feel good about where gold stopped rallying on the upside. I thought that if $1550 were cleared, upcoming resistance would come in $25 increments. The high as it turned out was very close to $1575.

Below is a Seasonal Chart of Gold prices produced and provided by Moore Research Center, Inc., (www.mrci.com). I’ve been writing about gold’s historical tendencies for a long time.   

For those of you that wish to learn more about seasonal historical studies, visit the Moore Research Center and sign up for their 14-day free trial.

Below is a Daily Chart of the June Gold contract.

Each individual “green” bar on the chart represents one day’s trading session, except the last bar which represents trading through the time I captured the image.

In “red” I have plotted the 18-Day Moving Average of Closing Prices, in “dark blue” the Swingline Study and the “black dashed line” is the Bollinger Band Study. The Swingline Study is shown as a “brown” line.

The Swingline Study broke through its most recent low of 1492.00. To me that means that the current Swingline Pattern is one of a higher high and a lower low. The market is now searching for where it can or will find support. Given that prices are now trading under the 18-Day Moving Average of Closing Prices, the bias has shifted to the downside and the possibility of hitting the Bollinger Band Bottom at $1443 is the near term downside target. A lot depends how desperate the longs get on the silver washout. At some point silver will bounce. Wherever that bounce comes from may not end up being silver’s trading bottom low as charts often test highs and lows more than once.

There is some good news in today’s washout. Silver prices have quickly become oversold given the slop of the SSTO (Slow Stochastic Study) and prices have moved down to n.  

I want you to read again what I wrote in my summary…

As long as the Slow Stochastic reading stays bullish, embedded, price breaks look to me to be buying opportunities. At the same time, seeing practically nothing but bullish stories on gold in the press is bothersome. For example, hearing today about a university putting 5% of their assets into gold falls into the type of news item that I look for when markets get overheated. I don’t think gold is yet as overheated as it will ultimately become, which means I remain bullish, but nervous about buying to a $50 rally that has taken place in but 6-days.

Another thing to look for is when you go out in public, ideally with friends, to stores or whatever and hear lots of conversation about silver or gold. If you hear about it where you normally don’t, it might be time to become cautious. Think back to real estate bubble and all the people investing in real estate that had little business in doing so. I recall conversations with my barber, house painter, waiters in restaurants and so on bragging how much they were making. I am not implying that gold or silver are yet where real estate was. I am simply concerned about crowd mentality and gold clearly being the laggard in this leg of the bull market.

So what now?

Well the first thing to do is understand that when you see a liquidation sale like the one taking place it’s not wise to not get in its way as prices can easily get out of whack for a while. For those that invest in actual gold, not futures, this looks like an opportunity to begin nibbling at gold, as long as you maintain a long term outlook and are willing to buy even lower. Keep in mind that you’re picking up gold nearly $110 an ounce cheaper in gold than it was just three days ago.  

The pull back in pricing today was not limited to the metal markets. Liquidation and lower pricing was the norm pretty much across the board. For example, crude oil was down nearly $11 a barrel, gasoline down nearly 25 cents a gallon, grains down sharply as were a number of currencies including the Eurocurrency, Swiss Franc and British Pound. Stock indices were lower. However bonds and notes were bid higher as traders moved to safe havens.

I like gold much more than silver. While its lagged silver on the upside, it should also lag it silver on the break. This does not mean that gold futures are yet ready to buy or sell.  They aren’t until the panic of the moment goes away and things simmer down.

As a chartist, I see the short term trend in gold as having turned down, but hope to see unfold near the $1440 price level. The best advice I can offer is that instead of picking a trading bottom, wait for one to unfold. I think it better to be late than early when using the leverage the futures markets offer.

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Disclaimer: This publication is strictly the opinion of its writer and is intended solely for informative purposes and is not to be construed, under any circumstances, by implication or otherwise, as an offer to sell or a solicitation to buy or trade in any commodities or securities herein named. Information is taken from sources believed to be reliable, but is in no way guaranteed. Chart data is courtesy of LGP-IraCharts. No guarantee of any kind is implied or possible where projections of future conditions are attempted. Futures and Options on Futures trading involve risk. In no event should the content of this market letter be construed as an express or implied promise, guarantee or implication by or from The Ira Epstein Division of The Linn Group, Inc or The Linn Group, Inc. that you will profit or that losses can or will be limited in any manner whatsoever. No such promises, guarantees or implications are given. Past results are not indicative of future performance.

-- Posted Friday, 6 May 2011 | Digg This Article