In Like a Lion and Out Like a Lamb: Silver

[UPDATE: THE GOLD VERSION OF THIS POST IS AVAILABLE HERE.]

Yesterday I noted that the markets (PM and non-PM) in March had behaved much like the old English proverb about the weather in that month: "In like a lion and out like a lamb". Gold closed on 1st March at $1725 and silver at $35.50, before they cratered later in the month to $1625 and $31.25, respectively, and then climbed back to close the month at a timid $1668 and $32.28.

Yesterday's post dealt exclusively with gold and its miners, and I concluded that the outlook for both - from a technical analysis standpoint - was very bullish for April. Today I'll take a look at silver. Will the grey metal follow its bigger, yellow sister to cheer up all the silver bugs?


Let's kick off with the daily chart, which, as with gold, is exhibiting quite a fine inverse head and shoulders formation that looks like its due for either confirmation or failure any day now.

I'd discussed this IH&S formation a couple of weeks ago, but I wanted to take another look at it to see if I could more precisely locate the left shoulder. The short answer is 'no' (the beginnings of shoulders are notoriously difficult to define precisely), but it does seem like it started 59 - 66 trading days before the 'head'. As we've now had 63 trading days since the head, it does seem like next week, or the following week at the latest, is crunch time for the IH&S resolution.

Let me re-stress: such formations can and do fail, so I've added both possibilities to the chart. Bulls will like the green line; bears will like the red. It's vital to be aware of these two possibilities, as there is so much chatter about the IH&S on the silverogosphere at the moment and many observers are talking about it as if it's a done deal. It isn't. But next week should hopefully give us a solid indication of which way things are going to go from here:

The case for the bulls is that gold's IH&S looks good (please do read my previous post, here, if you haven't already) and it's not very logical to assume that gold's IH&S could break north at the same time that silver's IH&S breaks south. Fine. However, logic doesn't always have a big part to play in market action, so let's not get too hung up on that. Regardless, it is fair, I think, to assume that momentum buyers of gold during any move towards the neck are also likely to be momentum buyers of silver at the same time.

The case for the bears is that the indicators (I prefer a combination of the RSI, MACD and Slow Stochastic) are not indicating that conditions are as oversold as they could be. It's telling that the RSI in particular is not at levels seen prior to the last two big runs up in silver. I think our main clue here has to be with the MACD, as the lines are currently trying to make up their minds whether or not to cross. If they do, then the bears might get a shock as silver storms higher; if they don't, then the bulls could be sorely disappointed as they watch it fall.


The weekly chart - good news for the bears?

I have to say that, on balance, the weekly chart is making me feel more bearish about silver's short-term prospects:

I often find weekly charts to be the best indicators of future trends, as much of the 'noise' of day-to-day action is eliminated (and the candlesticks are more revealing and reliable), but they still retain some of the 'fine detail' that is smothered by the monthly charts. The thing that has me worried on the silver weekly chart is that the 'neckline' of the IH&S formation coincides a bit too neatly with the 52-wma. Any failure here could precipitate a sharp fall. Whereas gold has just neatly bounced off its long-term trend line on the weekly and monthly charts, silver looks like it's riding a bit too high for its own good.

OK, I'm just going to come out and say it, even though I know it won't make me any friends. Silver was in a bubble last year. This was evidenced by the insanely oversold conditions in April, the classic 'bubble curve' that it traced on the chart, the hype and extraordinary sentiment in investing circles, etc., etc., etc. Now this does not make me a bear long-term on silver: it's an important commodity, and I'm bullish on commodities and hard assets in general. But silver is still suffering from its post-bubble broken parabola in May and the obvious points of support are still quite a long way down. Viz.: the long-term trend line at $28, previously solid support at $26, or even the $22.50 indicated by the 200-wma. Take your bearish pick.

Although the MACD on the daily looks like it might turn bullish, the MACD on the weekly looks more alarming. The two lines must not cross if the Slow Stochastic is to avoid continuing on its merry way down to 20. If they do cross, then a move to at least $28 seems likely.


The silver pennant

Many people write to me to ask me just what 'my problem' is with silver, as I'm pretty bullish on gold at the moment. The short answer is that 'my problem' is that whereas gold is following its trend line nicely and fairly neatly, and is finding support where it should be, silver seems to be plagued by indecision. I wrote a piece about the silver 'pennant' a few weeks ago. Let's pull up that chart (now slightly modified) again:

Does this pennant look like it's about to resolve to you? We're certainly due for a retest in one direction or the other. This would either be a challenge to the downward-sloping green line (between $36 - 33, depending on how long it takes to get there) or to the upward-sloping blue line (between $29 - 31). The extraordinary thing is that silver is bang in the middle between these two retest zones. It's also exactly at the price where the pennant will 'close' in September. So if anyone can honestly extract some clues from this chart alone about which way silver will move next, then I'm full of admiration for them. But it's beyond me.


The gold:silver ratio

Although ratios are controversial (none more so than the Gold:Silver ratio), I do find them useful on occasion when one wants to compare market sentiment towards two different things. For what it's worth, I'm not remotely interested in arguments about what the 'historical' GSR was or what it will be again. What I'm interested in here is to see if there are any clues regarding which way silver will trend relative to gold in the short term. And I think there are:

The chart is certainly not conclusive, but the fact that the ratio has just got back above the 50-dma means that I'm minded to conclude gold now stands a chance of out-performing silver for a bit. The ratio has been in a trading range since October 2011 (between 48 and 57), and if it maintains itself above the 50-dma next week, it looks like a move to the top of the range is in order. Ratios are often misunderstood, so let me be explicit about what factors could cause this to happen (apologies if this is obvious):

1. Gold and silver both have sharp moves higher (e.g. following a successful IH&S resolution for both metals), but gold's is more impressive in percentage terms than silver's.

2. Gold moves higher (its IH&S is confirmed) but silver moves lower (IH&S fails).

3. Both metals fall in price (both IH&S formations fail), but silver falls more precipitously than gold.

If I had to rate them, I would say that scenario (1) is more likely than (3) which in turn is more likely than (2), as I'm still rather wedded to the idea that both IH&S formations will do the same thing at the same time. Scenario (3) concerns me as I am bullish on gold for the whole host of reasons outlined in my previous post, and a failure of gold at such a critical point could represent a real shock to the whole PM sector.

So PM bulls of all stripes will be praying for either (1) or for the GSR ratio to slip back below the 50-dma on an upward move for both metals (ideally by so much that silver smashes its way out of its pennant to the upside).


How are the silver miners shaping up for April?

Finally, as we did for gold, let's now take a look at the silver miners to see whether there are any clues there that can help us identify short-term trends. It's tricky to find a reliable index/ETF for silver miners (or at least one comparable to the HUI or to the GDX), but I personally think SIL is probably the best:

Now, I think this silver miners chart looks more promising than the charts for silver itself. The indicators are showing genuinely oversold conditions for the miners, in keeping with their gold-mining sisters, and the 50- and 200-dma are battling it out for supremacy. If the 50-dma succeeds in crossing the 200-dma, and some clear blue water is then put between them, then I'd say that a sharp move higher is on the cards.

A more bearish view would be that there is still some way to go between the final print for March of 22.23 and the 'support zone' between 20 and 21. The indicators allow for a further dip down to about this level, so we'll have to see what the week brings. Regardless, if this support zone is successfully tested, and gold and silver start making a big move higher, then this could be a very good buying opportunity for silver miners.


Conclusion

I'm still wary of silver. It has a lot to do to make up for that broken parabola last year, and it's difficult to make an argument that sincerely says the trend lines indicate anything other than the fact it's not oversold and has potentially quite a lot of downside risk. That said, its fate probably will be tied to gold, and a successful resolution of gold's IH&S should hopefully secure a similar resolution for that of silver. If the move is of sufficient force, then silver could even smash through its pennant and put its murky history since April 2011 firmly behind it.

But for me, now, silver is sitting at $32.30 with an apparent upside expectation of $36 and an apparent downside expectation of $28. That's not the sort of trade that entices me. The silver miners look stronger, but their fate is of course tied to their parent metal. If both make a move higher, then I wouldn't be surprised if it is the miners that outperform the metal on this occasion.