The Silver 'Pennant'

Our fine in-house TA tactician, GrundleMaster 'GM' Jenkins has frequently made reference to the large silver pennant that has formed on the silver chart over the last year (here being a fine example).

He is right to highlight this pennant's importance as, in my opinion, it is this formation that will govern the silver price through much of 2012. So I'd like to take a closer look, and see what conclusions we can draw about suitable buy-points and sell-points (for the traders amongst us) and a wise entry point for those wishing to sit on a stack of the metal for a long period of time (for the investors that grace this site).

Essentially, a pennant is a chart pattern which takes the form of a triangle (with the 'base' being vertical and the two 'sides' of the triangle sloping in the direction of time on the chart until they meet at an apex). Their predictive power is generally based on the fact that before the apex is 'reached', the chart needs to make its mind up and either make a trending move up or a trending move down. Fans of the pennant will often claim that one can determine which way this trending move will be, based on the pennant's properties. One can therefore have bullish or bearish pennants.

So check out this behemoth for silver on the daily chart:

Two important points here. First, I've (perhaps provocatively) described the blue line as the long-term trend line. Many silverbugs would disagree, as they consider September 2010, when the JPM proprietary trading desk ('prop desk') was disbanded, to be the start of a new trend and an aggressive phase of a silver bull run. My views on this are known, and I won't dwell on them here. However, my point of view states that any bears looking at this chart will have their most realistic target for the downside hitting the blue trend line. In other words, realistic bears will want to return to the status quo ante (and it has to be said that the bears have had considerable success in doing this since April 2011).

This is an unorthodox approach by me, as effectively there's only one 'data point' on the blue line after April 2011 (that during the Christmas/NewYear holidays). My justification therefore is that the other data points (which are admittedly not there) are psychological/virtual data points existing in the minds of the bears. I know this is a stretch (and statisticians are currently raising as many eyebrows as they can muster, I'm sure) but the preceding trend line is so strong I think it is a reasonable approach. Regardless, 'other' blue lines are certainly possible, and I'll discuss one of them at the end of this article.

[NB: on the above chart, I've drawn a long blue line simply to show from where I've extrapolated it. It is not meant to imply that the pennant started in April 2009. The pennant started in April 2011.]

Secondly, although I've described this pennant as 'text-book' on the chart, it is actually far from text-book for one important reason: its duration. Pennants are typically considered reliable for formations of between one and eight weeks (or twelve weeks at a real push). Anything longer, and the pennant is considered to be a 'symmetrical triangle'. But 'The Silver Symmetrical Triangle' wouldn't have been nearly as snappy a title for this blog post...

Moving on, it is my contention that this 'pennant', having held so beautifully for nearly a whole year, despite having been tested many times to both the upside and downside, seems unlikely to be ready to break just yet, for the sake of another five or six months. So silverbugs may have up to half a year's wait ahead of them before they see some truly dramatic action (in one direction or the other).

This brings us to the thorny issue of pennant resolution. Well, the big hope for silver investors (but not necessarily silver traders) is obviously that it will break dramatically to the upside, as shown in this chart:

The statistics are on the silverbugs' side: most analysts estimate that three-quarters of such resolutions follow the direction of the trend line, which as we have seen is definitely 'up'. So buyers of silver between $28 and $35 per ounce have a 75% chance of making a killing by Christmas.

They also have a 25% chance of being (figuratively) killed by Christmas. That would look something like this:

In such a scenario, all silver investors can pray for is that the fall stops sharply at $26. Below that, are dragons galore. The significance of $26 is that this point was successfully tested three times in 2011. A fourth successful test in 2012 would signal very strongly that the blue line in the above three charts is not after all the 'correct' line to have chosen, but rather that a horizontal line is the magic indicator.

This is the chart interpretation favoured by Turd and some other blog commentators. It would have the effect of stretching out the apex of our 'pennant' (which is now a right-angled triangle, but never mind about that) to April 2013 (!) It sure looks like the charts want to teach silverbugs a thing or two about patience...

However, in such a scenario, it seems that a move to the upside will become even more likely than in that outlined by me, above.

So there we have it: a few clues and indications for silver traders and investors. My strategy (in so far as I have one) is to not rush into silver until some of these issues have been resolved. I could easily be caught out by this: a quick move to the upside in gold (as I am calling here) would probably pull silver with it, and perhaps by enough to smash it out of its pennant earlier than expected. If so, so be it. But after the multiple shocks of 2011, I think discretion is definitely the better part of valour in silver's case.


Unknown said...

Ok today I have a chance to buy 400 OZ of RCM silver bars for $31.50 Canadian. That pennant looks like a gamble. Pass or buy?

Anonymous said...

@The Big Setup:

I don't know (and nor does anyone else). But from my version of the pennant, $31.50 looks expensive. From others' version (the horizontal line, chart 4), it looks really expensive.

That said, if my views on the gold and gold miner market play out (see here), then silver could conceivably get dragged up and pushed through the pennant way before the September 2012 (or April 2013) cut off.

That's really what I want to achieve at Screwtape. Present the bear case; present the bull case. And let the trader/investor decide.

You pays your money, and you takes your chances...

Warren James said...

@TheBigSetup: I am currently using the dollar cost averaging strategy for all bullion purchases - it takes away huge amounts of pressure. I wish had used this during 2011 rather than trying to identify 'the right price', especially with Silver.

Warren James said...

I keep this ready-reckoner in my investing scrapbook (sorry, too lazy to quote the original source). It's a reminder that with high volatility, dollar cost averaging can really work for you. But as I described in our 'when to buy silver' joint post, your investment timeframe is just as much a consideration.

Unknown said...

The problem us Canadians have, is the Cdn $ keeps rising. We are now above the US dollar. Great for an American with CDN dollars to buy then transport it back.

TFV said...

Excellent analysis longer term. While I do not disagree that silver's longer term set-up could be bullish, I am still concerned that shorter term we will see sub $30.00 prices. Her's my take on the shorter term view if you don't mind. Great work on the longer term perspective though. I've linked it on my own blog.

Anonymous said...

Hi Dan - Thanks for passing by (and for linking to us from your site).

I think our two analyses fit well together. My version (the pennant) implies a retest of $28 at best, and $26 at worst. And of course, a 'retest' is not always successful - far from it! If the events/fundamentals/whatever at the time of the retest are not favourable, then we could get to low twenties very quickly. But I do think that would be too ambitious for the bears, and they'd be hurt in the counter push by the bulls.

Your falling wedge version (which I'd recommend everyone take a look at) implies a retest at lower levels, if I've read your chart right. Somewhere around $26 - $23, perhaps.

So, although we differ in our levels of pessimism, we don't differ in our view of the short - intermediate outlook.

And even long-term, who knows? My pennant could break to the downside, and your falling wedge could just keep on falling. That thought should put the willies up the hardiest of silver investors...

All that said, in terms of this week's action (i.e. very short term), silver's RSI and stochastics are looking very oversold. This implies perhaps a move towards the top of your wedge/my pennant before moving back down. But who knows?

Keep up the great work!