Sunday pre-game, 10/28/2012

Hello friends,
First, I'd like to address the question JdA raised last week: Is silver a bubble that has already burst? She believes it will stagnate and/or trend downwards for a very long time. I disagree, mainly for the same "fundamentals" based reasons I continue to be long gold. (Certainly it's possible that gold outperforms silver in a major way going forwards, but I think there's a very heavy burden of proof on anyone who thinks gold will eventually blast past $2000, while silver won't even make another sally at its 1980 high. They're basically making the old "this time, things are different" argument.)

Aside from fundamentals, I think the technical analysis picture also argues against the idea that silver is a bubble that has burst. For one thing, the rapid ascent to $50 last April only took silver to the top of its long term price channel. There was nothing "blow-off" about it in the long term picture. Gold didn't hit the top of its post-2001 price channel until August, but apart from that has behaved very similarly. 

But let's dig deeper into this question. Kagi charts are probably the most useful tools to help us answer macro questions like these because they filter out a lot of noise (so much noise, in fact, that I don't find them very useful for trading.) There are of course many smoothing mechanisms you can use to filter out the bs of day-to-day market fluctuations (and big player manipulations), but the Kagi chart is the best for investors (versus traders) because it removes time from the equation altogether. The "periods" of the chart are not hours or days, but events -- namely reversals X% up or down from the most recent low/high. You're adjusting for the fact that no market goes straight up or down: "wake me up when something important happens." 

Only if an asset falls X% from its current rally's high (or rises X% from its current downtrend's low) will you consider it a "new day", and a new "bar" will correspondingly be formed. But even then, you expect even the biggest bull markets to have X% corrections (assuming you set X to a reasonable value like 2% or 4% or on long term charts, even 20%), so another benefit of these charts is that the color of the "bar" changes to tell you whether you're in a "meta" bullish or bearish trend. Let's take the perspective of someone long silver: if silver is trending up, you eventually expect (and actually want!) a correction, but you don't want the price to go below the lowest point of the last correction. As long as it doesn't do that, the bars on a Kagi chart are colored black. Contrariwise, if silver is in a downtrend (as it was recently), you expect some "relief" rallies, but the bars will stay red until a rally goes higher than the high of its previous rally. 

Let's look at the monthly Kagi chart of silver, with the threshold set to 2%. Thus, if price keeps making new highs month after month (even if it's very volatile during those months), then that action will all be reflected in one (growing) bar. Only if the price does not make a new high during a month, and moreover, sees a low during the month 2% lower than the highest point that was reached during the latest trend (i.e. the highest point of the growing bar) will you mark the top of the bar (with a short horizontal line), and start moving downwards (and vice versa when price is falling). 

What we see above is an almost perfect stair step pattern, wherein the strongest rallies (which coincide almost perfectly with the equidistant vertical brown lines) are followed by 10 or 12 reversal events and then a new high. Thus, it appears we are 2 to 4 reversal events away from the next big move in silver (and note that the next reversal event will almost certainly occur in the next 3 days, as November will start more than 2% below the $35.44 high of the current rally). The 2011-12 correction has been "milder" so far than 2008 in one important respect:  in 2008, price fell below the previous stair step; it would take a dip to $21 for that to happen now. 

Now let's look at a similar stretch of time (~12 years) during the NASDAQ bubble 

One striking difference is that there was no comparable "wall of worry" during the decade long ascent captured here. You see a steady rise with nary an example of the waterfalls and long, painful consolidations that (ironically) make silver bugs the biggest worrywarts in investment space. (Who they blame for their worry and whether that blame is justly attributed is besides the point, if you think about it.) The other thing that pops out is that the bursting of the NASDAQ bubble reflects a canonical pattern: precipitous drops within a red sea of lower lows and lower highs. (Exercise for the reader: look at a similar Kagi chart of the real estate bubble, e.g. $DJR; you will see very similar action). Now, I'm not promising we won't begin seeing that in silver, but it hasn't happened yet, and if I were a betting man (hang on, let me try to think like a betting man here), I'd say it's more likely we're simply seeing another example of the stair-step consolidation pattern that we've seen over and over for the last 10+ years. Frankly, the >50% correction of 2008 looked a lot scarier. Now that we know 2008 was one big bear trap, I think the silver bears (and I'm not talking about the farting ones on youtube) should be more cautious.

Now let's look at gold for the hell of it. 

Whoa! What you'll immediately notice is how *clean* the climb has been. If we consider the entire gold bull market up until 2012 (stopping at the holiday shellacking of last December), we see that there had been 28 monthly reversals from uptrends (recall that all of these reversals begin with months in which new highs aren't made, and in which price hits an intra-day low 2% lower than the high point of the previous rally). But on only one of those occasions did gold continue to fall below the point where the previous rally had begun. Maybe we should begin worrying about the gold bubble, not the silver bubble! But until we start seeing an ugly series of long red candlesticks making lower lows and lower highs, we can probably relax. 

Alright, moving on, since I'm using exotic charts, let's look at the silver Heikin-Ashi chart, because the doji / "spinning top" formation to close the week suggests that silver may be about to reverse into an uptrend:

And now 3 gold charts, which all look to be at very important support. This week should be exciting.

Gold in euros, weekly

Daily $GOLD, 9 yr; post-2004 price channel

Daily $GOLD, 12 yr