Silver Going to $98?

Having an extra long weekend has given me a chance to think through the large decrease in my precious metals exposure which I effectuated on Thursday, ahead of the long weekend. Having taken down my exposure from 58% to 15% via futures contracts has given me a few things to think about. First and foremost, I feel satisfaction from having made a great call 2 and 3 years ago. But this just leads me to the conclusion about being careful about what you wish for. As I have said many times in this blog, that if I am right about precious metals, then it means that something is going terribly wrong in our country. The divergence between my concerns about the plight of our beloved US of A, and the apparent rally in stock prices, and the associated positive mood which that infers, causes me to think that the end of the world scenario which has gold going above $5000 an ounce and silver over $100 an ounce, is not upon us. Accordingly, I should feel okay about reaping some of my gains, and waiting for market consolidation to re-load. The operative word in the previous sentence is ‘should’ because I have seller’s remorse. This is because I have a macro-theme which entails the purchase of precious metals as a hedge against what is going on in this country. In fact, our politicians have raised concerns about our deficits to a higher plane than before, and that is having an impact on the precious metals. Along those lines, S&P just placed the US government on down-grade watch list, which speaks to my long-running concerns about the solvency of the US government, which I have been espousing for the last 3 years.

Is it possible that while a crisis is not upon us yet, that the markets are starting to act out in this regard? Because one of the main venues where this act is supposed to play out, is in the precious metals arena. I am a long run believer in technical analysis, which posits the belief that markets can and do move ahead of the fundamentals. Over the past 6 months, and notably, over the past few weeks, silver has launched itself on a nearly vertical projection. Here are a couple of take-aways which I want to share with you:

1> When markets go vertical, hanging on for the last few days of rally can add great amounts of return to ones portfolio. Accordingly, I have a range of concerns that silver could possibly double from here.

2> I ask the question, why is silver go up so strongly? Clearly, there is not enough supply to meet the speculative demand. In addition, there are over 3,000 industrial uses for silver. In short, silver can go up until those speculators, who have been buying it, decide they are supposed to get out. Given that I have been in it for so long, my decision to cut back my position is not likely to be indicative of the crowd, which leads me to think that silver could run a ways further. Furthermore, silver has not gained appeal with the average person; perhaps the professional trader has taken note, which it is their job to do, but you do not hear from your barber or grocery clerk about how well they are doing in silver, so I still believe it has not made it into the mainstream.

3> is silver entering a new paradigm? Are those who have been professing that we have been using up silver at a rate faster than we can produce it, finally getting their day in the sun? One can go back and look at oil when it went from $1 to $2 a barrel in the early 1970s, and then vaulted to $40. Even when oil was kicked lower, it never got below $10, substantially above its early 1970s level. Is silver going to do the same thing, with a floor around $25 or $30 an ounce, and an upper range between $100 to $300? Let me just say, that nothing is out of the question. It is going to get down to the staying power of those who are invested in silver, coupled with the idea that industrial demand is inelastic, and is not likely to decline regardless of how high the price rises to.

* Be careful about what you wish for: When the markets do what you think they are going to do, the outcome usually is accompanied by a different set of events surrounding that rise. Accordingly, the rise in precious metals is signaling some sort of dollar collapse, despite the high level of bullish consensus amongst traders, there is no real panic going on, but rather an orderly decline in the dollar, and an increase in precious metals. Interest rates are declining, which is the opposite of what you might expect if the dollar was collapsing. There is no panic in the US bond markets, nor are investors concerned about the solvency of the US government. 

Nonetheless, the FX and precious metal markets are on the rise. What is this telling us? If you go by the technical markers, then you need to believe that the markets are telling us the truth, and that explanations to the contrary are only what we want to believe. And so it goes with precious metals.

On Thursday, I decided to hedge out the bulk of my precious metal holdings because it seems as if the markets have run their course, and we are coming upon a time period which is usually less friendly to risk assets. I have had the entire weekend to think about this move, and I do not feel comfortable with what I have done. Even if the markets are ready for a set-back, the idea of owning non-dollar assets is where my comfort zone is. And since I cannot decide which foreign currency I feel should own instead of the dollar, then it just comes down to owning precious metals. And this is exactly what is going up the most. I spent considerable energy this weekend looking at alternative scenarios for precious metal prices, with emphasis on silver, and I come away thinking that there is more upside left in the trade. 

Aside from a profit motive, I do not feel that the reasons for owning precious metals have been removed by virtue of their recent performance. The other sign of a market top will come when the world adopts gold and silver as a standard of exchange. And when it does, there is no price in the current realm which is where prices will settle in at. Does this mean that gold is going over $5000 an ounce in short order, with silver going over $100 an ounce? Probably not, but one never knows. And if it does, how ridiculous will I feel not having kept my position in precious metals? Accordingly, I have reinstated the bulk of my exposure to precious metals. I have kept a very small gold hedge, but have taken off my entire silver hedge. On top of this, I have started to layer in put options on silver; to create some level of down-side protection should those markets reverse in short order.

Here are some paradigms for valuing where silver should go to:

 

1> Gold/Silver ratio: as the attached graph shows, this ratio briefly touched 15.9 at the height of the 1980 bull market. Coincidently, when the US was on a gold and silver standard, in the 1880s, silver was convertible to gold on a 16:1 ratio. Here are some projected prices for silver according to various Gold/Silver ratios depicted on the first graph of the attachment:

G/S Ratio         Silver price with Gold at 1515
46.27                      32.74                     white line (on graph)
31.35                      48.33                     red line
24.41                      62.06                     green line
15.36                      98.63                     yellow line

As the list of potential prices for Silver indicates, silver can potentially trade as high as 98, with gold at 1515. This would take us to valuations similar to the peak in 1980, and as well, to valuations consistent to the last time the US was on a silver standard. I am not saying this will happen over the short run, but this is clearly within the realm of possibilities especially if you push your time frame out over a few years. Likewise, the white resistance line on the gold/silver ratio chart also suggests that silver has support around $32 an ounce, which sounds like a good floor for the market.

 

On the next graph, I present my Elliott Wave Count, which suggests that the move from 2001 to 2006 was a completed 5 wave pattern, and the sell-off into November 2008, was a simple 3 wave correction. According to my interpretation, we are only working on wave iii of 3, as part of the next rally phase, which could end anywhere from where we are today, to much higher levels. From wherever wave iii ends, this also suggests that there will be a wave iv down, and then a wave v up, to complete the sequence, which will then end of wave 3 (green). Following wave 3 (green)’s completion, there will be a subsequent wave 4 (down) and wave 5 (up), labeled in green. The subsequent wave v should exceed wave iii, and then wave 5 (green) higher should also launch prices to new high levels, and exceed the highs of wave 3 (green), and ultimately culminating in prices well above $100 an ounce.

The take-away from this analysis, is that the rally in silver has a long way to run. Within this context however, there will be volatile periods of significant corrections. It is only since the silver rally has extended into the 40s, that my take on the situation (this weekend) is that silver’s rally could have much more to go, and is only getting going.

Possible projections for wave iii are 61, 90 and 137, by using a Fibonacci multiple of wave i, which is added to the end of wave ii. Those would be pretty fancy numbers if in fact such a level is reached in short order. Even 61 would be quite a heroic accomplishment.

 

The next chart on the attachment shows Fibonacci targets in the 53-54 range, using a different method of projecting a possible top. I have not figured out how to determine higher targets using the software I have, but 53-54 could be a good short term target to aspire to. Word users can use the magnify function in the lower right hand portion of the window to zoom in on the details of this chart.

Clearly the upside potential for silver is high, and it is impossible to know where this market will ultimately end over the short term. And when the corrections do kick in, the downward moves are likely to be equally violent. But I do believe that there are definitely much higher long run targets which can be attained. 

To summarize, for technical and fundamental reasons, I remain committed to precious metals. While I have left a small amount of my (gold) hedge position in place, I have taken off most of it. I have moved some of my hedging strategies to put options, which will allow me the upside, while at the same time, providing downside insurance to manage the volatility of the swings in the outcome of this strategy. It looks as if this wild ride has many more chapters to play out.