Today In Silver

The silver and gold rockets appear to have misfired a bit after a very promising setup that appeared around January 22, 2009. It looks like we are about to test the $12.50 and $900 levels in the next couple  of days and price action around there should tell us quite a bit about how controllable the flare-ups are on board the PM rockets.

I have previously laid out the scenario that the launch sequence wasn’t going to be very safe — that investment demand wasn’t very widespread, that speculators had returned to gold in significant numbers, that no true capitulation had yet occurred despite gold falling below $700 last October, that gold timers and analysts were being complacent, that Jim Cramer has just pounded the table for his disciples to buy gold, that the dollar would keep rising, that U.S. Treasury prices wouldn’t collapse, that oil and commodities would continue to weaken, that the stock and credit markets would enter another liquidation phase, etc. Despite all this, silver and gold are actually holding up relatively well and I think there is an even chance that they will find support near the aforementioned price levels. This is quite incredible if you think about it — the number of conventional factors aligned against the monetary metals, gold in particular, are massive and yet gold remains within 10% of its all-time highs. The result is both risks and opportunities.

The odds that the monetary metals quickly head back to their October lows remain slim but discreet. I continue to believe that put options in gold futures and perhaps GLD have the best risk-reward profile. These are not outright bearish bets but rather attempts to catch a falling knife as gold prices first slice to extreme lows and then immediately recover to some interim level perhaps around $800. I’ve described this strategy to subscribers at Metal Augmentor. Adding significant new long positions whether they be in the metals or mining stocks remains too risky for most portfolios and outright leverage should be avoided entirely.

The main danger signal right now is that the short-term investment case for silver could form some serious cracks in the days ahead. Already the Barclays ETF, SLV, has liquidated around 4 million ounces of silver and this occurred against a backdrop of ETF premiums merely returning to par. This was not likely due to selling pressure but rather a small decrease in buying pressure. Should we see selling pressure develop, it will be evident in the “ETF Basis” figures that I track at Metal Augmentor. At that point, the risk of the ETF liquidating a large amount of silver accompanied by $1+ daily drops in the silver price will increase substantially. As I write this, there is scant evidence of such selling pressure. The ETF Basis for SLV has, however, returned pretty much to par as I mentioned above. Since January 21 at least, SLV has traded at a premium to its net asset value (the underlying silver), which was an indication of very strong investment demand. At a minimum, investors are taking a rest.

Backwardation is also disappearing in LBMA silver — today’s level is essentially equivalent to par (neither contango nor backwardation). Keeping an eye on this figure, which everybody can do here and here, is advisable in the days and weeks ahead for buyers, sellers, traders and speculators.

Investment demand for gold has backed off as well, but a slight “backwardation” remains in the gold ETF GLD. Consequently, no metal has been liquidated by GLD although new additions have stopped. It is probably more important to watch what happens with the gold basis in the days ahead compared to silver because gold has been the undisputed sentiment leader. Given market conditions, even a moderate change in investment sentiment toward gold could result in very significant price fluctuations.

While everybody is looking the other way, the dollar appears ready to break out with a minimum target of 95 on the dollar index and possibly 100. Don’t believe the claptrap that gold has permanently decoupled from the dollar — this is an illusion created by the vigorous buying of gold in countries where the financial situation is even more dire than the U.S. Such buying may slow down at some point and if the dollar is near 100 at that point then gold has serious downside exposure in dollar terms.

Today’s drop in the stock markets was cold and vicious; the gains of the late 1990s bull market are now being handed back. The S&P 500 (a much better measure than the Dow) is now trading at late 1996 levels after having fallen 56% from its peak. At some point it will bounce violently and this could place significant pressure on silver and gold prices because such bounce is unlikely to be due to expectations of near-term hyperinflation. A 30-50% rally in the stock markets along with the dollar index trading near 100 could create significant headwinds for the monetary metals, at least for a few months.

Even if things play out as I generally outlined above, gold and silver in the longer term cannot help but be among the best stores of value. Either we get a deflationary, civilization stunting monetary collapse or we get a hyperinflationary melt up. Those are the only two choices. The timing might extend further than the 6-18 months I predicted last October but probably not by much. Therefore, I would recommend against being caught without a protective shield of monetary metals even as they ride a roller coaster to their fate.

silverax Windbag Wisdom