Silver: A Near Double In 2004 ?

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Published : January 01st, 2004
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Category : Market Analysis

 

 

 

 

If ever a market was said to be at a crossroads, that market is silver today. Effectively sideways since 1994, the market is being crushed between the titanic forces of secular demand and a potential technological change that is coming up over the horizon. For 14 year consecutive years, global consumption of silver has outpaced global production. The once massive multi-billion ounce global supply of silver bullion that developed as a result of the 1970s super bull cycle has dwindled to less than 1 billion ounces. Contrasted with that condition, global sales of digital cameras in 2003 for the first time surpassed sales of traditional film cameras. What we see here is a market that is caught in a dilemma between the powerful forces of diminishing supplies on the one hand and, on the other hand, the potential for a lasting drop in demand that is based on technological change. This analysis will focus on a multitude of long-term technical factors that, we think, indicate potential for a resolution of the dilemma in favor of higher prices. However, we also think that the market must show evidence of that resolution in 2004 or shortly thereafter. Silver's failure to show sustained upward price movement in the next 12 - 18 months will leave the market technically vulnerable to lower levels -- a development that we think would reflect the ascendance of the negative price forces of technologic progress.

 

Given the impressive 14-year shift in the supply/demand equation, we might have expected silver prices to move higher by now. Certainly many observers have been announcing that scenario for years but so far the market has not complied. Our first chart (Chart 1 below) shows a 12 month moving average of Comex silver prices. During the 14-year production/consumption imbalance, prices initially moved lower to an ultimate 1993 low at $3.835, recovered, and subsequently oscillated sideways. The moving average has been in an uptrend since early 2002, reflecting a generally higher price structure. However, the point of this illustration is to show that the market has trended generally flat (see horizontal blue lines on chart) despite the positive supply/demand backdrop. Current spot month values are about $6.00, which is slightly above the moving average high point made in 1998 at $5.62. Moving average values above $5.62 would signal a clear cut market upturn. Of course that would require spot month readings well above the current level.

 

 

The next point we want to discuss is the relationship between gold and silver prices. A common assumption is that, precious metals prices (including gold, silver and platinum) move in sync, i.e., the markets go up and down in tandem. While that general relationship may be true in times of monetary inflation, a more significant point, in our opinion, is that there can be long periods when one metal's relative performance can outstrip another's. Particularly in the absence of global inflation. Consider the gold/silver ratio (price of gold divided by that of silver) chart shown below. Throughout the 1980s, as seen by the rising ratio, gold was relatively stronger than silver prices when both markets were in evolving long-term downtrends. The opposite was true during most of the 1990s after silver established at least an intermediate-term price low while gold prices continued to erode. Since 2000 gold has again outperformed silver.

 

 

We think that the most notable development on this chart is that this year's high point occurred in proximity to a Fibonacci-related 61.8% retracement (approximately 78.5) of the 1991 - 1998 decline. The ratio made two monthly top reversals from above that level in January and June 2003 (circled on chart). As the second reversal occurred, the monthly stochastic indicator turned down, confirming a negative momentum divergence (see box on stochastic indicator). From that price and momentum action, we can infer that the gold/silver ratio made failed test of its 1991 all-time high this year. Therefore, the ratio should be at the start of a sustained decline which would mean a period when silver prices outperform gold prices. December's somewhat expanded downside range may be the start of that condition. The current position of the stochastic indicator, circled in neutral territory but declining, holds out the prospect of further downward movement in the ratio. That is something we think must occur if silver is beginning a cyclical, or even secular, advance. However, as with our lead paragraph remarks, we think that silver's price action must soon start to show strength relative to gold.

 

These two factors, the fundamental supply/demand backdrop and the relative relationship of gold and silver, appear to be the ambivalent variables in the long-term prospect for higher silver prices. Other technical aspects, which we will consider below, generally favor the bullish price case. The first of these we have identified as a 127-month cycle of price lows. Dating from November 1971, which was the last significant low prior to the super cycle thrust to the 1980 bull market high, the market has established major trading lows about every 10 and a half years. These are seen on the monthly silver chart below. The most recent ideal 127-month low was due this past August. There was no prominent downward price spike to make a low obvious although October did see an 11% break of 60¢ that would satisfy that definition. Prices have worked higher since then and have traded at a 4 year high. If the cycle is valid, then silver has considerable time ahead of it to reach higher price levels.

 

 

In the context of wave analysis, the long-term down cycle that has dominated silver prices since 1980 may be interpreted in different ways. We can make several cases for the decline having reached a turning point, but the one that has the most appeal for us is that on the monthly chart below. The various price swings suggest a complex correction, a-b-c - x - a-b-c-d-e . This pattern is interpreted as a combination of a standard zigzag (a5-b3-c5), an X-wave, and a triangle (a-b-c-d-e). Taken together, this combination translates to an A-B-C correction (see boxed annotations) of the previous up super cycle. We like this scenario not only because of its outright wave structure but also because of a multitude of swing relationships (mostly Fibonacci-type) within the pattern. We have never before seen so many swing ratios within a pattern and consider their existence as bolstering the case that the entire pattern from 1980 through 2000 is "of a piece" and that it reached completion just above $4.00 in 2000.

 

 

Here are the lengths of the swings as well as various relationships:

 

A = $36.72; a5 = $30.70; c5 = $20.22; X = $10.15; a = $10.08; b = $4.945; c = $6.29; d = $3.895; e = $3.38

 

 

Although we interpret long-term pattern development as being completed, prices are still within the boundaries of the pattern's terminal triangle phase. Its line "bd" (shown), currently crossing at about $6.10, basis spot month, defines the actual upper edge of the pattern. It is worth noting that triangles often are completed with explosive exit thrusts. Therefore, potential price movement above $6.10 could be surprisingly aggressive. If that level is violated, then we would not be surprised to see initial uptrend development at least to the high of triangle a-b-c-d-e, point "b" at $9.795, and possibly to $11.05.

 

 

The weekly silver chart above shows several price and momentum factors. First is price behavior this year. Outright price action in September-October 2003 featured a move above $5.15 (point Y) which was the high of the last significant rally in the 1998 - 2001 downtrend. Although short-lived, that show of strength was an initial indication that the prevailing downtrend was being compromised. The subsequent aggressive price breakdown was checked at $4.745. A weekly bottom reversal there confirmed an area of dual support associated with the 40-week moving average and the 2002 - 2003 resistance line (see circled arrow). Prices are now at a new trend high and above their illustrated 200-day moving average which is rising. That relationship is generally considered the definition of a long-term uptrend condition. The rising stochastic indicator is at a 5-year high, above levels that previously were associated with interim price tops, but uptrend development continues. Price gains in the face of an apparent "overbought" momentum indicator, as in this case, is one of the hallmarks of the start of a sustained up trend. Trading at the end of December saw prices gap above an obvious shelf of intermediate-term resistance at $5.81 (see dashed line on chart). That area stopped 3 widely spaced rallies in 1998 - 1999. That has put the market in proximity to the key long-term downtrend line "bd" discussed above.

 

In summary, 14 years of production deficits have not resulted in higher silver prices but the digital photography revolution has not yet diminished global demand figures. The technical condition of the price relationship between gold and silver suggests that silver prices could begin to gain on gold prices. Both of these factors, the supply/demand balance and the gold/silver ratio, require market action in silver to confirm that a shift to higher price levels is underway. Numerous other long-term technical factors also considered above imply that silver is ready to respond on the upside. As we view the market now (approximately $6.00, basis the spot month), we think that a medium- to long-term position trading stance is warranted. We would need to see a weekly close below $5.04, basis spot month, to reconsider that view but only a weekly close below the long-term 40 week moving average, currently about $5.00, would be technically damaging.

 

 

Eidetic Research

 

 

 

 

 

 

 

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