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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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