It’s been an exciting start to the year thus far for precious metals investors. Both metals are off to a good start, and the January rallies are very reminiscent of 2016. Despite the 9% rally off the lows for silver, we still have a reading of more than 3 bears for every 1 bull. Bullish sentiment is still in bearish territory on silver, and the metal has been locked in a descending channel for nearly 7 months now. Fortunately for the bulls, the trend in sentiment in data is finally starting to turn the corner, and brighter days may be ahead.
Trend changes in an asset class can be very powerful, especially when they come from readings of extreme pessimism. We can see an example of this in early 2016, when bullish sentiment (white line) climbed above all of its moving averages (after being below 10% bulls). This trend change led to a 54% rally in silver prices over the ensuing 6 months.
Thus far 2017 is looking very similar, as bullish sentiment is making higher lows and above all of its moving averages. The key to this setup is that the sentiment moving averages are all rising and trending higher, compared to mid October where we had a different setup. While the bullish sentiment breakout in October was valid, it was nowhere near as exciting. The 21-day moving average (red line) was sloping down for most of the move, and this did not give a high likelihood of new bull market beginning.
The 3-day pullback in silver prices of 3.5% last week put a serious dent in bullish sentiment. Bullish sentiment in silver plunged from 39% to 23%, and fell to the lowest levels since December 30th of 2016. What’s interesting to note about that is the massive difference in silver prices despite sentiment being at very similar levels. On December 30th, 2016 the price of silver closed at $15.93 and silver bulls were at the 20% level. Just last Thursday silver closed at $16.73, and silver bulls were at the 22% level.
In my opinion, this tells us that investors in silver are extremely skittish and are having a hard time trusting this move. Despite the price of silver being 5% higher, bullish sentiment was only 2% higher. To put this in perspective, a 3.5% drop in silver eroded silver bulls by 16% just last week. So a 5% increase in silver led to a gain of 2% in bullish sentiment, but a 3.5% drop in silver led to a 16% decline in bullish sentiment. This is unprecedented in terms of historical sentiment data for silver.
In spite of us coming out of a violent 4-year bear market in 2016, bullish sentiment was nowhere near this flighty. I believe this can be attributed to the pummeling investors in precious metals have received the past few months, which came almost completely out of nowhere. By mid last year investors were beginning to get euphoric and were under the assumption that we were entering a new massive bull phase for silver. This was evidenced by the 97% bullish sentiment reading in July, which showed that 9.7 out of every 10 investors were bulls on silver.
Fast forward 4 months and the election result sent silver diving off a cliff. Most precious metals were not positioned appropriately for this and being blindsided by a move can significantly erode one’s trust in a market. The fact that silver has been ping-ponging back and forth in a channel for 7 months has not helped silver investors in the trust department either. Every time the rally looks like it’s getting legs, we see a sharp reversal off the top of the channel. Fortunately for those with conviction, this may be a good thing. The fact that no one trusts this move and few want to be a part of it is a very positive development. Typically when no one wants anything to do with a market, that is exactly when you want to be getting your feet wet.
So how do we know this test of the channel isn’t the same as the last 4 in the picture above? Unfortunately we don’t and I see no reason to get aggressive until we see a clean breakout above this channel. Having said that, this pattern is beginning to get a little stale and too easy to predict and trade. When a channel becomes obvious like this it often does the exact opposite of what is expected and fools the majority of traders. This is due to traders finally “figuring it out” and setting resting orders at the channel bottoms and tops, as they’re convinced they know what the market will do next. For those of us with any experience in the markets, we know that the market typically trades in the direction which causes the most pain to investors. This means that if silver bears are finally in control and convinced that this breakout will fall short at the channel top, it probably won’t.
So what do we need to confirm a breakout in silver? A close above $17.40 should do the trick, as this would represent a clean break-out above resistance. As we can see from the above chart, the October swing lows have been acting as resistance for the past 3 months. A move back up this level that is sustained would take the lid off of the silver price, and open up the door for a new bull market.
Taking a look at silver from a trend following perspective, silver is also beginning to show us some signs of life. I often use the 20-day and 50-day moving average crossover to give me cues of a change in trend. As we can see from the above chart, the 20-day moving average crossing down below the 50-day moving average was a very ominous sign in mid August. This bearish crossover marked the beginning of a new downtrend for silver, and the 20-day moving average was stuck beneath the 50-day moving average for the remainder of 2016. Just two weeks ago we saw a bullish crossover, and thus far the moving averages remain in bullish alignment.
I would expect any dips in silver to find support at the 50-day moving average, as this key moving average is now rising for the metal. The 50-day moving average at $16.59 is roughly 3% below the current price, and it is now trending higher. This is another positive development for silver as the 50-day moving average has been sloping down since mid August.
These positive developments do not guarantee we will begin a new bull market for silver, but they do put the odds in the favor of silver bulls. A trend change in sentiment coupled with short term bullish crossovers from a trend following perspective tell me that the correction has likely run its course. The next level of resistance for silver above $17.40 is $18.12, and above that I expect to see the $21.00 level tested again.
For those that have stuck it out during this nasty correction, I believe there are better days ahead. If we can exit this descending channel, we may finally get the real bull market we’ve all been waiting for so patiently. Get updates on our sentiment, our top silver stock picks, trade alerts and the monthly contrarian newsletter by clicking here.
