Gold and Silver Peaking?
February 3, 2008
Timothy Silvers
?It looks like gold and silver may have topped out. I have received many emails over the months and would like to have posted more updates since my last article in September. However, I have been traveling in remote parts of Asia with limited, and often poor, internet access. Whenever possible, I have been following the developments in the financial world and US economy. I think we are close to a major correction point in gold and silver and another buying opportunity in the next month or two.
?Looking back, I expected silver to surpassed $15 and gold $800 before the end of 2007. They reached these targets in early November. The main factor driving that move was a 7% drop in the dollar from August to November. It wasn¡¯t so much a bull market move in precious metals as a bear market in the dollar which fueled that rally. Until mid December, the metals consolidated after reached multiyear highs in early November. They were trending down but then started a great bull move on the 17th bringing gold to new all time highs and silver up to $17. This run was fueled by deterioration in the world credit markets related to sub prime mortgage loans problems. This has seen the metals perform their typical flight to safety role as investors scrambled to find a safe place to preserve their capital.
?Looking at the candlestick charts, gold reached overbought levels twice in January and started to correct Friday. Silver has moved up strongly over 20% since the lows in mid December. On Friday its candle shows that it tried to make new highs but closed below its open. Sometimes these candle structures appear at a top. Even though the Fed has dropped rates 1.25% in January, the dollar appears to be finding support and has double bottomed above 75. One might expect investors to flee the dollar after these drastic rate cuts. However, the dollar is still, for the moment, the reserve currency of the world and many governments have a vested interest in making sure the dollar doesn¡¯t collapse overnight. In the short run I don¡¯t expect gold to get much support from further dollar weakness and is vulnerable to a dollar rally.
?Another factor weighing on gold is that the gold mining stock indexes HUI and XAU both topped in mid January and then failed to break that top at the end of the month. The XAU is now at the same levels as it was in mid November, when gold was $100 lower. This is showing some lack of conviction in the strength of the current move by precious metals stock investors. As an aside, from the lows in August to the peak last week, silver has gained 50% and gold more than 40%. The XAU and HUI had gained 60-65%. This indicates that it can be valuable to have some mining stocks in your portfolio as opposed to only bullion. Sometimes the stocks outperform bullion and vice versa.
?I said before that the COMEX Commitments of Traders (COTs) reports are not as reliable an indicator of future price changes as they once were. Certainly in 2006 they were next to worthless. However, in 2007 there was an 88% correlation between the price of gold and the number of commercial short contracts. Silver showed a reasonable 77% correlation. For the first 4 weeks of 2008, the correlations are 80% and 72%, respectively. Looking at the chart below, gold recently broke a new 3 year record of 24.5 million net ounces sold short and corresponding record 20.5 million ounces of non-commercial traders net long. These typically are trading funds which sell mechanically when technical indicators are broken to the downside. Such a large non-commercial position represents a risk of a lot of profit taking if gold has a few bad days or if traders need to raise cash to increase their equity. We aren¡¯t out of the woods yet with the credit problems in the economy, and selling profitable assets is likely to happen again, as it did in August.
?The chart below I use to get an idea of the trend of the commercial traders¡¯ silver short position. When the Sum of $Short indicator is bottoming it is always associated with a short term low and buying opportunity. Obviously we are not at a low risk buy point now. In fact it is close to the record in December 2005. The $3 billion change from the low reading at the bottom of the previous large correction in August is the most dramatic since I started tracking this data. Also, in the past 10 years, open interest in the COMEX silver contract has never been as high as now (183,056 contracts) and there is a record surge of non-commercial spreading contracts (51,780). I don¡¯t expect a repeat of December 2005, where the impending launch of the silver ETF helped fuel silver speculation and drove the price of silver higher as the commercial traders covered into a rising market. I expect the commercials to cover on price declines soon, as they have been able to do so well in the past.
Summary
?It¡¯s difficult to predict when a bull run will finally die out and correct. Nevertheless, there are several red flags saying that there is a lot of risk right now to establish new long positions in the precious metals. We have risen for six weeks without a significant correction and we haven¡¯t had a major correction since August. The market needs a healthy pullback at least to the 50 dma (848 for gold, 15.25 for silver). A major pullback would test the 200 dma (739 for gold, 13.79 for silver). The next buying opportunity will correspond to an RSI dropping to 50 for a minor correction or the low 30¡¯s for a major correction. I plan to write another update when I think we¡¯ve reached the next buy point. If gold closes above $930 and silver $17 for a few days, then I¡¯m wrong about an imminent pullback. In that case, I still think it would be unwise to go long now and chase the bull to the top. If you are trading and stay long, use stop sell orders to protect your gains.
?On a personal note, my wife and I are enjoying our world trip. We have seen many amazing places and shared some great experiences. I have especially been fascinated by China and have spent the last few months living here, learning Mandarin Chinese and studying traditional Tai Chi with Chinese masters. If you¡¯d like to follow our world travel adventures, please check out the travel blog which my wife has been maintaining at http://travelingsilvers.blogspot.com. We enjoy getting feedback and comments from readers but usually cannot respond to emails personally due to limited internet access.
Best wishes on your investing and future and God Bless,
Timothy Silvers
Disclaimer: This article represents the opinions and personal views of Timothy Silvers and is not intended to be investment advice. If you choose to use this analysis for your personal trading, Timothy Silvers assumes no liability for the direct or indirect losses you may incur due to using this article to make your investment decisions. You are totally and completely responsible for your own investments. At any given time, Timothy Silvers or his friends and relatives may have positions in silver related investments that may or may not follow the recommendations contained in this article. The information in this article may not be completely correct and accurate. Even though Timothy Silvers has done his best to review the content and accuracy of this article, he is in no way liable or responsible for any mistakes or omissions.