SILVER UPDATE

 

Silver Update

Back in March I wrote a post suggesting it was time to buy gold or gold related stocks (see https://kiwiblackers.blogspot.com/2021/03/is-time-right-for-precious-metals.html). At the end of that post I mentioned that whilst I was very bullish on silver in the medium and long term, I didn’t feel it had corrected enough at that point and that there was still the risk of a more severe correction. A few months have now passed and the situation has evolved a little more so it’s time to take a closer look.

 Since those March lows for gold, silver has continued to track gold’s movements as is normally the case. It did form a low in April, bounce into a May high and has since been correcting again. But despite these extra months, the picture is still unclear with a number of competing factors, so lets look at the positives and the negatives and see if we can draw a conclusion.

Positives

1. Time

Corrections can complete in a number of ways. They can move dramatically, with steep price movements quickly taking the price back to areas of support, bleeding off the excesses, flushing sellers out and allowing the rally to continue. They can achieve the same end over a much longer time period with minimal price movement, but with the stagnating price slowly disheartening investors into selling their holdings. Once these investors have sold, the rally can once again continue. Finally and more commonly is a combination of the two. Price and time combine in order to drive out the sellers until only buyers remain. When we apply this to silver we can see that it currently has been consolidating for around 11 months since the spike highs of August 2020.

  It is worth pointing out that silver has a history of long consolidations, but this is a reasonable time period and has taken the technical indicators down into neutral or oversold positions

      2. Seasonality

As we know, gold and silver are highly correlated, so whilst there might be a lag or a more extreme move of one versus the other, there paths are generally aligned. As a consequence, when we are looking to predict silver's path, it makes sense to also look at what drives gold. One recurring factor is the seasonal aspect to gold's price movement, as there a discernable pattern of rallies and corrections, and this is in part driven by different cultures attitude to gold as an asset or store of wealth.  Unlike most of the western world which is entirely comfortable with banks and the banking system (although that is starting to change) in many parts of Asia, farmers in particular still tend to use gold as their primary form of savings. As we head towards late summer in the northern hemisphere, many of their crops are being harvested, and the profits from this activity start to be invested into gold. The other main driver is the Indian wedding season. August is a particularly auspicious time for weddings in India, and the custom of  using gold in jewellery and as dowries leads to a bulge of purchasing around this time. These two events combined, have over the years, contributed to the major uplegs that have been commonly seen over the next month to six week time frame.

      3. COT Chart

We've used the COT charts on numerous occasions to highlight how the professionals are positioned and whether it points to a potential price move.

Here we can see the red bars (professionals short positions) have been reducing, meaning they have been buying silver as the price has been falling. They are almost at the level that preceded the low in silver back in April.

      4. Earnings Season

There are a number of ways to invest in precious metals. You can own silver through coins or bullion. You can buy ETF's relating to silver thereby giving you exposure to the silver price, or you can invest in the mining companies themselves or ETF's of an index of these companies. For many people the last route is the most favourable. It avoids the need to physically store the silver (although this can be avoided if you invest using institutions like the Perth Mint for example), but more importantly it gives you leverage to the silver price.

 The mining companies have costs associated with the extraction and processing of silver. These costs can fluctuate depending on numerous factors, but as a general rule, they are creeping up. However the big variable is the silver price. When silver has a big move and effectively stays there for a period of time, it can have a profound effect on the earnings of these companies. They can explode higher, pushing their valuations down and making them a very attractive option to investors. We saw this during the bull market run up to 2011. As the silver price increased, the companies earnings rocketed up driving the share prices higher but without driving up their valuations. It's a virtuous circle in a bull market (however it is the exact reverse in a bear market!). Many of the companies will be reporting earnings over the next few weeks, and the consistently high silver price over the last few months bodes very well.

      4. Inflation 

When inflation first started to pick up a few months ago it was dismissed by virtually all analysts, pundits, central bankers and politicians as being transitory and nothing to worry about. Well unfortunately over the last few months inflation has strengthened and now there are some very nervous central bankers and politicians around the globe. They're worried because the only way they have been able to sustain economic activity is by keeping interest rates abnormally low and using various forms of money printing (quantitative easing). Without it we would have had a global recession and the incumbent politicians would have been voted out, so acting in their own best interests, politicians the world over have ensured that didn't occur. Unfortunately there is no free lunch. This course of action over many years has just encouraged the explosion in debt, and the actions taken to counter Covid 19 has now ballooned government debt to an unimaginable scale. These responses have also resulted in huge disruptions to food production and the supply chain generally. This, allied to the impact a rising US dollar will have on imported inflation will lead to a systemic inflation problem over a number of years. In the past, these periods have been very positive for precious metals as well as many other commodities, and I don't see why that should be any different now.

      5. Silver Miners 

We can get a feel for how the silver miners are faring by looking at an index of silver mining companies. Here we can see a similar picture to the silver price chart which is not surprising but does corroborate things.

We can see two areas of support at the blue line and the 100 day moving average. The indicators are also moving up from oversold positions which is positive.

Negatives

      1. Oversold Enough 

We saw from the weekly chart of silver that most indicators were either neutral or oversold currently, however if we look at the monthly chart it shows a different story.

Here we can see that the indicators are at best mixed, with some still in overbought territory, some neutral and the RSI 3 nearing oversold territory. It can't be painted as a roaringly bullish picture, however there are some caveats. For almost the entirety of this chart silver has been in a bear market, and in fact that only changed with the rebound out of the 2020 lows. As a consequence the technical indicators will react differently going forwards. For example we can see that the RSI 3 indicator only made it into overbought territory on 6 occasions throughout the entire 9 year period. Now that we have flipped into a bull market we can expect the reverse of that, with the indicator hitting the oversold zone very infrequently. All this said, it still leaves room for a further consolidation in either price, time or both.

      2. Stock Market Correction

In my previous post I mentioned the potential for a stock market correction after their great runs from the 2020 lows. We did have a correction in June but have since rebounded, but the indicators have largely rolled over and a decline feels more likely at this point.

The silver mining companies are affected by both the price of silver and the wider stock market sentiment. Selloffs in the market can affect the price of silver but not always in a predictable way. However should we see a serious selloff  then the mining companies would almost certainly be affected  and we could see some serious if short lived declines. This doesn't affect my long term bullishness on the US stock markets and I don't believe there is anything indicating a crash at this time, but it is something to be aware of.

      3. A Strong US Dollar

As I've mentioned previously, excluding any other factors, silver and the US dollar tend to move inversely, and we have in fact seen that over the last few months. My feeling is that there will be other factors that will make them much more correlated as we have seen in the past. However the US dollar chart is looking interesting.

Here we can see that the price has moved down to a confluence of moving averages and that the technical indicators have all turned or are turning up. If we now look at the long term monthly chart we see a very bullish picture, and we must take on board that in 'normal circumstances' this would be silver bearish.

With price having bounced off the 100 day moving average and the indicators turning up from oversold levels, this is indicative of a very strong dollar moving forwards.

Conclusion

We are rarely given absolutely clear cut signals to invest. We are always looking for price and corroborating evidence to show us that the odds are swinging in our favour. There are still risks involved as I have highlighted, and I do think we are heading into a period of serious volatility where the costs of the Covid response and associated strain on government balance sheets, the psychological damage of repeated lockdowns, the disregarding of long held civil liberties and the associated civil unrest, will continue to impact investment decisions. This volatility may well result in opportunities to invest at lower prices, however on balance I don't think this is a time to finesse too much. Personally I would rather be invested to some extent and run the risk of some short term loss.

 I've long argued that as Europe and Japan struggle with their economic problems, the path of least resistance is to the US dollar. This flow of money has only just started, and with the impact of the Covid response bringing these issues to a head, this flow will become a stampede.

We are living in anything but normal times.

Take care

Is the Time Right for the Precious Metals?

Back during those March lows of last year I wrote a post suggesting that it might be a good time to buy the Dow Jones index as it was sitting around some very strong support levels. This has proven correct, as the Dow has gone on to virtually double in price since then. However I was a little more reticent with the precious metals as I wrote at the time.....

There are some reasons to think that the precious metals have bottomed. With the exception of gold itself, silver and the miners have been hit hard and the charts are in oversold territory. However there are a few things nagging me. 

1.     Firstly, it feels like gold has benefited from a safe haven status (this is not surprising) and that some of that still needs to be washed out.

2.      The panic is not over yet, and forced liquidations should affect gold the same as everything else.

3.     The COT positions are still bearish despite some improvement.

4.     Despite being oversold, the technical indicators are not severely oversold which I would would expect to see at a major bottom.

5.     The 2015 low. It never felt like a true bottom to me. There just wasn't enough panic and liquidation for my liking. I may be wrong and we may not reach those levels on this move, but before going long I definitely want to see more downside, and I think the US dollar rally might be the trigger that causes it.

For the time being I'm happy to watch and wait with respect to the precious metals.

Unfortunately, my reticence was misplaced, with both metals proceeding to rally strongly, confirming that the corrections from the 2011 highs are over and that a new bull market has begun. Whilst missing the bottom is always frustrating, the good news is that now a bull market is confirmed we can look for a price correction to give us the opportunity to enter long positions. Which brings us nicely to the here and now.

Below is a weekly chart of the Gold price showing the collapse of March 2020, the subsequent bounce and the corrective wave since August of last year. We can see that the correction has now lasted for some time, that the technical indicators are all at the lower end of their ranges, and that gold is now around an area that has provided support in the past.

I have often used the Commitment of Traders reports in the past to give insights as to how the professionals are positioned relative to the speculators that tend to just follow the trend. If we look at the chart below we can see that the positioning has been pretty stable in the last year, with the professionals (known as commercials and represented by the red bars) maintaining a short position until the last few weeks when they have started to buy back their short position as prices have fallen.

The chart isn't yet compelling but it is reassuring, as if the commercials are now in the market buying gold on any weakness, this will act as a support to the price and likely reduce the magnitude of any further falls in price.

Lets now move on to the mining companies themselves. As we know, the miners tend to magnify the movements in the underlying metal by some margin, so are often the best place to take advantage of any price moves.

Below we can see the weekly chart of GDXJ, an index of some of the smaller gold mining companies. It unsurprisingly looks similar to the gold chart above, with a long correction, oversold technical indicators and price now close to areas of support.

So having outlined the bullish case for gold and the miners, what could go wrong?

Firstly is the fact that these corrections often take time to form a base, with a number of selloffs and rallies taking place in order to exhaust selling pressure and provide the basis for a sustainable rally. Therefore, just because the price reaches an area of support does not mean it just stops and rockets higher. The basing process can be a roller coaster, but this is where the charts come in. They give perspective, allowing us to see where the price is relative to any support levels and how oversold it is relative to previous corrections. Seeing the price with an historic context shows us that by previous standards, this seems a good entry point.

Secondly, whilst I've outlined many time previously why I am so bullish on US equities in the longer term, they have had a very good run recently. I don't think there is a crash coming, but there could be a short-lived selloff that should it occur would put downward pressure on the gold miners.

Lastly, the US dollar. Most of this last year it has been buffeted by the political circus going on in the US which has driven it down to its 100 day moving average as we can see in the chart below. However the recent uptick in bond yields in the US has got everybody worried about the likelihood of rising rates. This prospect of higher rates has been dollar positive and the price now seems to have turned with the technical indicators moving up from oversold levels, meaning it will likely resume its long term uptrend from 2014. 

Normally, a rising US dollar is bad news for any US$ based commodity, with their trends often inversely correlated.  And at this early point of the change in trend for the dollar, any strength will probably be taken as gold bearish and will put pressure on the gold price. However, we are living in anything but 'normal' times, and I expect to see both a rising dollar and rising commodity prices in the months and years ahead.

So if and when gold does rally, how do you get the best bang for your buck?

As I mentioned earlier, the miners tend to outperform gold itself, and the smaller miners tend to outperform the majors . There are numerous companies to choose from out there depending on your preference and risk profile, but one way of obtaining exposure whilst avoiding the 'eggs in one basket' problem from buying an individual share is by buying an exchange traded fund (ETF) of one of the gold mining companies indexes. These indexes are comprised of a number of underlying companies, with their profiles differing depending on what they are trying to achieve. 

One of the largest etf's is the VanEck  Vectors Gold Miners ETF (GDX). This contains some of the largest gold mining companies around and has traded for some years. An alternative is the VanEck Vectors Junior Gold Miners ETF (GDXJ). This contains some of the smaller companies and is therefore more volatile but with greater leverage to gold. Another to consider is the Sprott Junior Gold Miners ETF (SGDJ), which is also more focused towards the smaller companies with more volatility and more upside potential.

In conclusion, whilst the negative gold sentiment might continue a little longer and the price could well be buffeted accordingly, I think we are at or around a level where there is some good upside potential. It is always hard to buy when the price is falling and sentiment is rotten, but in bull markets they are the best opportunities, even when they don't feel like it at the time.

Lastly, you might be wondering why I haven't mentioned Silver. I am tremendously bullish on Silver in the medium to long term, but the price got taken up and over-extended on the recent Gamestop and Bitcoin frenzy and it has yet to fully correct. Historically, Silver is much more volatile than Gold and I expect there to be more downside before we reach a buying point. I will be doing an update on Silver shortly as that is one rally I don't want to miss.