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DOW THEORY
ANALYSIS SAC
Silver is like the relative that no one wants to invite over to their
house, and if you do, it’s only on Christmas so your conscious
doesn’t bother you. You know the one I’m talking about; his
clothes went out of style in the 50’s and he doesn’t smell too
good either. Silver is also a bit of an enigma. A search through the dozens
of articles on any of the better known websites for gold bugs will see it
referred to as an industrial metal, a precious metal, or money. There are a
lot of people in the first camp, more every day in the second camp, and
almost no one in the last camp. For those of you who do subscribe to the
“silver is money” hypothesis, keep the home fires burning because
you will eventually have visitors. Through out the late 1980’s, and for
the entire decade of the 1990’s, silver was definitely one thing: it
was a poor investment as the price spent most of its time between $4.00 and
$6.00. That’s just 1/10th of the all-time high registered in
1981. As a result, a strong case could have been made for silver as an
industrial metal and you probably wouldn’t have gotten any argument out
of me.
With the new millennium came new opportunities, and with these
opportunities came new life for the previously defunct white metal. As you
can see in the historical chart for silver below, it made a significant
bottom in 2001 at $4.03. As is typically the case, the bottom was followed by
a prolonged period of consolidation. This in turn was followed by fits and
starts that included a run to a 2004 high of $8.21. That surge sucked a lot
of investors in who believed that they were on there way to $50.00 silver
sooner rather than later. They were quite wrong as they found themselves back
at $5.60 two months later. There was one difference though as silver then
rallied to the $6.50 - $7.50 range before undergoing a significant
consolidation. Better yet, silver built a huge base that would eventually be
used to test significant resistance at the $14.81 level. This first test
proved to be a bit much and the price then fell back to $9.55. On Friday,
August 25th, silver closed at 1237.0 bases the September 06
futures contract on Friday.
Before discussing present conditions, I would like to take a look at
the supply/demand issues that affect price. As I see
them, they are as follows:
- Demand
currently outpaces supply be minimum of 3% a year,
- A
lot of mines were forced to close in the 1990’s and at best it
will be several years before that source is replaced,
- There
are new demands in medicine, solar power, computer technology, and
telecommunications, to name a few, for silver.
- The
new silver ETF’s are taking silver off
the market and out of circulation,
- Unlike
gold, some silver is “consumed” and therefore forever
removed from circulation, and
- Increased
demand in the jewelry business as silver is
once again viewed as a precious metal.
With respect to jewelry
demand, Peru
is one of the largest producers of silver in the world yet it was unheard of
to see silver pieces in a fine jewelry store two
years ago. Now they can’t get hold of enough to satisfy customer
demand.
Given everything that is mentioned above, the long term outlook for
silver is bright. Then you begin to factor in other political and economic
issues like the Middle East question and the overall health of the U.S.
economy and you can’t help but get ex-
cited about the white metal’s
future. Whether you believe inflation stagflation or deflation is in the
cards for the U.S.,
the end result will be the same, higher silver prices. The only difference
will be ‘timing’!
For purposes of our analysis, I am going to assume that stagflation is
in the pipeline although most of my clients know that I was firmly entrenched
in the deflationist camp for several years. I’ll admit that I still do
a bit of mental fence-sitting from time to time. There is no question in my
mind the U.S.
economy is slowing and that prices have increase significantly over the last
five years. Even Helen Keller could see that in an historical chart of the CRB Index. Given the existence of a huge demand for raw
materials in China, India, and the rest of Asia,
I can only assume that prices will continue to increase. Hence we’ve
met the true definition for stagflation; rising prices in a slowing economy.
Silver will reap the benefits on both fronts. As a commodity its boat will
float along with the CRB, and as a precious metal
its sensitivity to inflation will make it the leader of the pack (along with
gold).
I am quite focused on the long term, and much to the amazement and
chagrin of my clients, pay little attention to the short term. I do
understand the fundamentals of human nature though, and in an effort to
appease, would like to expound on where I see silver going in the coming
months. Below you’ll
see a Daily Chart of silver:
I think it’s quite a bullish picture
and here’s why. You can see the June 14th low at $9.48
followed by an initial rally that topped out at $11.82. That rally was then
followed by a correction that produced a higher low at $10.45. Higher lows
are good and the higher high at $12.65 produced by the second leg up is even
better. What really tickles my fancy though is the way silver has managed to
consolidate above the first high of $11.82. I see that as a very
positive development. I suspect we’ll continue to consolidate at or
just above the old high for two very good reasons:
·
There is very good Fibonacci support at $11.69 basis the September
contract, and
·
The 50-dma also lends good support at $11.49.
Throw into the RSI
which recently turned up along with the 50-dma and you have further reason to
believe we are on the verge of a significant rally. If I am wrong, I risk a
trip down to the 50-wma at $10.20 which has held firm for more than 20
months.
In conclusion, I expect silver to really take off in September and at
the very least test good resistance at $14.81. Furthermore, I expect it
surpass this level and more than likely reach $20.73 by March 2007.There are
a number of pivot points along the way which the average investor can use to
gauge the white metal’s progress. The first and foremost is $12.37 and
the second is $13.03 (both are based on the September 2006 futures contract).
Then of course we have the $14.81 Fibonacci resistance level. Once these two
initial pivot points are out of the way, silver should really be off to the
races. Meanwhile we consolidate. The only real impediment would be the
presence of deflation. That would delay the process, but it would not alter
the final outcome. Why? Because silver, like gold, is destined to become money!
This transformation is a long process, but it is irreversible. The only
question is when.
Enrico Orlandini
August 27, 2006
Dow Theory Analysis S.A.C.
Lima, Peru
For those of you interested in receiving
information on the Funds we manage, please feel free to e-mail us at ebo@dowtheoryanalysis.com and we will respond as soon as possible.
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