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One of the laws of market espoused by those that embrace
the efficient-market hypothesis
states “Stock market prices
are unpredictable.” Technical analysis, however, has proved effective at predicting future price
direction through the study
of past market
information, primarily price
and volume. To be sure, predicting
future prices of a stock or commodity
can be challenging, and
not always successful,
but the speculator can
profit from correct technical
analysis of a traded
good. The price movement
of silver over the last eleven
months provides a good example. So let’s examine
the anatomy of a technical
trade in silver.
One of the most liquid markets for silver is the market for silver futures, traded on the COMEX. Other markets for silver include exchange traded funds, or ETFs, which trade similar
to stocks. Price and volume history for each type security are readily available, which allows the technician to work.
The technical analyst searches for chart patterns that develop with price action over time. Volume associated
with price action is an important factor in evaluating
the validity of a particular
chart pattern. Independent indicators
can also help confirm the validity of the primary pattern. Back in September
2010, we identified a breakout pattern in COMEX silver
that predicted a bullish move up. We saw this
play out in higher silver prices since that prediction.
Here is what we observed on September 3, 2010:
BREAKOUT
As we survey the various elements of the precious metals group in the run-up to
Labor Day, it becomes very clear that
something big is brewing. As we see, the chart of silver has formed an ascending triangle going back
to Dec. ’09. This triangle has broken
out today, and it presages breakouts throughout the precious metals group. Using the
semi-log continuation chart (www.timingcharts.com) we can predict
the price objective for silver
at about $60 using the present data.
Technical analysts know the ascending
triangle pattern is a bullish
formation that usually forms during an uptrend as a continuation pattern. Although
there are instances when ascending triangles form as
reversal patterns at the end of a downtrend, they are typically continuation patterns. Regardless
of where they form, ascending triangles are bullish patterns that indicate accumulation. The length
of the pattern can range from
a few weeks to many months with
the average pattern lasting from
1-3 months. As the pattern develops,
volume usually contracts.
When the upside breakout occurs, there should be an expansion of volume to confirm
the breakout.
We use the ascending triangle pattern to
calculate the price target by projecting a line parallel to the ascending trend line (bottom
trend line) starting at beginning of the horizontal resistance
line, and extend it to intersect the price scale. This can be seen as a mirror of the ascending
triangle with a common
horizontal base. Care must be taken
to account for semi-logarithmic
price scale. For COMEX silver, the September 3, 2010 breakout from the ascending triangle pattern produced
a target price of $60/oz.
We recommended subscribers
buy COMEX Silver at $20.78 on September 17,
2010.
Price action in November
and December produced bullish pennant patterns that confirmed the continued move up for silver.
The chart below was explained to subscribers on December 10,
2010.
The key technical formation of the moment is
the pennant which formed in silver over the month of November. Silver did move into new high ground early
in December.
But it fell back
and appears to have met support at
the $28-$29 level. The November
pennant gives a point
count to $40. There was a 61% move in silver from late August to early Nov., and the pennant predicted an equal (percentage) move.
A 61% rise from
$25 gives us a target price a touch
over $40. Our objective for silver at $40 is mid February
(on the argument that the second leg out of the pennant will be equal
to the first leg in time).
We know that commodities,
including silver
correspond to movements in the Dollar. This makes sense since
silver is usually purchased in Dollars.
So when the Dollar weakens,
the same ounce of silver commands more Dollars in
exchange. Likewise, the strong
Dollar buys more Troy ounces
(31.1034768 grams) of silver.
Hence, silver usually has an inverse relation to the Dollar. It is important to recognize that the price movement of one does not cause
the price movement of the
other. Prices rise when there
are more buyers than sellers for a particular good.
The value of the Dollar decreases with increases in the money supply. The technical analyst can use these facts to his advantage in predicting future price movements.
We can see the
inverse relationship between
the Dollar and silver in the chart
below.
We saw the Dollar drop steeply in September-October
2010. This corresponded to the first large leg up for silver over the same period. In December we recognized a bearish pattern (head-and-shoulders top) on the Dollar index that
broke to the downside for
the next five months.
This corresponded to the second large leg up for silver over the same period.
Here is what we told clients about the Dollar
on December 15, 2010:
Here is the weekly
basis chart of the US Dollar. Notice that
the chart gives the clear head-and-shoulders top. This formation has to dominate
our thinking on the intermediate term. A breakdown from
the neckline predicts a
drop to 74 or lower. We can expect commodities
to benefit on the Dollar decline.
We saw silver
continue on a parabolic rise
on its way to $60/oz. At $50/oz, the CME slammed the door on buyers by raising margin requirements to 50% of position value. Retail buyers who got in late
bailed out, or were called out on margin. Since then, silver
has made a return to over $40/oz as investors
return to silver and gold as the debt crises in the EMU and the US unfold.
Today, silver and gold have reclaimed milestones. Gold is trading over $1600/oz and silver is trading
over $40/oz. The Dollar is selling
off, just a point away from its May low of 72.86.
Resolution of the US debt issue is likely to reverse the Dollar’s slide, and
pressure gold and silver. But the US debt issue has devolved into a day-to-day melee; Congress
and the White House may not be
able to control the situation before the credit agencies take action. One thing is certain- downgrade of the US
sovereign debt would be catastrophic
for the markets here and around the globe.
Scott Silva
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