The Silver Bull is Running: UPDATE - By Brent Harmes

My last newsletter The Silver Bull is Running was published on December 8, 2006. This quick update will take a look back, see what I predicted correctly, what I predicted incorrectly and to see where we are now in the market.

I wrote:

"After a breakout from many technical patterns, the price can come back and "test" the breakout to make sure it holds. In the chart below, these testing periods are shown in the green circles. After the first triangle, this "testing" came back down to the pattern and then the price proceeded higher. After this latest consolidation pattern, the price made a faint effort at coming back for a test, but didn't make it all the way down to the pattern because there were too many anxious buyers pushing the price higher... another bullish sign. Now having said this, it is still possible that we could get an official test of the triangle pattern and the price could come back to the $12 range or so before it takes off for good. If we break the current up trend line then we might be headed to this price range. Although this testing is possible, the odds appear to be favoring continued strength in the silver price both short and long term."

This was the chart of silver at the time.

And here is the chart showing the trend line at the time.

Now let's fast forward to today's charts and analyze what has happened since then.

Silver did indeed break its trend line and came back to "test the pattern" and found support in the $12.00 range.

Now that the curtain has been pulled back a little further and we can see more of the price action of the precious metals, we have more pieces to this chart puzzle and will look at what this new information is telling us in a second, but let's look now at why we had this "pull-back."

A Commodity Blood-Letting

Anyone who has only been watching precious metals recently has not been witnessing the carnage in a large portion of the commodity market. Here is a chart of the CRB (Commodity Research Bureau) index. It is an index of 17 different commodities from the metals to orange juice.

Nearly 2 years of gains in the CRB have disappeared in 5 months.

A similar pattern has developed in oil.

Will commodities dive further or are they ready to rebound? There are credible arguments both ways. But until a trend has re-established itself, I will not argue either way. However, the price difference between the precious metals and other commodities does lead to an interesting point.

Even though gold and silver are commodities they are also monetary metals; because of this, they can act differently than the other commodities. If the economy were to go into a deflationary recession, the price of base metals and other commodities would probably decrease as people can buy less of the goods that require base metals. So the price of goods goes down and the relative price of money goes up. In other words, it takes less money to buy a pound of copper or a car so the money is worth more relatively than it was. However, look at gold and silver. They are monetary metals and are money (in addition to being used industrially). This is the reason that governments hoard gold and used to trade it back and forth to settle debt and to back their currencies (before 1971). So, if we go into a deflationary recession then at some point we would expect gold and silver to "decouple" from other commodities and start to rise while the others fall. Take a look at the following one year charts of the CRB , gold and silver. Note how they all peaked in May, but then watch how they acted after that.

This is a one year chart of the CRB.

This is a one year chart of gold.

And a one year chart of silver.

Ratio Charts

To take a more detailed look at relative performance I made 1 year ratio charts. I was introduced to these charts by Mike Maloney and find them very revealing because they take the dollar out of the equation as a measuring tool. Mike points out that when something is measured in dollars (such as the price of gold, the price of the Dow, etc) it can be very misleading because it is difficult to determine whether the value of the underlying item (gold or the Dow for instance) really gained, or did the value of the dollar just go down and it takes more dollars to buy this item? However, if one commodity is compared directly to another then the dollar is taken out of the equation and we can see which commodity or index is outperforming the other. It also makes it easier to see which commodity or index is under or over valued compared to another.

The first ratio chart is the price of silver divided by the CRB.

Note that in May silver fell faster than commodities as a whole but then put in a bottom and started to steadily outperform.

Next is a ratio chart of gold divided by the CRB.

As we would expect, the chart is similar to silver's chart as gold outperforms the CRB but with less volatility..

To get the big picture on this ratio using gold versus the CRB I took the chart out to 10 years.

This chart shows the entirety of the commodity bull market thus far. Something is different starting in 2006. The precious metals are taking on a life of their own. With other commodities crashing and the dollar staging a rebound (these should be negative for precious metals), gold and silver are staying relatively strong. When the market down current puts pressure on the entire commodity sector it is an opportunity to see what is truly strong and what has only been floating upward for the free commodity sector ride.

Where do we go from here?

With the many strong cross currents affecting precious metal's prices the analysts are bringing in forecasts that run the full range from bearish to Dave Morgan of silver-investor.com's forecast of $18 silver before April first (last I heard).

It seems to me there are three options for short term precious metals prices:

1. My original analysis during The Silver Bull is Running was incorrect and silver has recently put in a top or will at least stay in a flat pattern for a considerable period.

2. My original analysis during The Silver Bull is Running was correct if you consider this recent pull-back a standard "testing" of the triangle or coil pattern. If this is the case then silver should continue an aggressive upward pattern.

3. Silver is outlining a new triangle or coil pattern now and will break hard down or up when it exits this pattern. Take a look at this latest chart with the new triangle pattern drawn on it and compare the price movement in the green boxes between this new triangle pattern and the last one we had.

This price action looks too similar to dismiss so it will be watched very closely. A nice factor regarding triangle patterns is that it allows one to relax and just wait and see which way the price breaks out of the pattern to determine which direction the price will head if one wants to be conservative. However, if one waits for this approach they need to move quickly to establish a position either way once the pattern is broken because the movement can be swift. Triangle (or coil) patterns are also considered "continuation patterns" which means that approximately 75% of the time the price will break out of its pattern in the same direction that it entered it. In this case silver and gold both entered their patterns in a very strong upward bias so the odds favor a break-out to the upside.

Conclusion

The fundamentals for precious metals appear strong and technically they have withstood the recent breakdown that many other commodities have experienced. We view this as a strong positive. Also, geopolitical risk appears to be rising and could contribute to the price of this "safe haven" investment if individuals and governments become more concerned about the future. In 2006 gold returned approximately 19.2% in terms of US Dollars and Silver returned a jaw dropping un-leveraged 43% . These numbers even include the pull back we have experienced that started in May 2006. These investments (gold, and even more than that, silver) continue to rocket forward much to the delight of those who have achieved life-changing wealth thus far during this cycle.

So far we are not seeing anything that should permanently change this upward trend. We still appear to be in phase 2 of the 3 phases of this precious metals bull market. If you have not read our articles about The 3 Phases of a Bull Market we highly suggest you take a look.