Friday, September 4, 2009

Silver/gold cleared for take-off

There was a powerful rally in precious metals this week, with silver up close to 10% and gold up 4%. To my eye, this rally looks like the start of a much larger move. As I remarked on Tuesday, there was an unusual divergence in the first couple of days with the gold equity index (HUI) falling while silver was rising. The vast majority of the time HUI leads the markets, but in this case HUI wound up following precious metals higher - rallying 10% on Wednesday, 5% yesterday, and 1% today. So the divergence was resolved in a bullish manner, with the HUI now leading the market higher.
Gold has traded up to $1000 3 or 4 times now, so it would be very unusual to not see a significant breakout above those levels after testing it for so long. The reasoning for this? There are only so many sellers and so many ounces that are up for sale in the $950 to $1000 range. Since the market has traded into that range a number of times, there are less ounces up for sale than if this was the first or second time we traded to $1000.
From my sample size of intelligent traders and associates, the majority are not bullish precious metals right now. My sample size is small, but I would say that roughly 1/3 are bullish, 1/3 are neutral, and 1/3 think gold and silver will trade to much lower levels. What is remarkable is that most people in my sample are normally quite bullish on gold. I have a friend who was long silver for years and has sold the majority of his physical over the past 6 months. Every retail gold/silver shop I've been to in the past couple of weeks has been bulging at the seams with bullion, and seemed to be short cash. Perhaps gold bugs have been exhausted by precious metal prices advancing less (or falling more in the case of silver) than was expected. I think there may be a subconscious feeling that if precious metals didn't perform in the past twelve months, then under what circumstances could they possibly perform? Also, the majority of intelligent market watchers are now convinced that deflation is the likely outcome and inflation is almost impossible given the capacity utilization levels. So a lot of people are on the sidelines right now.
The most convincing breakouts are (ironically) the ones with the fewest people already "on board." This makes technical sense because it means there is a lot of sidelined money that can change its mind. Neutral money in particular can easily switch to bullish, and I think that a significant break of $1000 in gold would bring in a lot of neutral money.
As this week's action proved, you don't need the dollar to fall to get a big rally in precious metals. But a falling dollar would probably contribute to a rally. I've been pretty well convinced by friends and associates that the dollar will rally in a second wave of deflationary recession, but the technical appearance of the chart points in the other direction. Rallies above 79 have been rejected last week and this week. We broke an important support at 78 several weeks ago, so there isn't much to support the dollar if it starts to fall.
The bottom line is this: there was an impulsive move up this week (I define "impulsive" as a trend move on high volume and a low degree of variance from the trend) in precious metals. Silver led the way higher, and HUI and silver are both rallying more in percentage terms than gold. Sentiment is at a level that is consistent with a breakout as well.

The next steps to watch for in a breakout would be:
1)Gold takes out its March 2008 highs (70%)
2)The dollar falls to 75 (65%)
3)HUI and silver take out their highs from March 2008 (50%)

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