Silver Rallying on Questionable Rumors

April 8, 2004

I’m a long-term precious metals bull, but the recent action of silver has been bothering me. I don’t like it when stocks trade on rumors—this company’s going to be taken over, that one’s going to miss its numbers— so why should my approach to precious metals be any different? With stocks, this sort of thing usually causes people to make dumb trades and it’s my impression the same thing has occurred recently in the silver market, as rumors of a shortage of deliverable silver have been behind the metal’s recent spurt.

Wanting to get a feel for the credibility of these rumors, I spoke last night with the traders at the Perth Mint in Australia, with whom we have a particularly close relationship. Their answer? “If you hear of anyone that’s having a hard time getting their hands on physical silver, tell them to call us; we have plenty to spare.” These traders were well aware of the rumors and that silver had become the “flavor of the month,” but they considered those rumors silly.

Again, let me state for the record: I believe that precious metals are early in what will be a prolonged bull market. However, along the way there will almost certainly be false starts as well as false pullbacks. So, how can one determine whether the experts in Perth truly have their fingers on the pulse of this metal? Personally, I look at charts, and it’s my ongoing opinion that we’re going to see a continued consolidation of a number of related trends.

For starters, take a look at a long-term chart of the U.S. Dollar index:

It’s plain to see that as this index approaches 80, it gets into an area of heavy technical support, a level where it spent 6 years basing in the early 1990’s! Now, perhaps this support will fall without a fight; I just don’t ever expect things to be that easy in the market.

At the same time, look at the rallies the following foreign currencies have seen:

As a course of business, we buy holdings directly in these foreign markets everyday and we’re bullish on the long-term prospects of the currencies and markets represented above, but a realistic look at these charts says, at the very least, that the pace of this trend isn’t sustainable—a continued pause is in order. Indeed, it would be healthy.

Likewise, how sustainable is the following trend?:

I’ll admit that this spurt might carry silver a bit higher in the short run, but I suspect that the magnitude of silver’s correction of this rally, when it does occur, will likely surprise a lot of recent buyers of the metal.

I just don’t like it when anything in the market gets so easy. I mean, you can see it happening: Chuck Butler’s Daily Pfennig commentary, for example, has become just a little too popular… his readers will have to tire of hearing his daily promise of a dollar breakdown and ultimately stop reading his essays before he’ll be proven right. And while subscribers to various currency options newsletters made a ton of money last year, I can tell you, because some of them trade through our firm, that these investors don’t realize they and their newsletter authors aren’t market geniuses, they were just on the right side of a powerful trend. I’ve had the conversation with a few of them myself: ‘be careful, take your profits, it’s time for these currencies to pause,’ etc. Unfortunately, the majority of those folks have already ignored such warnings and seen their former profits shrink… if my experience with options traders is any guide, they’ll probably make it a full round trip and lose every dime they thought they made in those contracts before they believe such comments. That is when the dollar will resume its downtrend and metals will embark on another sustainable rally.

After writing a piece like this, I feel compelled to state yet again: the U.S. Dollar is indeed in big trouble. Because approximately two-thirds of our entire national debt matures in three years or less and because consumers/homeowners are so highly leveraged, the policy course for the Federal Reserve is clear: it must keep rates down and pray that a lasting recovery results, which it will not. That being said, however, the decline of the dollar will take time to play out, which doesn’t bode well for the sustainability of silver’s recent move.

Think of it this way: we’re early in a bear market for U.S. stocks that began more than 4 years ago, but the in the last year we have witnessed a surprisingly powerful counter-rally. Likewise, the dollar might be due for a surprise.

Also, let’s admit it: there are a lot of precious metals perma-bulls out there, people who come into their offices every day expecting to find the dollar at zero and the end of civilization at hand; these people have been recommending gold and silver for years, regardless of market conditions. They’re the type who would fuel such a rumor and there are plenty of speculators that haven’t minded seeing this idea catch fire, either. In my opinion, however, it’s just crummy trading to chase such rumors; a number of converging chart trends suggest we’re not going to see precious metals going to the moon on the back of a U.S. Dollar wipe-out just yet.

The charts, then, make me believe that Perth does have it right: don’t chase silver at present.

Chip Hanlon
C.O.O./Chief Domestic Strategist
Euro Pacific Capital, Inc.