How far will silver and gold fall?

published 12 May 2011

I keep saying silver is not for the faint hearted. But even by silver's standards this past fortnight has been breathtaking.

The rally from $8 to near $50 has taken some 30 months. In just five trading days, as silver slid from $50 to $33, 40% of that rally was given back. It was the biggest weekly fall in silver since 1975.

Three days later, silver was up another 20% back near $39. Yesterday it was selling off again in a similarly dramatic fashion.

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Talk about a white-knuckle ride.

They say the bull does everything he can to throw you off. But this one has an excess of testosterone or adrenaline or whatever it is that bulls have.

What drove the fall in silver?

Much of silver's fall has been blamed on the fact that the owners of the Comex (Chicago Futures Exchange), CME, announced that the margin requirement on silver was to rise by 84%. In other words, if you were betting with borrowed money, you had to put a bigger deposit down.

This will no doubt have caused any leveraged traders to make a move towards the exit. This move quickly became a rush, which became a stampede. In total, five margin hikes were made in nine days.

Regular readers will know that I don't have a lot of time for the various rumours you hear that suggest the silver market is manipulated. Not because I think they're false I don't know but because there's not a lot I can do about it, except shout.

In general terms, the problems I have with such theories for example, that there is a deliberate plan by governments to suppress the price of gold and silver is that they imbue the perpetrators with too much competence. Competence and government are, as far as I'm concerned, two words that rarely, if ever, meet unless there is a large not' somewhere around.

Was the decision by Gordon Brown, for example, to sell our gold at the bottom of the market a deliberate scheme to suppress the gold price? Or was it simply idiotic?

But the fact that this announcement came just as silver was closing in on that hugely significant (from a technical point of view, at least) 1980 high of $50, is almost too coincidental. It's as though someone wanted the price to fall.

Fortunately, if any such shenanigans are going on, we won't have to endure them or the rumours for much longer. On 18 May, the Hong Kong Mercantile Exchange (HKMEx) will make its trading debut with a one-kilo gold futures contract (roughly 32 troy ounces), offered in US dollars with physical delivery in Hong Kong. If this is successful and I'm sure it will be, the Chinese will be all over it it won't be long before we see a HKMEx silver futures contract.

If there really are dark forces at work on the Comex, business will quickly move to the HKMEx, particularly our Asian pro-precious metals fraternity, rendering the former as obsolete as the infamous London Gold Pool of the 1960s.

It makes sense that silver peaked at $50

But to be fair, if we are honest with ourselves, we must accept that silver had gone parabolic, that $50 was an obvious place for the party to end, and that parabolic charts rarely end well. What's more the correction has come at a time of year when precious metals are weak.

Wearing my trader's hat for a moment, I would say this correction isn't over. Corrections usually come in three waves. We've had the initial drop from $50 to $33. We'll call that wave A.

With silver, typically, these waves last between three and six days. (This is based on the evidence of the major silver sell-offs of 2008, 2006, 2004, 1993, 1987, 1980, 1979 and 1974.) And typically they give back between 30% and 45% of the previous rally.

So, thus far, silver is behaving according to the script.

The rally to $39 may have been the dead cat bounce, which we'll call wave B. But it does seem to have unfolded a little quickly. Typically with silver, the dead cat bounce will end 15 to 20 trading days after the initial high (the intra-day high was 25 April; the closing high 28 April), although in May 2006 it was just 12 days.

If Monday was the end of the dead cat bounce, it has only come eight (or 11, if you count the high as 25 April) days after the high.

As I write this, silver is starting to sell off once again. It's back at $35. So it does seem that we are now into wave C, which will take us to our final low.

Typically the final low is made between 22 and 33 days after the high, which would suggest the second or third week of June as a target. But perhaps it will come sooner, given the speed with which this market is moving.

The most bullish case is that the eventual low does not exceed the low of the first sell-off. In other words that $33 holds. But I'd suggest a more likely scenario is that we go back to somewhere in the $20s, maybe even as low as $22.

I went to a dinner last night where a number of fund managers each gave a two-minute presentation on where they think markets are headed. The sentiment is generally a little on the bearish side, but a number of speakers were suggesting we are making a major top here in both commodities and stocks. If they're right, and we're in for another deflationary wave, just as Bernanke and others end their latest bout of quantitative easing (QE) in June, then silver may even fall further than $22.

But I doubt it. If markets fall, policy-makers will print. That is their strategy. And silver will benefit.

But there are so many people that will have been hurt by all this volatility that I suspect it will be some while before the market falls in love with silver once again.

Where is gold heading next?

Meanwhile, I'll be looking at gold and the 144-day moving average, which shows the average price of gold over the last 144 days, as it's likely gold and silver will make their lows simultaneously. The 144-day moving average has been catching the lows beautifully since the bust of 2008, as this next chart shows. (Read: Gold will hit $1,650 before the end of the year to see how beautifully it worked in January) That average currently stands just above $1,400 and rising.

Will it work this time? We shall see.

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