We would like to begin this essay by touching on the popular belief that precious metals - and especially silver - tend to drop heavily this time of the year. The saying suggests selling in May and going away - is this really the best way to go? At Sunshine Profits we're rather reluctant to take the common knowledge for granted - we prefer to dig deeper and check ourselves if every fact is really fact, not just an opinion.
So, while the "sell in May and go away" phrase does appear close to being true, we would still prefer to provide you with details before making final calls. This week, we will provide you with two seasonal silver charts, as the white metal is known for is seasonal tendency to decline in May. Let's begin with the May chart, and then we will move to the June one.
If you are not familiar with the way of reading these charts - you will find a quick reminder below.
While the idea of seasonality is nothing new - for instance, most investors are aware of the summer doldrums pattern, which means that virtually all markets tend to trade sideways in the middle of the year, we are taking it to the whole new level not only by focusing on the precious metals sector itself, but also by taking a very detailed approach allowing for the seasonal patterns to be used also in short-term trades. Additionally, we are measuring the quality of projections made using this tool. As you will soon see, there are times when these patterns are really reliable and there are times when they are to be approached with caution.
The way the below chart "works" is this - we've checked silver's performance in each May/June from 2002 to 2009 and extrapolated silver's average performance to where it was at the beginning the month. If that history is to repeat itself then perhaps the average performance of silver in May provides us with a "road map" to where it is likely to go during the whole month. Of course gold does not move in the same way each year at the same day, but at times these tendencies could provide a valuable confirmation or (which is even more important) non-confirmation.
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Surprising, isn't it? Based on the way silver performed in each May from 2002 to 2009, we see that silver has used to move over $1 higher during May with the top being right at the end of the month. Yes, there is also a tendency for the white metal to move lower in the middle of the month, but it tends to rise once again in around the third week of the month or so. Then, the local top is formed around the end of the month.
So, does the above chart say that silver will go above $20.60 at the end of the month? No. No promises here, of course, but it does say that this is what used to happen on average so the "more average" this May is, the more reliable the above "roadmap" gets.
Taking a look at the green slope (quality of projection), it tells us that silver being 80 cents above the May 1st level is more certain at about May 27th, than it is at May 13th - the quality of projection is slightly higher in the former case.
Therefore, although it may seem like a no-brainer to dump one's silver holdings right now, seasonal tendencies don't scream "sell" at this point yet, as silver tends to rise during the whole month of May. In other words, while we may move slightly lower from here, seasonal tendencies suggest that PMs are going to be higher in about two weeks than they are at this moment.
The situation in June is quite different... (Click to enlarge)
While the second half of June is nothing to call home about, the first two weeks tend to wipe out May's gains. While silver used to rise about $1 in May or so, it also used to decline about the same amount in June. Please note that we used Thursday's close as the beginning price for June. The goal was to put percentage moves into proper perspective, not to tell you that we expect to see silver at that price on June 1st.
The first 10-15 days of June are most likely to provide us with lower silver prices - still, the white metal didn't use to plunge before the end of May.
Summing up, silver - and also the rest of the PM sector - is not likely to plunge severely now - odds favor a decline in a week or two. Still, the main point here is that the "sell in May and go away" is slightly inaccurate, as the top is usually formed right at the end of the month. If one took this advice to the letter and sold in early May each time during the past 7 years, one would on average miss out on a $1 rally each year in silver. Therefore, let's keep in mind that there's much more to the analysis of the seasonal tendencies than just suggesting to "sell in May and go away."
Now, let's take a look at how we could translate the above analysis to the current situation. As you may know, this is just a small version of the whole analysis, so we will not cover everything here - instead, we will focus on PM stocks. Let's begin with the long-term HUI Index chart (charts courtesy of StockCharts)
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With respect to the mining stocks, last week we mentioned that the HUI was ready to move above its resistance level. As we know now, this finally happened for the first time since its February bottom. The strength of this move and the resulting momentum are significant. We may, in fact, see the whole PM market move higher. The RSI, slightly above 70 suggests that we are close to a local top but not necessarily at one.
What we see in our analysis of the charts leads us to believe the local top will be at or near the 2009 high. This reasoning is based on the fact that this level proved to be a very strong resistance level during both 2008 and 2009 highs.
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Turning to the short term GDX ETF chart, we can analyze volume, which recently has seemed to be on the low side along with lower values of the ETF. This is normal during small pullbacks - not a signal of coming decline. So, we are bullish at this time to see a small move upwards.
Still, mining stocks do not show as great a potential as silver and gold at this time. In the Wednesday's Market Alert we wrote the following:
Given the strength of the momentum (confirmed by volume) it seems that PM stocks may need to slow down before the local top (also in gold) is reached. This is what we usually see before the top is in, and we didn't see it so far.
One other fact, which we wish to make note of here, is that the bottom, which we forecasted, took place exactly as stated (marked with the blue ellipse on the chart).
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For a final chart in this essay, the GDX/SPY ratio often forms tops and bottoms along with PMs and PM stocks. Therefore, what's bearish for the ratio is partly bearish for the whole PM market. As we have mentioned in the previous updates, tops are often accompanied by a huge volume, and they take place when the RSI is right at the 70 level.
The latter has been the place recently, so the question is if the volume has been high or not. We have marked it on the chart with a big red arrow as it is visible on a relative basis, but if we take into account the volume that we've seen from November 2009 to mid-April 2010, we see that the very recent volume is quite normal.
Comparing the current situation to what we've seen in November 2009 (final stage of the rally), it seems that perhaps we might need to see more significant spike in volume before we can state that the top has been confirmed.
Summing up, we are presently less bullish on PM stocks than on PMs, and we believe that they are not going to perform as well in the final stage of the rally, which by itself will serve as a confirmation that it is - in fact - the end of the rally.
Disclosure: No positions
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This essay is based on the Premium Update posted on May 14th, 2010