With the price of silver having dropped by 29% over the past week, I can quit making predictions about a correction. It's here!
And like most corrections, this one has caught the majority of investors off guard. But let's not waste time debating how the drop started. Instead, we need to get a handle on how long the correction could last … and how low silver prices could go.
To do so, I'm convinced that we need to focus on three key factors – past silver selloffs, technical patterns and the U.S. dollar. So let's get to it …
If You're Holding Silver, History Isn't on Your Side
U.S. Founding Father, Patrick Henry, once said, "I know no way of judging the future but by the past." And we'd be foolish not to examine past corrections for guidance on what the future might hold for silver prices.
Thankfully, the number-crunchers at Bespoke Investment Group have done the heavy lifting for us. They've found 10 other times when silver prices corrected by at least 15% in three days.
The good news? In the week immediately following the corrections, prices stabilized, rising by an average of 1%.
The bad news? Prices quickly resumed their descent, averaging declines over the next one-month (-3.1%), three months (-7.0%) and six months (-10.5%).
In short, history suggests that silver prices could experience a short-term bounce this week, followed by months of declines.
Of course, those are just the averages. If we examine the individual corrections, we find declines of as much as 30% after six months. Such a severe correction this time around would entail silver prices dropping another 25% to about $26 per ounce.
I'm sure that's not the news you want to here if you failed to close out your silver positions before last week. And I wish I could tell you the technical analysis paints a rosier outlook. But alas, it doesn't.
Charting Silver's Next Move
I don't often talk about technical trading patterns because it's not my specialty. But that doesn't mean we should ignore them.
That's because many other investors swear by technical analysis, which thereby influences market prices. Plus, there's no denying that technical analysis is useful in determining key psychological levels of support and resistance for any asset.
When it comes to silver, technical analysis firm, Peak Theories Research, agrees that silver could experience a short-term pop.
"I wouldn't be surprised in the least to see silver bounce nicely off of its Friday close and even take out a critical level of resistance around $37 per ounce," says founder Abigail Doolittle.
However, she also says the move could be short-lived: "There's an excellent chance that such a bounce will be brief and volatile." Recall, the historical analysis from Bespoke Investment Group suggested the same thing.
The key support level to keep an eye on, based on Doolittle's analysis, is $33.18 per ounce. If silver prices breach that level, look out below, because the next support level sits at $26.95 per ounce, followed by a more ominous level that Doolittle "won't even mention."
Add it all up, and my prediction last week that the price of silver could drop as low as $30 per ounce looks too rosy. Based on history and technical analysis, a fall to $26 to $27 per ounce is more likely.
Whether or not prices actually drop that far, though, could have nothing to do with silver at all. Here's why…
It's All About the Almighty Dollar
Since commodities are priced in dollars, it's impossible to ignore the fact that fluctuations in the value of the U.S. dollar are also driving silver prices. Put simply, as the dollar declines, it automatically drives silver prices higher. And vice-versa.
Take a look at the chart of the U.S. Dollar Index versus the Reuters/Jefferies CRB Commodity Index and you can see this relationship in action. As the dollar started its decline late last May, sure enough, the basket of 19 commodities represented in the CRB index began to rally. Coincidence? Hardly.
The dollar is universally despised at the moment. Heck, you could probably recite the reasons why in your sleep: Ballooning government debt, endless Federal Reserve money printing, slow economic growth and the specter of much higher inflation are the most cited factors.
But to quote famous contrarian Humphrey Neill, "When everyone thinks alike, everyone is likely to be wrong." And guess what? At the end of last week the world's most despised currency jumped almost 3%.
That move obviously isn't enough to declare that the dollar is on the mend. But with debt problems in the eurozone returning to the fore (case in point: Greek government officials needed to squash rumors of the country's withdrawal from the euro over the weekend), the stage could be set for the dollar to extend its gains.
Call me crazy for even suggesting such an occurrence, but I'm not alone. Peak Theories Research also pegs a dollar rally as a possibility. As Doolittle says, "I expect a strengthening of the U.S. Dollar index to the mid-80s by later this year."
Like me, she's been talking about the possibility of a dollar rebound since the end of the last year. And quite frankly, whether you agree with us is irrelevant. All that matters is that you realize this: Silver prices dropped 29% in an instant, shaking out scores of speculators. And that opens up the door for U.S. dollar action to be the primary driver of silver prices in the near-term.
Bottom line: Based on history, the charts and the U.S. dollar, silver could lose even more luster in the weeks and months ahead. So again, proceed with caution.