Silver And The Australian Dollar: Follow-Up To The Trade That Is Up 35% In 2 Months

| About: iShares Silver (SLV)

Silver is one of the best assets for trading purposes. The factors that affect its price are simple. The asset moves mostly on market sentiment. I have been very successful in predicting the turns made by silver's price in my articles about silver (iShares Silver Trust ETF: SLV). In my latest article about silver (How I Got-It Exactly Right On Silver And My Next Trade For It) on May 16, 2012, my main argument for silver was that the price likely would be oversold around $26 (for the ETF) and that would prove to be a short-term bottom.

However, I suggested the better trade to make was to go long the Australian dollar (CurrencyShares Australian Dollar Trust ETF: FXA) as the risk/reward ratio was better and the two assets moved on similar underlying factors. Here are the excerpts from that initial article based on the conditions as of the writing of that article. I should note that both the arguments that there would be a short-term rally in silver and then it should be shorted from the high of $28,4, and the argument that Australian dollar is a better long trade than silver have turned out to be very accurate.

I would argue that SLV has become oversold, along with many other assets, and investors should be disciplined with realizing their profits on the short trade. There is no reason to get carried away with the possibility that SLV might go down even further... There is certainly a good chance that SLV will take out $26 to the downside in the summer of 2012. However, the chances are, with many assets at extremely oversold levels, there is bound to be a short term rally. Based on the expectation of that short-term rally I would suggest closing the SLV short and waiting for it to rally back to at least the $28,7 level to initiate another short position.

For investors open to trading other assets similar to SLV, I would suggest going long the Australian dollar (FXA). As of this writing, it has a better risk/return tradeoff than SLV. AUD moves almost on the exact same fundamentals as SLV does, so it is a very similar trade. I expect the AUD to appreciate to the 1,03 level which is approximately a 3.7% increase. The main determinant of profit in FX trades is adjusting the leverage, however, and acceptable leverage levels for FX trades like this are higher. I would suggest using approximately a 10X leverage. That would give about a 37% profit for the investors.

In this article, I want to give my suggestion about whether Australian dollar trade should be kept longer or any adjustments are necessary due to the changes in market conditions since the publishing of the initial article.

In my opinion, the Australian dollar will increase at least to the 1,06 level along with market sentiment until mid-August of 2012. However compared to holding a long position in silver, the Australian dollar has lost its advantage in risk/reward ratio. Actually, I would argue that silver has the upper hand as a long trade compared to the Australian dollar because silver has established a very strong bottom in $26.

My trading suggestion is the following:

The initial FX trade is up about 35% (based on 10X leverage as suggested). So investors can liquidate 55% of that position and realize profits of 19.2%. Then, my suggestion would be to take that profit and get long the July 20, 2012, $28 Strike silver call options. In such a trade, investors have very limited downside risk, as the capital at risk with the option trade is entirely from a realized gain on a previous position. The trade also decreases the leverage on the FX position, so the risk of losses on that trade is also decreased.

I will try to write a follow-up article to this trade as the silver call option stated above is close to expiration. Investors who find my trading suggestions and analysis of good quality can use the "Follow" feature of SA to get that follow-up article.

Disclosure: I am long SLV, FXA.