Silver: Do You Think It Is Breaking Out?

Includes: AGQ, SLV
by: Avi Gilburt

Last week, I suggested that we can see a move up to as high as the 31.60 region again, which would be an ideal shorting opportunity. While the market did top exactly at that level and turned down, it did come back up to stop us out of that short trade.

But, there is something I want to point out about a trade that was not deemed to be a "success" in some people's eyes. Note that the market did turn down right at our target to the penny. This is the power of Fibonacci turn points in all markets. While the market may not change direction to the extent we always expect, the market will almost always respect those levels, if calculated properly, and provide some form of reaction, as we saw this past week. And, it is setting up trades in these regions that will allow you to not even have a loss if your entries and stops are set up properly.

So, when the market did not drop as we had wanted to see from the 31.60 level, and when we saw that the pattern was not extending down appropriately, we identified a higher target based upon Fibonacci extensions, and many stopped out of the current short trade to re-strike the trade higher. But, before you think this is some foolish game we are playing in attempting to short something as volatile as silver, please remember that our long-term money is now 75% deployed in long-term positions in silver, and this is simply a very short-term trade. However, it does seem as though we are now in pretty good company, as many of the commercial traders have joined us in this short trade, based upon the most recent COT data.

The higher region we calculated in our Trading Room was the 32.10 region in the futures. The market came right up to that level, spiked through it by 4 cents, and immediately turned back down. Once again, the power of Fibonacci extensions to identify turning points based upon patterns of sentiment in the markets. But, we still do not have confirmation that the futures are going to appreciably head down just yet, so our stops in the futures are now set at break even, which we are able to do simply because of a good entry.

Fundamental Perspective: Sentiment Controls Metals Market

Throughout the last year and a half that I have been writing for Seeking Alpha, those who have consistently read my articles know that my perspective has been that the fundamental driver of market prices in the metals is investor sentiment, and not any exogenous market event or factor.

While I have clearly not been 100% in all my market calls, I believe that, if you read my market calls with an honest perspective, you will hopefully recognize that my correct market calls are at quite a high percentage, especially when you consider the exacting nature with which I make such calls. In fact, almost all my market calls specify much more than a directional bias, and there are very few other authors who will provide targets that are exact as the ones I provide. This clearly has opened me up to significant scrutiny, which I have always welcomed, as long as such scrutiny is voiced in a respectful and reasonably intelligent manner.

But, nonetheless, I hope you recognize that the market turns at the levels I site a very high percentage of the time. Otherwise, my critics would simply be posting comments that I am wrong all the time and no one should be even considering my advice. In truth, if the methodology that I used did not provide highly accurate results a great majority of the time, I would be the first to abandon such a methodology, in search of something that provided better results. But, to date, I have found none better or more consistently accurate.

But, many of you have such strong disbelief in the ability of this methodology that you have commented that the use of pattern identification or the mathematical tracking of investor sentiment is akin to "voodoo," "witchcraft" or the use of a "Ouija board." Yet, none of those critics have come out and said that my methodology has provided consistently wrong results. Since they do not understand it, they simply attempt to call it a "name," which is typical of frailty of the human ego. Others, who have recognized the accuracy in a great majority of the very specific predictions, have taken the perspective that it is simply "luck," which then potentially makes me one of the luckiest people on the face of the earth. But, I can assure you that my life, of late, has been quite difficult, so I will be the last one to view myself as simply "lucky."

So, please allow me to digress and explain what it is about Fibonacci mathematics that makes it such a powerful force in our financial markets in being able to track the primary driver of silver prices - human decision making and sentiment. I am hoping that you will then gain a better understanding as to why I feel sentiment is the driving factor behind price and directional movements in markets, and why it is so important to have an understanding of this perspective if you want to be a successful trader or investor.

Fibonacci Mathematics: The Key To Tracking Sentiment

After the fall of the Roman Empire in 476 C.E., much of European advancement in mathematics and philosophy was either lost or simply remained stagnant. Although there is a difference of opinion among historians regarding the classification of the period after the fall of the Roman Empire, this period became commonly known as the Dark Ages. Among recent historians, the Dark Ages lasted until around the 10th century.

Around 1170 C.E., Leonardo Pisano Bigollo, or more commonly known as Leonardo Fibonacci, was born to Gugliemo Bonnacci, a wealthy Italian business man. To give you some reference during which times Fibonacci lived, the Leaning Tower of Pisa was being constructed at the time.

While Leonardo was still quite young, Gugliemo was appointed as an official at a port east of Algiers in North Africa. It was not long until Leonardo was traveling with his father through the Mediterranean. It was during this period of time that Leonardo learned about the Hindu-Arabic numeral system, and recognized that these numerals were simpler and more efficient than the Roman numerals being used in Europe at the time.

It was not long thereafter that he published his famous book Liber Abacci (Book of Calculation). This book was a key turning point in European mathematics, as it introduced the European community to one of the greatest mathematical discoveries of all time, namely, the decimal system, in addition to the numeric system which we still use to this day. This was considered to be the most important advancement in mathematics since the start of the Dark Ages.

Also included in his major work Liber Abacci, Fibonacci worked through a mathematical problem which led him to the discovery of what we call today the Fibonacci sequence, which is based upon Phi, or the Golden Ratio. 1, 1, 2, 3, 5, 8, 13, 21, 34, 55, 89, 144, 233, etc.

Within this sequence, each higher number is the sum of the prior two numbers, and the ratio of any two consecutive numbers approximates 1.618 or its inverse, .618. The higher you move through the sequence, the closer you move towards the 1.618/.618 relationship. This .618 number has been referred to as the "Golden Mean" throughout history. We also refer to this number as Phi.

Phi is a number which exhibits many unusual mathematical properties, and is also the solution to a quadratic equation. These concepts have been understood by Plato, Pythagoras, Bernoulli, Da Vinci and Newton. Historic structures have been built by architects of famous Greek structures, such as the Parthenon, based upon the concept of Phi, and even as far back as the architects of the Great Pyramid of Giza in Egypt, who recorded their knowledge of Phi as the building block for all man nearly 5,000 years ago.

What makes Phi even more unusual is that it can be derived in many ways and is exhibited in relationships throughout the universe, such as proportions within the human body, plants, DNA, the solar system, music, population growth, and the stock market. Phi is the one underlying constant throughout all of nature and governs all the laws within nature. In fact, the greatest minds of history, such as Pythagoras, Plato, and Kepler, all felt that Phi was the key to the secrets of the universe.

As an example of how Phi is the building block within the human body, in the 1960's, Drs. E.R. Weibel and D.M. Gomez dissected the architecture of the human lung and discovered a Fibonacci relationship in the formation within the bronchial tree. Others have discovered that the diameter of the bronchial tubes decreases in Fibonacci proportion. Another example is when Eugene Stanley of Boston University, along with researchers from MIT and Harvard discovered that the physiology of neurons in the central nervous system also exhibit Fibonacci relationships.

Further examples include the fact that the naval in the human body divides the average adult body into Fibonacci proportions, the neck divides the distance from the naval to the head into a Fibonacci proportion, the heart muscles in the left ventricle are made up of a series of spirals that repeatedly contract to a point that is approximately .618 of the long axes from the aortic valve to the apex, and so on. In fact, Leonardo Da Vinci depicted the general external Fibonacci relationships within the body of man in one of his most popular drawings entitled "Vitruvian Man."

In recent times, we have seen evidence that Phi even governs man's decision making. Social experiments have been conducted which resulted in price patterns, based upon a mathematical standard, that mirror those found in the stock market. In 1997, the Europhysics Letters published a study conducted by Caldarelli, Marsili and Zhang, in which subjects simulated trading currencies, however, there were no exogenous factors that were involved in potentially affecting the trading pattern. Their specific goal was to observe financial market psychology "in the absence of external factors."

One of the noted findings was that the trading behavior of the participants was "very similar to that observed in the real economy," wherein the price distributions were based on Phi.

In a different study conducted by psychologist Vladimir Lefebvre of the School of Social Sciences at the University of California, Dr. Lefebvre came to the conclusion that "We may suppose that in a human being, there is a special algorithm for working with codes independent of particular objects." Specifically, when his subjects were asked to sort indistinguishable objects into two piles, their decision making within that process divided the objects into a 62/38 ratio. In other words, these individuals exhibited a Fibonacci tendency in their personal decision making.

Therefore, there is significant evidence that behavior and decision making within a herd and on an individual basis displays mathematically driven distributions based on Phi . This basically means that mass decision making will move forward and move backward based upon mathematical relationships within their movements. This is the same mathematical basis with which nature is governed. The same laws that were set in place for nature also govern man's decision making en masse, and on an individual basis.

From a technical market based analysis, in addition to the Caldarelli, et al. study cited above, there are many indications of how Phi governs stock market movements. As an example, until the times of R.N. Elliott, the world applied the Newtonian laws of physics as the analysis tool for the stock markets. Basically, these laws provide that movement in the universe is caused by outside forces. Newton formulated these laws of external causality into his three laws of motion: 1 - a body at rest remains at rest unless acted upon by an external force; 2 - a body in motion remains in motion in a straight line unless acted upon by an external force; and 3 - for every action, there is an equal and opposite reaction.

However, as Einstein stated: "During the second half of the nineteenth century new and revolutionary ideas were introduced into physics; they opened the way to a new philosophical view, differing from the mechanical one."

Yet, even though physics had moved away from the Newtonian viewpoint, financial market analysis had not. In the late 1930's, Ralph Nelson Elliott introduced the idea that the financial markets expand and contract in a series of waves which are governed by Phi. In theory, he proffered that public sentiment and mass psychology is what moves market within 5 waves in a primary trend, and 3 waves in a counter-trend. Once a 5 wave move in public sentiment has completed, then it is time for the subconscious sentiment of the public to shift in the opposite direction, which is simply a natural cause of events in the human psyche, and not the operative effect from some form of "news."

"Many services and financial commentators in newspapers persist in discussing current events as causes of advances and declines. They have available the daily news and market behavior. It is therefore a simple matter to fit one to the other. When news is absent and the market fluctuates, they say its behavior is "technical."

Every now and then, some important event occurs. If London declines and New York advances, or vice versa, the commentators are befuddled. Mr. Bernard Baruch recently said that prosperity will be with us for several years "regardless of what is done or not done." Think that over.

In the dark ages, the world was supposed to be flat. We persist in perpetuating similar delusions."

R. N. Elliott, Natures Law, 1946

To really understand Elliott, you would understand that this discovery itself was based in Phi, as 5 and 3 are, in fact, Fibonacci numbers upon which Elliott identified the market movements in his ground breaking discovery.

Even those market technicians that do not utilize Elliott Wave analysis recognize how most retracements and extensions within the financial markets adhere almost perfectly to Phi. Ultimately, any honest, dedicated market observer cannot deny the prevalence of Phi within our financial markets. Since Phi is the one underlying constant throughout all of nature and governs all the laws within nature, then that which created nature and instilled the laws within nature must, perforce, govern our financial markets.

Will I Still Attempt To Short Silver?

So, moving back into silver, is the market telling us that there are no more short trades to be had in silver?

Last week, I said that "until silver can move beyond the 31.60 level on strong buying volume, lower levels were still to be expected." So, even though silver has moved beyond the 31.60 level, and stopped many out of that prior trade at break even, it has not moved up on the level of heavy buying volume which historically accompanies a break out YET.

For this reason, along with other Elliott Wave and technical reasons, I do not think we have a confirmed break out in silver just yet, and it is still quite likely we can see my lower targets. I also want to point out that there is one more higher region of multiple confluence between the 32.25-32.40 region which can also provide a topping point. But, if silver were to move through the 32.65 level on strong buying volume, I would likely no longer attempt to set up a short trade, and simply stand back and watch how the pattern progresses to determine where I add my remaining 25% position for the expected rally over $60.

There are those that I am sure are thinking to themselves "why does he not just put in all the money now into silver?" Well, that is the same perspective that has kept people long in silver since the $50 region. My perspective as an investor and trader is to always be focused upon price improvement. It amazes me the extent to which people invest their time in finding the best price they can possibly find when it comes to their purchases of cars or electronics, but they do not put the same effort into doing so for their investments.

So, while many have maintained their long positions in silver since the top at $50, I not only sold up in that region, but I also have successfully shorted numerous times since that top (many of which were called for on this site), and have even gone long numerous times since that top. It was not until the prior nine months that I suggested that people start accumulating longer term positions again in the mid to high 20 region, and leave some money available in case we did reach targets in the low 20 region.

So, as I said last week:

My lower targets still remain valid - 28.67, 27.98, or as deep as 26.87. So, to answer the question in the heading of this article, yes, I am shorting silver in the very near term as a short-term trade.

But, I am not a foolish trader, as I still maintain a sizeable long-term long position in the event the parabolic rise begins sooner than I currently expect, as I am expecting a significant low to be put in in the near term. I recognize my fallibility as a human being, and understand the larger trend, for which I am prepared.

But, even if silver does not move in the direction I expect every now and then, I will not be playing the blame game and will simply recognize that I am wrong on approximately 20-30% of my silver trades and it is no one else's fault but mine, and it is not anyone else that is "manipulating" me out of my money.

I look forward to meeting many of you at the New York Traders Expo on Tues Feb 19, 2013 at 1:00-1:30 pm ET at the Marriott Marquis Hotel, where I will be speaking about Elliott Wave and Fibonacci Pinball. I will be meeting with attendee’s right after the presentation in a Q&A gathering at the hotel.

Disclosure: I am long SLV. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: I have shorter term put position in SLV as well as a much longer term call position.