Gold And Silver: What Support, Resistance, And Corporate Hedging Tells Us

Includes: IAU, SLV
by: Epsilon

Gold and silver appear to be making their long-awaited comeback from their Q4 2011 fall. But do they have enough left in the tank to continue toward, and possibly surpass, their respective all-time highs? Let's take a look.

Many believe that the price of gold and silver increases, historically. These charts, from, show this seemingly obvious long-term uptrend on a 10-year time frame:

(click images to enlarge)

But as most savvy precious metals investors know, when adjusted for inflation, this picture looks much different. CPI-adjusted, gold's high is actually around $2300 per ounce and silver's is around $130 per ounce, which both occurred in 1980. In other words, buying gold and silver with the hope that their respective prices will continually rise until the end of time may not be the best strategy.

(There is much debate over the true accuracy of the CPI adjustment, and many believe that inflation-adjusted gold and silver highs are, in fact, closer to $7100 per ounce and $400 per ounce, respectively. But this debate is beyond the scope of this article and, therefore, we will trust the CPI-adjusted highs.)

Regardless, the recent performance of both of these metals has reinvigorated investors, and has left many wondering if this trend will continue. To answer that nagging question, let's look at each scenario separately.

A one-year look at gold shows us that the metal is trading at what has historically been, at least over the past year, a strong resistance level right around $1800.

Similarly, iShares Gold Trust (NYSEARCA:IAU), an ETF that tracks gold, is also experiencing what appears to be strong resistance.

Now let's look at silver. A one-year look at the metal illustrates a similar picture, with resistance occurring around the $35 level, very near its current trading price.

Also similarly, iShares Silver Trust (NYSEARCA:SLV), an ETF that tracks silver, appears to be consolidating at a price level it has been unable to fully break above, at least in the past year.

As you can see with both metals, the resistance levels shown have proven to be significant barriers for the metals and lead me to believe that both gold and silver will continue to consolidate near their current levels, and will then experience a short term downtrend.

But this conversation gets even more interesting (and convincing) when we look at gold and silver futures and their related trader activity.

Here is a look at gold futures and related trader activity:

The lines below the price chart represent three trader types and their trading activity (in contracts of 100 troy ounces). The green line, which we will focus on, shows us the activity of the pros -- the Commercial Hedgers, i.e. corporations that trade futures to control costs. After just a bit of study, it becomes easy to see that gold generally experiences a significant drop in price quickly after the green line reaches a relative low. In other words, according to the above information, when Commercial Hedgers begin leaving the party, the price of the metal falls shortly after.

The clearest evidence of this can be seen in the price movements of September of last year, and again in February of this year. And currently it seems that the green Commercial Hedgers line is, once again at a relative low, suggesting a coming fall in the price of gold.

Now, let's take a look at silver futures and its related trader activity:

This chart tells a very similar story as the gold futures chart and, in some ways, is clearer. Like gold, we see dips in the green line in September of last year and late February of this year. Following these dips, we see a significant fall in the price of silver shortly after. Also like gold, the green Commercial Hedgers line currently looks to be at a relative low, suggesting that a fall in the price of silver is just around the corner.

In summary, gold and silver may very well revisit their respective, inflation-adjusted highs. But that doesn't seem likely to happen any time soon and, in fact, what we are more likely to see, based on the evidence above, is a short-term fall back toward respective support. Of course, a continued climb for the metals is certainly possible, but it just doesn't seem probable.

If this fall in price for gold and silver does occur, relative support levels -- $1550 per ounce for gold and $27 per ounce for silver -- may offer a good entry/reentry points for precious metal investors in future months.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. 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.