Silver Trading Range Ready To Change

| About: iShares Silver (SLV)
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For over a year now, the silver ETF (NYSEARCA:SLV) price has basically traded between a range of $25 and $34. During this time period, the price has swung 30% peak to trough a couple of times. It also in one period went down consistently for almost four months. This has made it extremely difficult to be either an investor or a trader in silver during this time period. However, that began to change in mid-summer of this year when sentiment and prices were so low it was a huge opportunity for profit.

One of the reasons that I'm being aggressive again in the silver market, after exiting the market for over one year, is that my instinct tells me something is about to happen in the next two to three months in the silver market that will spark interest in the metal again. About one week ago, the price fell below the 50-day moving average of $31.80 on SLV and stabilized for a couple of days. The important level to watch is the 200-day moving average at about the $30.10 level. I wouldn't be surprised if it falls below the current $31 price and even go slightly below that level in order to frighten those longs, like myself, in silver. This will allow the large players who accumulated large short positions to scoop up contracts and cover with a nice profit.

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The main reason I'm now being aggressive again in silver is a fundamental but mostly technical one. When you look at the SLV chart, it is interesting to note that the one-year bear trend in silver from its May 2011 peak until mid-August 2011 has just recently been broken. Notice from this chart how the series of lower highs and lower lows has now been broken at around the $29.75 level, and the price then rallied to $34. The primary trend appears to have now reversed to a bull phase again and ended the punishing bear market.

This can help lead to a change in the overall sentiment of investors and traders in the metal. For those who aggressively short the metal, it has introduced the risk of significant losses again for the first time in over one year. More importantly, it could lead to a sustainable rally that then breaks out of the $25-$34 trading range it has been stuck in for the last year. If that happens to the upside, the price could go to $40.

My view is that this time, unlike the last few trading ranges back and forth in silver over the last year, the price will hold near the 200-day moving average instead of breaking below it and going lower. Then the silver market is going to begin another period where silver climbs back steadily up to the $34 level. I think this will be driven by a combination of supply and demand fundamentals and, more importantly, some world events coming together in the next few months that will lead to renewed interest in both gold and silver. If we see even more dramatic events in the world financial system, we might even be setting up to go through the $34 level and break out and move higher longer term. When that occurs, it will be a major change in the trading range of $25-$34 that silver has been so consistent with for the last 12 months.

There currently is a divergence in the price of physical silver and the silver mining stocks. When you look at the chart of the silver miners ETF (NYSEARCA:SIL) vs. the physical silver ETF, the silver miners are staying relatively flat as the physical has corrected. The miners have still corrected 4.7% vs. about 8.7% for the physical. However, usually the price move down in the miners is more than the physical when silver falls in price. This could be a signal that investors in the mining stocks think that the correction in silver prices might be short-lived.

Possible catalysts for a breakout higher in silver prices include:

  1. The simple reason that the total demand for silver, relative to its new annual mining supply, is strong. Demand rose about 3% in 2011 while mining production grew only about 1.7% last year.
  2. A reversal of the current trading range and trend if silver fails to significantly fall below the 200-day moving average down to the $26 level again. If that does occur, it will signify a shift in the physical supply-and-demand situation, which could change the mentality of investors, traders, and especially the largest players in the silver market.
  3. The biggest potential price catalyst in silver is the large short positions that once again have been accumulated in silver. The pullback in price has allowed them to cover for a profit. This regularly happens in the silver market and is very profitable for bullion banks and the large players in the marketplace. However, once the market strengthens, they will again continue to short silver and follow the same pattern.
  4. This time the combination of tight supply and demand and world events will catch them on the wrong side of their consistently profitable trade. If this happens, the price will break out of the $34 level and steadily climb and then accelerate higher. This will attract more momentum investors and the price will go on another nice run, probably up to $40. This is what occurred in the spring of 2011 and was the cause of the 50% increase in price. The situation now is not near the same magnitude in terms of size of imbalances in the market as it was then. However, it will be enough to cause a significant rise in prices.
  5. There is a chance that there could be a crisis in confidence in the silver market soon. Many precious metals investors have "conspiracy" theories that say the largest exchange traded funds (SLV and GLD) don't really have the stated physical inventories they claim of physical gold and silver fully backing them. Even if this not true, there have been movements lately by governments and concerned large investors to take delivery of their investments to make sure they not actually own, but also have full control and custody of their investment. This sentiment has been building over the last two years, and I'm sensing that we're approaching a period when it is going to start affecting actual decisions by large investors about how their precious metals are stored. If this occurs, we will see big price moves very quickly without warning, so you have to be positioned ahead of it.

Because of a combination of all these reasons, my outlook on silver in the summer changed to being significantly overweighted to silver again after staying out of the silver market for over one year. The recent events and reasons I cite above are why I feel precious metals investors should once again now have very significant exposure to silver. I also prefer silver over gold because of more potential upside.

My personal trading strategy and that of my subscribers is to establish a core position in silver, continually add to it during pullbacks, sell into rallies, and repeat the process. That way I can harness the volatility and sentiments swings to my advantage. It also helps you smooth out and endure the wild price swings. However, I always keep a core position in silver because once the sentiment shift begins to occur, prices could go on another significant run higher in price similar to the time period of January to May 2011.

Disclosure: I am long SLV, PSLV, SIVR, PAAS, SSRI, FSM, SLW. 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.