Silver: The Next Wheat
Eric Fodness
Slipka, Inc.
October 24, 2007
For those of you that follow the grain commodity markets, you have witnessed a spectacular rise in the price of wheat over the past six months. Droughts, floods, competition for acres, and high demand have pushed up prices to levels never seen before. Old crop Chicago wheat has more than doubled since April, topping out at $9.61 a bushel, a new all time record high. End users scrambled to secure supplies and short hedgers worried that their lines of credit would run dry. Brokers and clearing firms became nervous over the validity of hedges. Unhedged producers, as well as speculators who were positioned early, made tremendous gains. So where might the next great opportunity lie? I believe it may be in silver. Let me outline my case.
December 2007 Chicago Wheat, Daily
Charts courtesy of eSignal. © 2007 eSignal, a division of Interactive Data Corp.
Why I think silver could be the next wheat:
Take a look at Clive Maund's excellent October 21st report as well as my charts below. He makes the striking comparison of today's silver chart with the pattern two years ago. The market simply exploded from this pattern, making a move up over 100% from the summer lows, to a price not seen since 1983. Even the time of year is the same. In both cases we had retracements off the initial run up. Both had massive pennant formations with triple tops. We don't know exactly what will happen with the current chart, but we do know what occurred two years ago.
Manipulation: I believe silver analyst Ted Butler is right in stating that the big players have the power to manipulate the market. The first step is for the big players to paint a chart pattern that looks like it will break down, flushing out as many longs as possible with margin calls. Just like we saw over the summer in 2005 and again in August this year. In percentage terms, silver fell much more than most commodities that day. After they have taken many of the longs out, they cover their shorts and/or go long. They started their buying in earnest on Aug 16th after we were down about $1.50 on the day. Now, with their positions secured, they simply wait for the natural momentum to take over again.
Very favorable COT comparison to 2005:
The 2005 chart is for the whole year and the 2007 chart is through 10/16/07. In 2005, the funds were long over 50,000 contracts at this time. Despite this, silver rallied over 16% to around $9.20 in December before correcting, with the funds accumulating over 65,000 contracts at the peak. And remember, at this point silver had not even broken $10 yet, and was on its way to $15. As of Oct 16, 2007, the funds were long just 30,000 contracts! I believe there is enough room in the COT data for silver to move to the $16-17.50 level before the COT is at an overbought extreme. At this point a correction would likely occur, flushing out the funds, and paving the way for the next move, possibly to $20.
Seasonal price strength: Most of the major peaks in silver have occurred between January and April. We hit $6.43 on 2/27/74, $41.50 on 1/21/80, $14.93 on 2/15/83, $9.79 on 4/27/87, $7.50 on 2/6/98, $8.50 on 4/2/04, and $14.69 on 4/20/06. The lone exception was $23.93 on 9/23/80, a retracement rally off the massive 1980 peak. We also went marginally higher in May 2006. All numbers are based on front month futures.
Inflation: We have Ben Bernanke on top of the Fed. The gold and silver markets first reacted to his confirmation in 2005 with a tremendous surge higher. Now he is cutting rates to save the housing market in an overall strong economy. If he continues cutting, I believe it will further fan the flames of inflation. This is all coming from a man who seems to think that any drop in aggregate demand can be fixed with a rate cut. Rumor has it that Ben received a barrage of phone calls and visits after leaving rates unchanged Aug 7th, leaving the editors of Trader Daily in their Oct 3rd Morning Call to wonder, "Where do we sign up?"
Weekly NY Silver Continuous Contract, with Projection to April 2008.
Monthly NY Silver Continuous Contract, With Targets.
I believe the technical setup is in place for a strong move higher. My price target going into April 2008 is the $24-25 range. I base this on the following:
Using previous resistance: The rally that ended in April 2004 reached to around $8.50, the same level as the rally in 1988. The move completed in April 2006 took us to the levels seen in the spring of 1983. If we can make a clean break of the low $15s, and stay there for more than a few days, I think we will approach $20, and possibly $25. This level marks the September 1980 high. If we can clear $15, the lead shackles will be off and I believe the market will move remarkably fast. Gold has already broken above its 2006 high, and I believe silver will do so in November.
Accelerated move projection: Another way I arrive at my target is my accelerated move projection. The first leg in the move ending in April 2004 resulted in a move of 78% higher. The second surge higher into April 2006 was a move of 113% off the low in August 2005. Another move of 113% would take us to the $24-25 range measuring from the low in August 2007, to a projected top in April 2008. The next move should be at least as strong as the last one. I think the market could be forming a parabola and these numbers are a reflection of that.
Cup and Handle: Yet another way to arrive at this price target is to apply William O'Neil's Cup and Handle Formation. On the chart above, the long base in the 1990s would be considered the base, or the bottom of the cup. A handle formed in 2004 and executed to the upside in late 2005. The distance of the bottom of the cup and the top of the handle should be the distance of the move when it beaks out of the top of the handle, according to O'Neil. I believe a second handle has formed in 2006-2007 and fits the pattern on the monthly chart. This would imply a possible move to just over $25 per ounce.
Suggested trading strategies:
I recommend buying or continuing to hold silver futures and consider buying May/July 2008 call options and/or spreads. I like the May calls for flat out option purchases. For a riskier short term speculation, consider the December calls. For the futures, I would use a buy and hold strategy, adding on breaks and lightening up on rallies. I would not use stops. It is far too easy to get flushed out on breaks and end up like the funds in the COT data. To control risk, I would instead keep the position down to size. Use mini-futures if necessary.
My associate Peter Kordell, offers the following additional strategies from The Daily Trade Blaster: You can consider buying the July 2008 Silver 20 call and selling the 25 call for about a 15 cent debit. The risk would be the cost of the spread ($750) and the potential reward would be $24,250. A second part to consider adding to this trade is to sell two 25 calls and buy two 26 calls to create a small bear spread and collect a premium. He estimates you will collect around 35 cents for each pair for a total of $3500. Buy adding this if the market approaches $25, you can take some cash out of the trade, yet still leave the spread on to potentially reach the maximum gain. You can also consider put options to protect your gain.
We will know soon enough if the above scenario will unfold. Before the October 31st Fed meeting, we could retreat back to the $13-13.20 area. Any lower than that and I see too much chart damage for a major price breakout to occur. I believe the Fed meeting could be a decisive point for silver. I expect a 25 bps rate cut. I believe we need silver to clear $15 some time in November for a shot at the $20-25 level next year.
Eric Fodness
Slipka, Inc.
www.slipkatrading.com
eric@slipkatrading.com
888.348.3665
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