Crunch Time (Silver etc)

The $64,000 question is whether the 200 day MA of silver (and the long term uptrend line) will hold or whether the price of silver will break down from here

In summary, the evidence "seems" to be pointing to an imminent (and violent) break up in the Silver price. Should this occur, it seems possible that this may be accompanied by severe pain in the bond markets, and a resumption of the Primary Bear Trend in the Equities Markets.

Below is a weekly chart of the Silver price (Source: http://tfc-charts.w2d.com/chart/SV/W ) which shows two fan formations - which is itself very unusual (normally there is only one)

A fan formation is a sign of a market trying to make up its mind. If the price breaks up from a fan formation, a strong move up is subsequently anticipated given that the market has now resolved its dilemma.

By contrast, if it fails to break up (and thus breaks down) a strong deterioration in the market can be expected to ensue.

Fundamentally the primary reason for the indecision lies in the attitude of consumers of photographic film, as was reflected in a conversation I had yesterday with a Radiologist client. (I am a Director of a company called The Axiom Attic Pty Ltd, which is a strategic adviser in business matters; and which also offers market research services as a means of validating a business' strategic direction).

By way of background, there is a move away from the use of conventional photographic film in the practice of Radiology and a move towards digital imaging which, as an aside, is being accelerated by a phenomenon known as "teleradiology". Teleradiology allows the radiology image (X-Ray, CAT scan, MRI scan) to be generated at one location and read at a remote location. Research has shown that the number of reads in the Radiology industry rose by over 80% between 2002 and 2004 (source: Radlinx) and this same research has concluded that most radiologists are under pressure at work. Teleradiology is facilitating a means of easing this pressure, and there is therefore a strong downward pressure on demand for X-Ray films, as hospitals move to embrace the digital technology.

All of the above is known and is the primary reason being offered by antagonists of silver as to why the silver price is probably going to break down. Nevertheless, because this information is known it is presumably already factored into the silver price. What is not generally known is that in an attempt to keep the price of film down in an environment of rising silver prices, some photographic imaging companies have been putting less silver halide solution on the surface of the films to minimise cost. In turn, this is adversely affecting the quality of the images, and is working to further encourage radiologists to embrace teleradiology.

The case for the silver bulls flows from three factors which are discussed in greater detail below:

1. The total known above ground inventories of silver are less than a couple hundred million ounces
2. There is an accumulated short position in the COT of around 7.5 months mine production
3. A silver ETF is in planning stage which will more than likely create investment demand in excess of (or at least equal to) the fall in net silver demand flowing from a fall off in photographic demand

Turning our attention once again to the chart above:

If line "F" is broken on the upside, line "C" will represent resistance.

If line "C" is broken on the upside we can expect the silver price to rise by between 25% soon thereafter, and by as much as 75% in the longer term

The nail biting question is: Will it break up or down?

The chart below has had a long term uptrend line drawn in. The reader can see that the intersection of this uptrend line with line "F" is scheduled to occur in about 8 -10 weeks time.

Below is a chart of MACMIN share price going back 10 years (source Bigcharts.com). Often, when one attempts to interpret the chart of the Primary metal, it helps to see what investors in the related shares are thinking

On this particular chart I have outlined three formations referred to as "falling wedges".

A falling wedge is bullish because the tops fall faster than the bottoms. Ie Emotional sellers are panicking out but level headed buyers are calmly buying in and stopping the price from collapsing. I,e, A Falling wedge is evidence of a transfer of ownership from weak hands into strong hands.

• Wedge 1 broke up from a low of 4 cents and went to a high of 15 in 8 months (approximately 4X)
• Wedge 2 broke up from a low of 6 cents and went to a high 25 in 7 months (approximately 4X)
• Wedge 3 has not broken yet, but looks like it will break up from a low of around 10 cents. If the silver price rises 25% - 75%, it can be argued that all hell is going to break loose in the silver equity market; and MACMIN - which is one of only 3 or 4 "pure" silver plays in the world - seems to be pointing the way.

Note that point "3" is at a level that was last reached in 1996, and that the entire formation from 1996 to 2005 is referred to as a "saucer" formation, which will have extremely bullish connotations if the resistance level is broken to the upside. This is yet another sign that the all hell may break loose if the silver price breaks up out of its fan formation and also penetrates line C on the upside.

To be totally objective, however, if the falling wedge does not break up, and the level of 25 cents is not broken to the upside, then the 25 cent level will represent a "double top" formation, and Macmin's shares could drift downwards below 10 cents.

What could cause the silver price to explode?

There are roughly 103 million ounces of silver in NYMEX warehouses. This represents the last large stock of silver anywhere in the world

www.nymex.com/jsp/markets/sil_fut_wareho.jsp

As at June 21st 2005 there were 130,000 outstanding silver contracts on the futures market - with each contracts representing 5,000 ounces. 75% of these contracts were "short sales" on the part of "Commercial Traders" and 69% represented long contracts on the part of "speculators"

75% X 130,000 X 5,000 = 487 million ounces. Which is over 4 X the Nymex Inventories.

Silver production -world wide - was around 623 million ounces last year. Ie. The net shortage represents 385 million ounces which, if diverted 100% to cover the short sales, will take 7.5 months of world-wide mine production to cover

www.silverinstitute.org/supply/index.php

One barometer of sensitivity is the silver "lease rate" - which is the price people pay to "borrow" stocks of silver to deliver into short contracts

Note the recent spike in 12 month lease rates from 1.2% to 3% (now 2.4%). Clearly, the market has been tight since April. Will it tighten further or will it ease?

Catalyst?

The reality is that this bullish argument is theoretical. There will need to be a catalyst to cause the short covering. If there is no catalyst, the current futures/options contracts may - as in the past - pass their use-by date, and expire out of the money / worthless. Under such circumstances, if an ETF is finally established, the demand/supply equation may merely land up being in balance, and the silver price could languish.

The overall dilemma facing the market is that of inflation vs deflation.

Will Inflation (The "irresistible force" of Mr Greenspan's wave of fiat currency) and the concomitant inexorable rise in commodity prices overcome Deflation (The "immovable object" of Asia/India's limitless capacity to produce and/or provide services to a market with finite boundaries)?

If inflation wins out, precious metals could run. If deflation wins out, precious metals (and commodities) could fall.

What are commodities and gold doing? (Charts courtesy decisionpoint.com)

Whoops! Both the $CRB Index multiplied by the US Dollar Index and the Gold Price in Dollars multiplied by the US Dollar Index have just broken up to new highs! The Commodidollar Index is now at a 17 year high, and the Goldollar Index is convincingly at a 10 year high.

So, let's understand this clearly: What these charts are signalling is that both commodities and gold will rise together with a rising dollar (in the event that the dollar continues to rise) or will rise faster than the dollar falls (in the event that the Dollar continues to lose buying power relative to other currencies.

Summary and Conclusions

The evidence "seems" to be pointing to an imminent (and violent) break-up in the silver price

• As a "falling wedge" is a bullish formation that typically breaks "up", and as the Macmin share price is showing its third falling wedge formation since 2000, it seems that investors in MACMIN shares are expecting the silver price to break up strongly
• As the Commodidollar Index and the Goldollar Index are both breaking up to new multi year highs, it appears that we may be seeing some early signs of inflation
• It is conceivable that, as the markets start to focus on inflation, this may represent the catalyst that is needed to "force" the short covering in the silver futures market which, in turn, may lead to the resolution of indecision in this market and the break-up from both fan formations that commenced just over a year ago.
• In the event of a simultaneous resolution of two separate fan formations, the move up (should the break up occur) may emerge to become chaotic.

Disclaimer: This article is not to be construed as "advice". No recommendations are made. It is emphasised that if the break up fails to occur within the next 8-10 weeks, a serious breakdown will likely be the logical outcome.

Post Script

If inflation breaks out, will this not lead to a spike in interest rates?

Some of the best brains in the investment world are arguing that interest rates will stay soft, but the charts are warning of the possibility of a different outcome.

The reader's attention is drawn to the "non confirmation" implicit in the falling bottoms in the monthly chart of 30 the year yield as shown by line A-B and the rising bottoms of line C-D in the PMO oscillator. (Source: decisionpoint.com)

The recent fall in bond yields to a level around point B was again "not confirmed" by the oscillator which is currently higher than point D

Further, a "gap" in a bar chart is a sign of emotion in a market place which, when it subsides, typically leads to a subsequent covering of the gap. The daily chart of the 30 year bond yields below shows two recent gaps. The inexperienced chartist may argue that the two gaps - when read together - signify a "gap island reversal" which will lead to a continuation of the down move. In this analyst's view that will not be the case. A gap island reversalsignifies the culmination and imminent reversal of a previous trend. As the previous trend was down, the gap island reversal here cannot logically be signalling a continuation of the down trend. If anything, it is signalling that the yields must now reverse upwards and that the gaps should be covered - although it must be admitted by this analyst that he has never seen a formation quite like this one in over 35 years of chart watching.

Now, if yields reverse upwards - leading to a covering of the gaps, then the previous "buy" signal (of the PMO oscillator as the blue line crossed up through the green line) will be confirmed. In turn, the non confirmation of line C-D will be further reinforced. In turn, if the monthly chart of yields starts to rise from here - as would be expected under a scenario of inflation - then there is likely to blood on the floor of the bond markets; where conventional wisdom has it that yields will remain soft.

And if long dated yields rise, what will happen to the stock market?

For an answer to this, we turn to our "old faithful" - Dow Theory - shown below in the monthly charts.

At present no definitive signal has yet emerged. However, if yields start to rise, and the DJIA falls below 10000 and this is confirmed by a fall in transports below 3400; we will be facing a very unhappy investment community - some of whom may very well panic into precious metals.