Precious Metals Update: Silver on the Edge!

by Joshua Enomoto, Founder of and Contributor

In a stunning turn of events over the last several days, several fundamental rules in the precious metals complex have dramatically shifted. No longer can investors speculate that simple inflationary pressures will lead to higher commodity valuations, given recent hawkish sentiment from the Federal Reserve led by Bank of San Francisco president, John Williams (not to be confused with Shadow Stat’s John Williams, who called for hyperinflation by 2014). Indeed, hyper-deflation now seems more likely, given the recent foray by the greenback hitting the 84.30 level in the dollar index, placing it on a very clear uptrend. But even there, gold and silver bulls can’t catch a break, with retailers self-imposing the divergence between the paper and physical price by increasing premiums to unprecedented levels. At the time of this writing, a one troy ounce bar of palladium (palladium!?) carries a lower premium than a 100 troy ounce Engelhard silver bar at a popular bullion dealership!

The alternative investment community is getting gouged by the very people that denounced such tawdry behavior from Wall Street executives: at no point should an investor relax his free market capitalistic drive to seek the most attractive entry point (from a net cost perspective), regardless of the asset class. Physical silver, especially purchased in bulk, should never carry a higher premium than 3% over spot. Of course, the retail market is in backwardation, where the immediate cost carries a premium over future delivery, but for select products, namely American Silver Eagles and Canadian Maple Leafs. Generic silver is not in short supply and should never carry excessive premiums. Many dealerships are advantaging the emotions of the investment community and individual bullion purchasers can hold such charlatans accountable by refusing to play their games.  
Now, let’s move onto the “paper markets,” where the real game is being played out:

Silver (05182013) A  

Many technical analysts, myself included, firmly believed that the $26 long-term support level in spot-silver would hold. In fact, there were early indicators, such as an uptick in price combined with the slight reversal in the Relative Strength Indicator (RSI) from extremely oversold levels, that suggested an opportunity for the aggressive investor. Other historical factors, namely that price has always bounced up from the $26 price point since late 2010, gave assurance that a stable consolidation would eventually lead to higher gains.

Unfortunately, with the massive sell-off that occurred on tax day and the session prior, the technical picture has completely changed. Silver is barely hanging on to the $22 level, which theoretically may be forming a bullish double-bottom reversal based on a cursory application of Elliot Wave Theory, yet none of the cumulative technical signs, such as the RSI or Moving Average Convergence-Divergence (MAC-D) is confirming the reversal hypothesis. While I am not urging investors to sell their positions, I also believe that it would be a mistake to consider current price points to be a buying opportunity.

As many of you may know, I am an ardent critic of the “buy at any price” philosophy of bullion acquisition, eschewing it in favor of a cold, rationally ruthless tactic of buying at the lowest price possible. I have zero loyalty to any bullion dealership other than the one that offers me the bottom rate today and I refuse to pick up the tab for anyone’s contango market.

With international fundamental drivers solidifying the current trend in the FOREX market (stronger Dollar, weaker Yen), it is financially dangerous to initiate an acquisition now. During this week alone, we witnessed the rise of the Dollar/Yen pair from 100 to well above 103, with the Yen losing an astounding 0.6% of valuation per session! Exacerbating matters more, the international community declined any criticism towards the Bank of Japan’s monetary policy. Only Germany, with an impotent declaration that they are “watching” Japan, was the only sign of resistance in an otherwise clear fiscal road to a one-way rebalancing. As if to punctuate the fiat atmosphere, the Euro currency fell to 128.4, all but assuring the launching of the US dollar.

This is deflationary for commodities in general and especially so for gold and silver. Contrary to misinformation spread in the blogosphere, deflation is bad for the metals, yet some bullion bulls will ignore all signs of impending danger. And the paper traders smell blood in the water… 
SLV Options (05182013) B  
In previous articles, I have mentioned that the put/call ratio in the options market generally reflected bullish sentiment towards silver. However, that has radically changed in recent weeks, with paper traders now heavily leveraged towards bearish positions. A contrarian perspective would suggest that an abnormally high ratio of puts versus calls in an oversold market is an indication of a potential reversal. While there is certainly validity towards that argument, as capitalists, we need to see how far the paper trade will lead us to the red. Jumping in now, especially against the backdrop of commodities-bearish fundamentals, is reckless: regardless of one’s personal opinion towards the games played by Wall Street, the powers-that-be are tipping their hand. No one other than silver bugs are initiating long positions in this current market environment as all indicators are dollar-bullish: how else can you explain the dramatic sentiment-shift in the options market?

While it is still too early to call a secular bear market in the precious metals, we have to commence a higher level of sophistication when investing in hard assets. Wall Street antagonists have never been our friends but we are learning now that neither are our previously immaculate bullion retailers. Everyone in this sector has an agenda, and the only way to ensure the best deal in any situation is through education: this downturn is a perfect opportunity to rationally re-evaluate our portfolio and to re-engage once market conditions are favorable for you, the consumer.