Silver: Too Far, Too Fast

There is a simple rule I have in investing: too far, too fast. Basically if a given asset makes too big of a move in too short a time frame, I look for the opposite trend to take place- at least in the short-term. This rule is valid on both the upside and the downside. For example, the panic sell-off in stocks in 2009 has been followed by a huge rally. On the other hand, the spike high in crude oil to $147 was followed by a breakdown to $35. Markets are characterized by extremes because people get too caught up in the moment and lose their objectivity. This happens on a regular basis.

That being said, the current rally in silver is concerning to me. With silver rallying to 30+ year highs, people probably think I’m nuts. But being as objective as possible, the current price action in silver is a little frothy. Silver is currently trading over 50% above its 200-day moving average. This is extreme. On a spike to new highs, I will probably lean bearish. Too far, too fast.

In the chart above, you’ll notice that we’ve had 100% moves in silver in relatively short time frames before. But let me just make 2 points: 1) The last 100% rally came on the heels of a panic low, which will tend to lead to huge snapback rallies; and 2) The last rally was followed by over a year of consolidation. The point I’m trying to make is that some kind of sideways action is likely in silver. And if a correction doesn’t come, it is actually bearish for silver long-term.

It is not necessarily the price that matters to me, it’s how we get there.. The more sustainable rallies are fueled by periods of consolidation or panic sell-offs. Consolidations are extremely bullish because the market is building energy for a strong push higher. Without periods of consolidation, markets are bound to collapse under their own weight. Remember, bubbles don’t consolidate before they pop; they spike to new highs. This is a situation to look for in silver if a correction or period of consolidation doesn’t arrive soon. I’m not sure if this makes sense because people tend to focus on price and price only. But time is important as is the path taken to a price level.

Gold vs Silver

Gold is much more likely to play a role in a new currency arrangement than silver, and this is why I like to focus on gold. Silver and gold are correlated, but they are by no means one in the same. There are times when gold and silver served as money side by side. But there are other times when just gold served as money. Although silver has very strong fundamentals, it is a little bit more of a speculative play than gold.

There are times when markets are screaming buys. When the gold:silver ratio was 83, silver was a screaming buy. Now that the ratio has tightened to 36, silver is not a screaming buy anymore. The gold:silver ratio may very well fall to 15 as some people are predicting, but I am a lot more comfortable saying that the ratio will fall to something like 30. If I am proven wrong, then great- I will have made a lot more money. But I must caution you all that the hard part is not necessarily making money, it is keeping it. Try not to get too caught up in silver’s advances or you will find yourself unwilling to sell when the time comes to get out.

I hope people don’t misunderstand me and think that I am suddenly bearish on silver. I personally have a very large position in silver and I am not complaining at all about this rally. All I am saying is to tread carefully. A correction in silver, if it arrives, is going to be pretty substantial.