The Long Legs of the Silver Rally

US Special Forces put a bullet through Osama bin Laden’s head yesterday. Unwittingly, this elite fighting force may have also thrust a stake through the heart of the silver market.

We will leave it to Wolf Blitzer and other world news commentators to articulate the geopolitical significance of bin Laden’s rendezvous with 40 virgins. Our beat is financial…and in our little corner of the news world, the death of bin Laden seems like a perfect excuse for a long-overdue dollar rally…and silver selloff.

The silver market has been hot…red hot…probably too hot. The dollar, for its part, has been stone cold – sinking lower and lower with almost every trading day. Both assets are fully deserving of their respective price trends. The silver market, in other words, deserves to be soaring against the US dollar. And over the next few years, your California editor would not be surprised to see the silver price top $100…or even $200.

But over the next few weeks, the precious metals are likely to become a bit less precious for a while. Your editor does not raise this caution to suggest that silver be sold. Rather, he raises it to suggest that silver be bought…at lower prices.

To begin this brief analysis of the frothy silver market, please consider one essential fact: the following remarks are no better than guesses. Educated guesses, yes. But guesses all the same. To continue this analysis, please consider a few fascinating data points:

1)    Silver has soared more than 50% so far this year, and 150% during the last 12 months.
2)    The price chart of silver has developed a parabolic trajectory, typical of toppy markets.
3)    Speculative trading activity is dominating many parts of the silver market. For example, recent trading volume in SLV, the $13 billion ETF that represents holdings in silver bullion, has been exceeding the trading volume in SPY, the massive $89 billion ETF that represents the S&P 500 Index. Prior to the recent silver frenzy, SLV would produce only about one quarter the daily trading volume of SPY. But now it is SLV’s trading volume that routinely tops SPY’s!

iShares Silver Trust vs. 5-Day Trading Volume of SPY

4)    Various gauges of investor sentiment are flashing extreme bullish readings for silver. The Elliot Wave’s Daily Sentiment Index shows that 95% of investors are bullish on silver. Likewise, the Market Vane’s Bullish Consensus shows 93% of commodities traders are bullish on silver. When such an overwhelming majority of market participants hold such an overwhelmingly bullish opinion about a given asset, that asset tends to disappoint its fans…at least for a while.

Taken together, these various signs, indicators and portents say loud and clear that a major correction in the silver market is very likely, very soon. On the other hand, Ben Bernanke’s reckless monetary policy – spearheaded by money-printing escapades that are so moronic only a PhD in economics could possibly devise them – say loud and clear that silver (and gold) are much better long-term bets than the US dollar.

So why bother worrying about short-term risks in the silver market?

Good question. Maybe you shouldn’t…unless you have an interest in converting these short-term risks into a long-term buying opportunity. The silver rally still “has legs,” even if those legs might wobble occasionally.

Eric Fry
for The Daily Reckoning

The Daily Reckoning