Tuesday, November 8, 2011

The Bullish Argument for Silver

Scott Gibson

The price of silver has been in a slow steady recovery since it gapped down in hard selling on September 22’nd and 23’rd of 2011. From a technical standpoint, price needs to fill the gaps and close above $38.34 before many investors are going to trend back into the water. But more aggressive investors may want to consider the following and start taking positions now.

Silver has been tracking up a regression channel since 9/26/2011 where the regression line defining the channel is gaining around $2 per month. SLV, the silver Exchange Traded Fund, has gain 10.74% in price since 9/26/2011. As the chart below shows, the price has almost filled in to the low of the second gap bar of $34.51. If the first gap bar is filled over the coming months it will take silver back up to $38.34. That price point is shown with the solid horizontal blue line on the chart. Right now, based upon the slope of the regression line, we may see the first gap filled by sometime in January.

The indicator shown on the chart below (click on the image to see it more clearly) the price bars is a consensus of 6 different measures of price movement along with volume momentum. When the green line is above the red line the indicator shows that silver is in an uptrend, or as we like to say has a positive bias.

From a fundamental perspective the Chairman of the Federal Reserve, Ben Bernanke, has signaled that additional monetary stimulus may be needed in February to lower the U.S. unemployment rate. This is the first break in the dam that the Fed is considering QE 3. The bottom line is that more dollars will be created to “stimulate” the economy. Anticipation of this move may already be showing up in the trend divergence between UUP and UDN, the Exchange Traded Funds that represent dollar bull and dollar bear. Since silver bottomed on 9/26/2011, UUP has lost 2.21% while UDN has gained 2.20%. This divergence reflects a weaker dollar.
Dollar weakness adds more support to the bullish case for silver. Silver (SLV) and gold (GLD) have rallied strongly during each of the previous periods of Quantitative Easing. Once the Fed gins up its printing presses it’s reasonable to expect that precious metals like silver will trend a lot higher and possibly take out or approach its April 2011 high of $48.35.

So how does a patient investor take advantage of all of this information? If you already own silver you may want to sell covered calls 2 standard deviations above the price regression line. Currently, November calls with a 36 strike price are selling for 0.30 which is close to a 1% return on your money during the next 2 weeks (these options have an expiration date of November 19, or 10 market days away). If silver closes above the 36 strike price at options expiration your return is 9.3% and your position will be called away.

For those investors who do not own silver but want to start accumulating a position at a good price you can sell naked puts with a strike price of $32 for $0.72 which gives you an actual purchase price of $31.28 ($32.00 - $0.72 = $31.28) if you are filled by the options expiration date (November 19’th). $31.28 is a price that is very close to the bottom standard deviation band shown on the chart. If you are not filled (meaning that silver closes at or above $32 at options expiration), you pocket the $0.72 and do it all over again in December, January, etc. until you are filled. Just remember that each option position represent 100 shares of the underlying, therefore if you sell 10 puts with a $32 strike price and are filled (which would happen if silver closed at or below $32 at options expiration) you will have purchased 1000 shares of silver for $31,280. If you are filled by the $32 strike, with an effective purchase price of $31.28, you are purchasing silver 6% below Friday’s close of $33.20.

On the other hand, if you sell 10 of the $32 strikes and silver closes at or above $32 at options expiration you will pocket $720.