Overly Optimistic Silver Faces Stiff Resistance

The silver market has rallied approximately 10% since Christmas and now stands above $17 per ounce. The new year undoubtedly brought new speculative Dollars to the silver market. Annual re-allocations, changing political climate, and interest rate concerns have all done their part to contribute to an additional 10,000 futures contracts ending up in speculative hands over the last couple of weeks. In fact, speculators are now committing $4.25 to the long side of the silver market for every Dollar committed to the short side. We'll look deeper at the relationship between the speculators and the commercial traders in the silver market and show why now is not the time to buy silver futures.

The basis of our trading relies on using the commercial trader group as our first decision. We want to be on their side because they are the largest players in the market with a total position currently about 1.5 times the size of the speculative position. The commercial traders are hedgers. Commercial producers sell more forward production as prices rise and, conversely, silver processors and end users buy more raw material as prices fall. The market pressure that comes from corporate entities defending their bottom lines results in the peaks and valleys we see as swing trading opportunities.

Let's contrast this with the large speculator population of the market. They typically represent the trend traders. These are the players expecting a structural change in prices. Breakout trading also fits this methodology. Failed breakouts coincide with market peaks and are  associated with speculative buying while the market's declines tend to come from the washing out of these same speculative positions. We've created our own Commitments of Traders indicator, the COT Ratio, which provides us with a synthetic betting scenario that quantifies the speculative long Dollars in the market versus speculative short Dollars in the market. While the current reading of $4.25 isn't nose-bleed territory, we think it is too high to begin a meaningful rally.

The trend line starting at the July high now comes in around $18.15 and drops about $.10 per week. Commercial traders are global, macro traders who base their calls upon industry consensus and the advisement of their interconnected boards of directors. Consider companies like Glencore, BHP Billiton and RioTinto are the top three miners and they're all from different parts of the world. If throw in number four, we're adding a Chinese national corporation and further extending the global nature of the mining industry. Therefore, it should be no surprise that their strength lies in their collective abilities to assess interest rate, currency conversion, and political climate risk. Is it any wonder, so many of their board members have financial backgrounds placing them at Goldman, Rothchilds, Icahn Capital and even the Mexican Central Bank, our Federal Reserve and the World Bank? Their knowledge and experience are big reasons we buy when they buy and we sell when they sell. We don't have to move billions. We just have to time a few well-placed contracts and hopefully, let them do the work from there.

The commercial traders are selling forward production against overhead resistance in a market that has rallied about 10% in one month. The silver market may go a bit higher and may attract more speculative long positions. We believe this will only add to the unsustainable imbalance building within the market at what are becoming overextended levels. This is a prime recipe for a reversal. We'll be watching closely and publish our short sale signal, accordingly.

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