Silver lining brightens up

Silver broke out of resistance to scale a new peak this week, finally following gold to new highs. The two precious metals follow each other, but gold has been substantially stronger than silver.

There are fundamental differences between gold and silver. Silver is used in several manufacturing processes, unlike gold which is predominantly used for jewellery and treated as a safe haven against the dollar and other fiat currencies. As the economy went into a tailspin, the price of silver dropped as its industrial demand contracted.

On the other hand, a fall in the economy increased fear in the markets, resulting in a rush for gold. Also with the falling dollar, gold is now seen as a safe haven and store of value. The depreciating dollar erodes the value of savings held by individuals and they prefer to move to gold. However, with gold turning out to be expensive, investors are moving to other precious metals and commodities.

Silver is a nice blend of a commodity and precious metal, which can also act as a store of value. Hence, we see the rush for silver and a consequent new high in price. Other commodities like oil and copper have rallied but have not made a new high yet.

Gold however, is much stronger than silver. The gold futures mini contract (@YG) made a high of $1,050 in March 2008, then had a correction before making a new high in October 2009. On the other hand, the silver futures mini contract (@YI) broke out of its March 2008 highs of $21.50 only this week. This clearly shows the relative strength of gold over silver.

However, with gold turning expensive, it’s making more sense to invest in silver. There are several points at which one can enter silver. A strategy used by most novice traders is to buy the break out, which means buying silver right away. This however increases the risk of loss as prices can pull back substantially. A safer strategy to adopt is to allow silver to correct back to its previous resistance area which is $21.52 and then buy with a stop a little below.

The other areas that present buying opportunities are $19.50 and $18. It is always possible that silver may never correct and just continue to rally.

Note that all commodities are affected by the value of the dollar. If the Dollar index, which measures the greenback against six major currencies, closes below 78, it can fall all the way to 77. A close below 77, can take the index to the 74 area. If the index continues to fall, silver will rally.

How far will silver rally is anyone’s guess. It’s extremely difficult to predict targets when an asset class is making new highs. However, using a projection tool – the Fibonacci extension – from the low of 2005 to the high of March 2008 and the higher low of October 2008, we do get some targets. They are $22.22 which was crossed this week and the next targets are $26.97 and $29.91. A lot of people use Fibonacci tools in trading, but they are not as reliable as support and resistance in price. So it’s prudent to exercise caution while using them.

The author is editor of www.capturetrends.com  and is based in Chicago