Taking a Shine to Silver - TheStreet

Taking a Shine to Silver

This long tarnished precious metal shows glimmers of a possible breakout.
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Investors are polishing the tarnish off silver, which could play catch up with its golden cousin in the weeks ahead. But it faces a series of technical hurdles before it can establish a new uptrend, so be cautious if you take a shine to this unique market.

While

gold keeps setting records

, silver is unlikely to match that kind of action due to something that happened 30 years ago. Back when Jimmy Carter was president, the Hunt Brothers attempted to corner the silver market, triggering a parabolic rally that topped out at $54 an ounce, before collapsing to $11.

Since broken parabolas rarely reinflate, silver probably won't exceed the 1980 high in our lifetimes. But that's OK. The overhead supply from that troubled era is now gone, allowing this instrument to trade according to the natural laws of supply and demand, along with a fair share of greed and fear, just like any other precious-metal market.

Silver finally settled down after the Hunt fiasco, dropping into a 20-year trading range between $3.50 and $10. It entered a new bull market advance right after the Sept. 11, 2001, attacks, rising slowly from an eight-year low at $4. The contract finally broke out of the range in 2006, charging higher along with other metals getting bid up at that time.

The multiyear uptrend finally peaked at $21.40 in March, 2008. Note the Elliott five-wave rally (red lines) off the 2001 low, with three primary impulses and two corrections. Precious metals markets often trade in nearly perfect Elliott patterns because the contracts are extremely popular with aficionados of that often-maligned market discipline.

Silver dropped off the multiyear high quickly and it plunged during the previous bear market, giving up more than 70% of the seven-year rally before bouncing back to nearly $8.50 in October, 2008. It's been on the recovery trail since then, charging higher in a V-shaped pattern. It has now recouped around 80% of the previous decline.

The weekly chart highlights the explosive 2008 selloff, followed by an equally rapid recovery wave, which lost momentum at the 78.6% retracement level in December, 2009. Silver rolled over at that technical barrier in January and tested support near $15, before bouncing big and falling back to the recovery high last month.

Sellers took control again in mid-May, with the contract now struggling below the retracement level. However, price is firming up despite multiple reversals, with a six-week basing pattern just above $17. In addition, the weekly Stochastics indicator looks ready to turn higher near the oversold level (red circle), indicating the start of a new buying impulse.

A breakout over resistance at the December high (red line) will open the door to a buying spike into the pre-crash high at $21.40. That won't offer much reward from the current price -- I said there were technical challenges -- but it's a required step before the contract can resume the upward trajectory in place between 2001 and 2007.

The daily chart illustrates how the battle lines have been drawn near $17 in recent weeks. The contract has bounced off that level four times since April, including this week's sharp reversal. Overall, the two-month price action has carved the outline of a sloppy looking head-and-shoulders pattern (blue lines), adding a measure of caution to the technical outlook.

Silver needs to rally over $18.60 to negate this bearish pattern and set up a test at the May high near $20. It might accomplish that over the next two weeks, riding on gold's coattails. However, it isn't wise to jump the gun here because a breakdown through the head-and-shoulders neckline at $17 would likely trigger a major selloff.

Alternatively, a rally back to the May high would mount the 78.6% retracement level for the third time since last December. Resistance should then become firm support, with pullbacks to $18.60 or so, marking solid buying opportunities ahead of a breakout over the 2009 high and a resumption of the silver uptrend.

More from Alan Farley:

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Alan Farley is a private trader and publisher of

Hard Right Edge

, a comprehensive resource for trader education, technical analysis, and short-term trading techniques. He is also the author of

The Daily Swing Trade

, a premium product from TheStreet.com that outlines his charts and analysis. Farley has also been featured in

Barron's

,

SmartMoney

,

Tech Week

,

Active Trader

,

MoneyCentral

,

Technical Investor

,

Bridge Trader

and

Online Investor

. He has written two books:

The Master Swing Trader

and

The Master Swing Trader Toolkit: The Market Survival Guide

, due out in April. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks.

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