A Low-Risk, High-Reward Precious-Metals Trade

After months of watching prices fall, silver bulls at last have some good news... They finally have an "extreme" condition working in their favor.

 

Regular readers know we urge every trader to become a "connoisseur of extremes." This means monitoring the market for extreme situations where valuations, technical readings, and sentiment are badly out of whack. These extreme, "out of whack" situations often precede big price moves.

 

And right now, we have such an extreme in the silver market.

 

This extreme was created by a giant "blowout" in silver over the last 10 months. In September 2012, silver was trading over $34 an ounce. Earlier this summer, it dropped below $19. In other words, silver lost nearly 50% of its value. (Gold lost "only" 33%.)

 

That massive drop has put investor sentiment toward silver in extreme territory...

 

Speculative trading funds hold historically low net-long positions in the metal. (Producers and consumers, on the other hand, are massively long.) At market extremes, speculative funds often lean heavily toward one side of the market... and it's a good idea to bet against them.

 

In the 10-year chart below, you can see that speculative trading funds hold the lowest amount of bullish bets in 10 years.

 

 

Now take a look at the next chart. It shows the last 12 months of trading in silver. Since bottoming around $18.50 in June, silver has dug in a "toehold" in the $19-$20 range. It's strung together a short series of "higher lows" and "higher highs." It's likely the start of an uptrend.

 

 

If silver keeps moving higher, the speculative funds that are now massively short the metal will rush in to buy in order to cover their short positions. That will drive prices higher. A rally back to $28 per ounce isn't out of the question.

 

Since silver is just off its recent lows, there's a compelling risk/reward trade right here. Traders can consider buying silver or the silver fund (SLV) and setting a stop near the recent lows.

 

Silver has been through a "blowout" bear market. Sentiment toward the metal is terrible. The price is moving higher. This makes for a low-risk, high-reward trade.

 

– Amber Lee Mason and Brian Hunt