Following Up on Silver

If you have been following the blog posts and newsletters over the last several weeks, you would have noticed an increased trading activity and focus towards various asset classes that seem to be “breaking out” from their consolidations or downtrends. One of these assets is Silver, which I first focused on over a month ago in a post titled “Decision Time For Silver“.

Chart 1: Silver has broken out as hedge funds start covering their shorts

Silver COT 

Source: Short Side of Long

As we can clearly see in Chart 1, Silver has now broken out from the so called downtrend line, just as hedge funds and other speculators became increasingly negative on the metal. The chart above shows the highest net short position on the Silver since at least 2006, just before a powerful rally took off. As we can see time and time again, it is usually better to be a contrarian at times when the so called “dumb money” turns extreme in one way or another.

The question now is what’s next for Silver?

One of the things that concerns me right now is that Silver is overbought from the short term perspective. The metal is up 13 out of the last 14 days, which is usually a signal that price will consolidate at best (or more likely correct properly). Sentiment is recovering rather too quickly and short positions are being covered rapidly.

Chart 2: From the near term perspective, Silver has become overbought!

Silver Bollinger Bands 

Source: Bar Chart (edited by Short Side of Long)

Furthermore, daily technical indicators such as RSI reading are at extremely overbought levels once again. Previous two instances where we saw similar readings marked intermediate degree peaks for Silver. We can also observe in Chart 2 that yesterdays price was trading more than 3 standard deviations away from the mean (even though Bollinger Bands are much more compressed now).

In general, these overbought readings are much more important during downtrend then uptrends, so it will be interesting to watch how Silver deals with these conditions. A consolidation of recent gains, as the price works of overbought levels, would obviously be positive for the bulls. From there, the price could move higher as the trend feeds on itself. On the other hand, a sharp reversal of the current rally will be an indication that bears still control the trend and all we went through was nothing more then a short covering move.