Silver has been on a wild ride, moving up to 31-year highs and outperforming gold so far this year. I believe it is important to understand the strong fundamental forces that have attributed to the rally in the silver market, which is trading just under $50 an ounce.  Once we understand where we have come from we can get a better feel for where this market may go.

First, let’s look at the impact of the U.S. dollar, as represented by the U.S. dollar index futures contract, a weighted index of the dollar against six major currencies. The dollar index has been in a bearish trend over the last couple of months.  This trend has developed in part by the Federal Reserve’s loose monetary policy, which has put it behind other central banks around the world which are now tightening interest rates.

The Dollar

Last week, ratings agency Standard and Poor’s announced that it was putting the U.S. triple-A credit rating on “negative,” which put even more pressure on the dollar.  The dollar’s weakness has lead traders to prefer other growth-sensitive currencies such as the Canadian dollar, Australian dollar, British pound and the euro.

The Federal Open Market Committee is meeting this week and will make its scheduled announcement on U.S. interest rates on Wednesday, April 27. Fed Chairman Ben Bernanke will conduct his first ever post-announcement news briefing.  This means that selling anti-dollar positions or covering short dollar index positions could be prudent, as Mr. Bernanke could surprise traders by turning toward more hawkish rhetoric by the U.S. central bank.

So far, the market hasn’t experienced widespread profit-taking in bearish dollar positions, and I find this surprising in front of such an important news briefing.  Now, I am not anticipating a full turnaround in the U.S. dollar, but there is a potential for an abbreviated short squeeze rally if Bernanke and the Fed hint at a move away from their easy policy stance. Again, I do not expect the dollar to trend much higher since the U.S. central bank is still one of the least hawkish banks globally.  Without a hint of policy tightening from the Fed, the dollar would be vulnerable to further setbacks in the weeks ahead.

U.S. Treasuries

U.S. Treasuries have been the risk-free benchmark rate for over 40 years, and have been used as a global safe haven investment.  The flight-to-quality trade driving U.S. Treasuries may be shifting toward precious metals.  Many traders realize that with the Fed’s second quantitative round of quantitative easing known as QE2 finishing up in June, (which means that the Fed will stop buying back Treasury bonds), and with inflation an ever-more present threat, traders and investors may start avoiding bonds.

Some of you may think, so what? What does all this mean for silver?

This environment has created a perfect storm for the rally in the silver market.  Silver has gained more than 160 percent in a year and has outperformed gold year-to-date. Here are some of the fundamentals driving silver.

  • Most commodities are priced in U.S. dollars, and since the value of the U.S. dollar has been in a steady downtrend, we are thus experiencing record prices for silver.
  • The Standard and Poor’s downgrade to U.S. credit has forced habitual purchasers of U.S. bonds to weigh their options, thus drawing large-money (fund) investors into commodities such as silver.
  • Inflation expectations. The producer price index (PPI) is up 5.8 percent year-over-year in March, and the consumer price index (CPI) up 2.1 percent (Department of Labor Statistic). We are seeing investment into inflation safe havens such as silver.

Silver Strategies

So what strategies can you pursue given the recent rally in silver? I am watching for silver to reach just above $50.  Many traders and analysts speculate that this resistance area may hold—and it may be tough to crack.  If you are currently long silver, I recommend holding your position.

In general, when working with clients I recommend entering markets before they move–not after they have made the move.  So if you think the recent rally in silver will fade (a market contrarian approach), you might consider the purchase of an inexpensive put spread on the silver market.  This would be utilizing a limited-risk strategy.

If you would like specific trading strategies for these markets or others, based on your unique goals and risk tolerance, please feel free to contact me directly.

Edward Shine is a Senior Market Strategist with Lind-Waldock.  He can be reached at 312-788-2905 or via email at eshine@lind-waldock.com

Past performance is not necessarily indicative of future trading results. Trading advice is based on information taken from trade and statistical services and other sources which Lind-Waldock believes are reliable. We do not guarantee that such information is accurate or complete and it should not be relied upon as such. Trading advice reflects our good faith judgment at a specific time and is subject to change without notice. There is no guarantee that the advice we give will result in profitable trades. All trading decisions will be made by the account holder.

Futures trading involves substantial risk of loss and is not suitable for all investors.

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