Will the Silver Rally Begin to Tarnish in the Near-term?
Today's Idea
The recent run-up in Silver prices has certainly spiked option volatility, and with the market appearing a bit overbought, at least in the short-term, a bearish short-term trading strategy may be in order. There appears to be strong psychological resistance at the 40.000 level for the May futures, and some traders may wish to consider selling out-of-the-money calls in May Silver futures options, with strike prices above the $40 resistance level. For example, with May Silver trading at 37.730 as of this writing, one could sell the May Silver 44.00 calls for about 0.065, or $325 per option, not including commissions. The premium received would be the maximum potential gain on the trade and would be realized at option expiration in late April should May Silver be trading below 44.000. Given the risks involved in selling naked options, some traders may wish to buy back the short options before expiration should May Silver close above 40.000.
Fundamentals
Forget Gold -- Silver futures have been the brightest performer of the precious metals sector so far this year, with the lead month May Silver futures up over $6 per ounce since the start of 2011. Among the reasons given for Silver's shining performance has been its dual role as both an industrial and precious metal. This has provided support not just from those buyers looking for a "safe haven" investment, but also from those looking for improvement in the global economy, which would benefit industrial commodities such as Silver and Copper. All the precious metals seem to be dismissing the "hawkish" comments from European Central Bank officials that Interest rates will need to rise to help control inflationary pressures. Though it appears that the bullish trend for Silver is firmly intact, one does have to wonder if we have started to move "too far and too fast". The Gold/ Silver ratio has strongly favored Silver, with the ratio trading below the 38-to-1 ratio for the first time since 1998. This may be a sign that the speculative interest in Silver has become overdone and a price "correction" may be needed to restore health to the bull market after shaking weak longs out of their positions. A look at the most recent Commitment of Traders report shows both large and small speculators holding a net-long position of nearly 60,000 contracts as of March 29th. This was a decline of over 600 contracts for the week, and with prices hovering near their highest levels since the end the great Silver bull market of 1979-80, it would not come as a big surprise if we see prices correct a bit before the bull market resumes its historic climb.
Technical Notes
Looking at the daily chart for May Silver, we notice how well the market has trended upward since prices moved above the 20-day moving average in February. Since that time, the 20-day MA has been a key support level, with prices failing to close below this indicator since that time. We are starting to see a few signs that the bullish momentum might be beginning to wane. Volume is starting to slow some, and down-volume has been higher than up-volume during the past several trading sessions. The 14-day RSI is showing a bearish divergence, as this momentum indicator is holding just below overbought territory with a current reading of 69.46. The contract high of 38.180 remains resistance for May Silver. Support is found at the 20-day moving average currently near the 36.220 area.
Mike Zarembski, Senior Commodity Analyst
