Silver breakout

18/02/2011 by Philinje.

As I was writing my last post, the silver price was just approaching its recent high of $31.30-ish. Then I went to bed. Silver never looked back and headed straight to $31.80, definitively breaking through its last high. The price did not decline in after-hours trading, as has been the pattern lately, and it’s still there as equity markets open on Friday morning in NY.

That is mighty strong behavior. Gold got to $1385, still far from its recent high, but making it through bearish resistance. The stage is set for some fireworks.

Of course, there is a lot of talk today about a short squeeze in silver, and also about backwardation (where future month prices are in fact lower than the spot or current price), a condition that some claim to be a precursor to major spikes in price. The reasoning is that physical silver is in short supply and that is why the spot price is higher than future prices. As this condition persists, holders of short contracts run the risk of not being able to cover, and therefore stampede for the exits by buying.

That is a short squeeze. In commodities, a short squeeze can be dramatic, because ultimately any trading position has to be covered by the real stuff. I was in the business of trading electricity some years ago, and it was amazing to see how prices could jump from $20 to $2000 - in minutes, if not seconds! That was simply because electrcity demand is instantaneous, and if supply is suddenly not there, it has to come from somewhere immediately.

To be fair, silver has gone into backwardation in recent years and that has not resulted in any immediate spike in price. That is a fact. So take all this backwardation hype with a grain of salt.

On the subject of msasive jumps in price, here is a level-headed assessment of how high prices could go in both silver and gold. Note that this is not a call on the immediate action, just a general idea of what is reasonable to expect down the road. Short answer: about 5X from today’s prices, a little less for gold.

http://www.caseyresearch.com/displayCdd.php?id=657

In terms of the immediate action, I’ve often referred to Toby at Gold Scents. His analysis is excellent and covers both the big picture and very near term. This piece talks about a possible scenario for the dollar and what that would do to commodities in this melt-up boom. If this scenario unfolds, we will know what to expect over the near term and into next year. We will know in a week or two.

http://goldscents.blogspot.com/2011/02/dollar-on-edge-of-abyss.html

On the subject of silver backwardation, James Turk talks like it’s already here. Well, December 2011 is almost in backwardation. And as of today, in fact just hours ago, the front-month delivery contract has gone to 0 spread against the current contract. Open interest in silver was just huge yesterday. Something is going on and chances are we’ll see some big moves shortly. Here is what James Turk says:

http://kingworldnews.com/kingworldnews/KWN_DailyWeb/Entries/2011/2/17_James_Turk_-_Silver_Squeeze_in_Silver_Could_Be_the_Big_One.html

Please note: he says there will be a short squeeze as we move toward end of Feb. At this moment it seems likely we’ll see into mid-$32. But short squeezes can be dramatic events, and silver was already moving into parabolic mode, so the end result could be $34 to $35, within the next week or two. Maybe.

Finally, here is a historic look at global trade balances resulting in silver movement from West to East and the Opium Wars. This episode with China has strange parallels with the current situation. It will get you thinking about how human history moves in big cycles, repeating itself in new but familiar variations:

http://www.atimes.com/atimes/China_Business/MB17Cb01.html

Buckle up and enjoy the ride.

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