Silver Investing—What Happened in 2011, and How To Play 2012?

Silver investing was the proverbial “Place to be” in early 2011.  In early 2011 the price of silver hit a new all-time high just shy of $50 an ounce.  Then price dropped sharply, leaving silver at a loss for the year. Did the silver bubble burst in 2011?  Many say it did.

Before I get into technical analysis, I’ll point out that in my observation, the price of physical silver has not fallen as much as the “paper” price of silver.  I cannot buy physical silver for spot price, as I often did during 2010 and early 2011.

The spot price of silver is determined by the futures market, in which total open contracts represent 100 to 200 times as much processed silver as physically exists. The futures market was established to provide sellers and buyers a market in which they can buy and sell commodities at guaranteed prices. Speculators provide the liquidity (the guaranteed price in the future) that all markets need to operate–and speculators take the risk.  For various reasons, those who owned paper silver sold in droves.  But those of us who own physical silver are not letting it go so cheaply.

If you are familiar with technical analysis at all, you know that “The trend is your friend.” Let’s define trend.  An uptrend is defined by higher price highs and higher price lows. When drawing trend lines on a chart, the slope of an uptrend is defined by a straight line drawn through the low points for the period of time being considered.

A downtrend is defined by lower price highs and lower price lows. The slope of a downtrend is defined by drawing a straight line through the high points for the period of time being determined.

Consider the five-year silver price chart below. I have drawn three trend lines; the longest labeled “trend 1.”  Trend line 1 depicts a nice steady uptrend that covers almost two years. Then, in Q3 of 2010, “trend 2” begins. The upward slope of trend 2 is much steeper than trend 1.

silver investing chart

In early 2011, the price of silver shot up steeply for about three months. Then it crashed; turning almost straight down for two weeks. We then had a recovery, and then another crash, during which the price of silver broke the short term trend line 2. In the middle of 2011, a new short term trend began. That trend is down, as depicted by “trend 3.”

An uptrend line often acts as price support when price is above it (note the number of times prices touched or approached trend line 1 and “bounced” back up). A down trend line often acts as resistance when price is below it.  At the beginning of 2012, price is below the downtrend line 3, but above the long term uptrend line 1.

I have extended trend lines 1 and 3 off the end of the chart, into the future. Down trend line 3 will act as resistance, and uptrend line 1 as support.  Obviously, price must break one of those two trend lines on or before that future date. Which is it likely to break?

Remember, short term trends occur within long term trends. Trend theory holds that longer term trends are stronger than shorter term trends. Also, the fundamentals that propelled silver into this multi-year uptrend remain in place.

Odds are, the longer term trend line 1 will hold.

Despite what the silver bears say, there is no price bubble.  Therefore, the bubble did not break in 2011.  There will be a bubble, but it will be several years before it forms and gets into bursting territory.

I own physical silver, and have sold none during this price drop. I look on physical silver as insurance against high inflation, which I am confident is coming, and against the risk of economic chaos, which I am pretty sure is coming.  I have not bought more silver because I think mid-term (1-3 years) fundamentals factors may take the price lower.  But that is another discussion

I also invest in “paper silver” in the stock market via ETFs and options. I was short “paper silver” in late 2011, and made some money.  There may be another opportunity or two to short silver before it take off to new all-time highs.

For silver investing ideas on how to play silver in these volatile times, see part 2 in a couple of weeks, with an updated chart.

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