Why the Sizzle in Silver May Stick Around

SilverSilver is hot again and is at its highest level in six months. The launch of QE3 (a third round of quantitative easing) by the Federal Reserve helped drive another upside move in the white precious metal. With QE3, expect to see continued low interest rates and a soft U.S. dollar, which in turn could drive consumer spending and inflation higher, along with silver and gold prices.

Just as gold is considered more of a pure-play hedge against risk, silver is also, but to a lesser degree. Silver is driven higher by increased jewelry demand and industrial output as many electronic products incorporate the use of the precious metal.

The price of silver has been sizzling on the chart since a breakout in August, based on my technical analysis.

As you can see on the chart, the upward move in prices above the 50- and 200-day moving averages (MAs) is bullish. The moving average convergence-divergence (MACD) is also quite bullish but may be approaching a top.

The risk is that the run-up appears to be overextended and may be vulnerable to some near-term selling pressure with resistance around $35.00.

Silver Spot Price EOD Stock Chart

Chart courtesy of www.StockCharts.com

Early on, silver traded in a tight long-term sideways channel around $5.00 between 1988 and 2004, prior to breaking out. Speculation and added volatility now make silver a good trading commodity for futures traders looking at playing both the short and long end.

Over the past 20 years, silver has largely outperformed gold, as shown in the following chart that indicates returns to July 1, 2012.

 Silver and Gold Chart

Copyright 2012 Lombardi Publishing

If silver can hold, we could soon see the precious metal take a run at $35.00. Of course, this depends on the global economy picking up. Silver is used in numerous industrial and electronic applications and is more of a trade with the direction of the global economies. The same goes for copper, which moves in relation to the economy and gross domestic product (GDP) growth. Take a look at small mining companies. (Read “Junior Miners Offering Great Upside.”)

Looking at it from another angle, the fixed exchange rate between gold and silver was 15.5:1 in the 19th century, but it has moved much higher in the 20th century to an average rate of 47:1. The spot gold price was $1,766 on Tuesday, compared to $34.53 for spot silver; this equates to a current gold-to-silver ratio of 51:14, which means that silver could be undervalued and could head higher towards the $38.00–$40.00 level.

I would be hesitant to buy silver after its recent run-up; rather, I would wait for some overbought selling to surface before buying. A break at $35.00 would be bullish and could drive silver towards $40.00—maybe even taking a run at the $50.00 level, which it reached last in early 2011.