Is It Time to Buy Silver?

By Jared Levy, Editor, 

Unless you have been hiding under a rock, you probably know that silver has had a major correction over the past week. The precious metal plummeted about 30% from a high of almost $50 an ounce to less than $35 yesterday. This six-day drop is one of the largest since 1983.

Silver has given back just about all of its gains for the past month and some traders are thinking it might be time to get long. But before you run and buy silver, there are a couple things to consider.

Forces That Move SilverThe U.S. Dollar

There are many theories on why this sell-off is happening. Obviously, any real strength or even support in the U.S. dollar will generally be bearish for precious metals like gold and silver. This is mostly because the U.S. holds the largest stockpiles of these metals and they are traded in U.S. dollars globally. Even though gold is more of a recognized currency, they both have sensitivity to changes in the U.S. dollar's value.

The falling dollar has recently leveled out. That means we've seen a small correction in dollar-denominated commodities and metals overall. Earlier this week, the European and London central banks held their rates steady. The ECB also hinted that they may not raise their rates next month either. This is good news for the U.S. dollar.

The dollar traded higher late in the day yesterday and sent other dollar-sensitive commodities like oil and even stocks much lower on the day. Oil had its largest percentage drop in three years. If you don't believe that the dollar is in control here, think again...

For now, it seems that the dollar will continue to be relatively weak. The rally seems more like a short-term bump rather than a long-term trend. Current Fed policy puts general downward pressure on the U.S. dollar.

Gold/Silver Ratio

Then there is the historical ratio between gold and silver. A good "average" ratio of gold to silver is about 55, according to many experts. That means 1 oz. of gold should buy 55 oz. of silver. The gold premium is because there is much more silver on this Earth than gold. Even though silver has industrial uses beyond gold, there is a global desire, respect and currency reserve with gold that silver just does not have.

If that ratio gets extremely high, like 100, that means that silver is cheap relative to gold and may be a good value. If the number is low, silver may be getting overly expensive.

On April 28, the gold-silver ratio was about 30, relatively low. Now the ratio is back up around 43, still low, but not extreme. I'd like to see that ratio above 48 if I were thinking of buying.

Using current gold prices of $1,494, that means a drop in silver prices to $31.12 an ounce. Remember, though, that ratios are a two-way street. That means gold prices can climb, too, putting the ratio closer to its "good average."

Technicals

Technical formations also play an important role in finding buy and sell points. Looking at iShares Silver Trust (SLV:NYSE), you can see the sharp sell-off on the right side of the chart. In my opinion, it seems that we are nearing a short-term bottom. The lower Bollinger band (gray area) was just broken yesterday, as prices dipped below the lowest level of the band. This is generally an indicator of an oversold condition just before a bounce.

ETFs

ETFs like the SLV hold actual silver and futures contracts. At present there are about 600 million ounces of silver held by ETFs. When traders begin to sell shares of an ETF like SLV, the ETF may sell silver futures to keep everything in balance. About 6 million ounces of silver have exited ETFs in the past week.

ETFs can also add to the domino effect, both long and short. But remember that stocks usually take the escalator up and the elevator down!

Once the hype settles down and the CME completes its margin increase on Monday, we should see silver prices stabilize. From my perspective, I see $33 as a level I may cautiously begin to buy. If silver breaks below that level, I think support will be around $29 until the Fed decides it's time to cool inflation.

I am sure that Ben B. was feeling quite happy with the corrections in gold, oil and silver this week. Perhaps Americans will feel some reprieve as well..