Silver At Parabolic Blow Off Top (Trader's Narrative)

Published November 10th, 2010 in Natural ResourcesTags: CME, Commitment of Traders, distance from moving average, DSI, parabolic,precious metal, reverse hammer candlestick, silver.

The market took a breather yesterday with many previously strong indexes and commodities selling off. The decline in silver was especially pronounced and produced a reverse hammer candlestick which has obviously bearish connotations.

Of course, yesterday the CME raised the margin requirements for silver from $5000 to $6500. While this is being credited with causing the reversal, I don’t think that it completely explains what happened. It definitely contributed to it but often we grasp at news or reasons for the market’s moves when all you need to do is watch the price action itself.

Anyone paying even cursory attention would know that the precious metal was already extremely overstretched to the upside and had been sporting extreme bullish sentiment for some time. I outlined just how extreme in late September when silver reached a new 30 year (nominal) high accompanied by a 95% bullish DSI.

Silver managed to shrugged that off and went on a parabolic rise peeking above $29. Personally I was expecting it to reach the nice round number $30 before reversing. But it doesn’t look like it is going to now.

There is currently a rare technical occurrence in silver: the relative distance from its medium-term and long-term moving averages is at an upside extreme. In the past 30 years, that has only happened 6 other times and all of them were instances of a major top:

Needless to say, the RSI indicator also reached an extreme overbought level yet again. Note that I’m ignoring instances where either one or the other is at an extreme and looking at just instances where they are both signaling an overbought condition. This confluence of overbought extremes identified the major tops in silver in the following years: 1982, 1987, 1998, 2004, 2006 and 2008. The current condition remains to be seen but historical precedent would suggest this is a major inflection point.

Interestingly enough, the large commercial hedgers have slowly reduced their large net short exposure since late September. They are still maintaining a large chunk of contracts short (54,811 net short) as of November 2nd, 2010 which is the latest data available. Meanwhile, small speculators are net long with 16,257 contracts.