Silver Market Strong, but it's Time to be Cautious

This guest article was written by James Hyerczyk from FX Empire.

Last week, July Comex Silver prices reached their highest level since January 2015, driven mostly by the Bank of Japan’s decision to hold off expanding monetary stimulus and weaker equity markets. The dovish U.S. Federal Reserve monetary policy statement also helped support the surge in prices. The Fed kept the door open to a hike in June, but showed little sign it was in a hurry to tighten monetary policy.

Although silver prices are relatively expensive and nearing a key technical resistance area, the news from the Fed is likely to support higher prices into June as long as there aren’t any U.S. economic surprises between now and then.

Some investors believe that silver prices could rally the rest of the year. This is based on the notion that the economy is too weak for the Fed to raise rates at all in 2016. Last week, economic data showed that U.S. economic growth braked in the first quarter to its slowest pace in two years.

Silver finished the month up 15 percent, posting its biggest monthly gain since August 2013. The rally was initially fueled by speculators taking advantage of the price discrepancy between gold and silver. Those who bought silver weeks ago were banking on it catching up with gold after lagging behind it in terms of price appreciation for several months.

The gold/silver ratio, which measures the number of silver ounces needed to buy an ounce of gold, fell to a 6-month low last week of 71.8. At the start of the month, the ratio stood at 81.3. There are some traders who believe that the ratio target is 70.0.

As the gold/silver ratio starts to near 70.00, we may begin to see profit-taking hitting the silver market. This coupled with the test of a major retracement zone at $17.48 to $18.81 could help to put in a short-term top. Additional resistance is the January 2015 top at $18.59.

While we don’t want to step in front of the strong rally in order to pick a top, we will watch carefully this week for signs of a short-term top. The most obvious signal will be a closing price reversal top on both the daily and weekly charts. The best suggestion is to remain cautious at current price levels.

During this kind of surprisingly strong rally, we shouldn’t be too concerned about the upside because if the trend is strong, higher prices will take care of themselves, however, we should have a plan to protect the downside because a break from current levels could be unforgiving especially to those who bought late in the game.

The winners at this time bought early when they noticed the strong buying going on in the Silver ETF market. During the recent accumulation period that lasted from early March to early April, professional investors were buying silver. Choppy, two-sided trading above a major bottom tends to indicate accumulation. Conversely, the vertical price action currently taking place tends to indicate that we are nearing a top due to excessive speculation.

My advice this week is to watch the price action and read the order flow inside $17.84 to $18.81 to determine if the strong buying is still taking place. If the buyers are still supporting the rally then the best you can do is to move up protective sell stops because once the selling becomes greater than the buying, July Silver may correct back to at least $16.41.