Looking for the Silver Lining

By Dr. Duru written for One-Twenty

May 21, 2006

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I know, I know. What an original title: "Looking for the Silver Lining." But looking for the silver lining is exactly what I find myself doing as I survey the current damage to silver stocks and commodity stocks in general. Two weeks ago, I stood in defiance as Bolivia's nationalization of its natural gas resources spread despair throughout any commodity play with ties to Bolivia or other seemingly antagonistic Latin American governments. At the time, I declared that there was no reason to sell and, for PAAS in particular, the decline was a great buying opportunity. Since then, PAAS has fallen for a gut-wrenching 20% decline while the silver commodity itself has "only" fallen 12.5%. It turned out that not only did the market have to deal with commodity risk, but it also had to deal with a "sell on the news" mentality that had folks selling commodities hand over fist as economic data emerged indicating that inflation may be picking up steam. Given that part of the excuse for buying commodities, metals specifically, was a protection against a declining dollar and increasing inflation, the media had to turn to another excuse for explaining the movement in these stocks. Suddenly, we have fear tha the Fed will keep hiking rates and will actually win the battle over inflation and a declining dollar. (Click here for my stylized diagram of the current "conundrum.")

I personally believe that a lot of the hot and speculative money rushed for the exits all at once and took a lot of the steam out of these markets. When you have something hitting multi-decade highs, you have to expect sellers will eventually find an excuse to hit the exits en masse at some point. So, now that news flow has sharply turned negative, we should not be surprised to see further weakness ahead. But it is exactly at these points that you have to keep focused on the fundamental story that was driving the beast just a mere two to three weeks ago. The transcript of the earnings call for PAAS at the beginning of the month provides an excellent review of the unfolding political drama and the fundamental economics that are driving the silver business. I will trust you to review your fundies in good time. In the meantime, I thought I would do a quick review of the technical picture of the three silver stocks I examined at the beginning of the month: PAAS, CDE, and SIL. Is there a silver lining? It is a tough call. If you still believe in the fundamentals, you have one gift of an opportunity to nab PAAS at prices last seen at the beginning of the year. CDE is almost there. SIL has already passed that point. Again, I am much more familiar with the PAAS story and have focused my silver investments there. Please refer to my previous missive for more details and links regarding these three silver plays.

PAAS, CDE, and SIL have suffered some serious technical damage in May, and all three have dropped nearly straight down over the past week or so. This is easy to see. So, I will train the technical magnifying glass on the larger picture using a 9-day chart on PAAS:

Pan American Silver chart

What the longer-term picture on PAAS shows us is that the stock is at a critical juncture. It spent two years spinning its wheels between big rallies and big corrections before breaking out in 2006. It currently sits on support that forms the approximate top of the previous range. If PAAS fails this support, it very well could get sucked right back into the old trading range. The long-term trend certianly remains up, but this is not a trend that has been easy to stick with. As anyone in the commodities pits knows, these plays are prone to serious, sharp, and rapid corrections that serve to shake the faith of all but the firmest of believers. I am sticking with the longer up-trend for now. (Click here for my disclaimer.) A lot will depend on the market's mood. If the market choose to reflect its fear of inflation by hedging in metals again, then PAAS will be just fine. If somehow the market choose to believe the Fed is on the verge of conquering inflation, then look out below. There are a bunch of other excuses for stirring interest in the metals anew: geo-political drama, falling dollar, economic uncertianty. It is all a matter of which one or ones the market chooses to believe in for the moment.

So what of CDE and SIL? Well, as I said, I know much less about these silver plays. But I will trust you to take your own long-term technical review of the two if you so choose. What I see is that CDE has corrected hard from a top it made in early 2004. It also remains well below the highs (and the trading range) it established for over 10 years starting in 1984. From that standpoint alone, I have to like it less than PAAS which has at least managed to break away from the former highs of the mid to late 1990s. SIL is now back to price levels it has visited often over the past four years. These prices also formed tops back in the late-1990s. I can't call anything on this one. I suspect its fate is now being strangled by the political drama in Bolivia. If you are a believer, you have been given an excellent gift.

Regardless, be careful out there...and keep polishing that silverware!

DrDuru, 2006