Silver Bullish Sentiment Hitting Extremes

(August 11, 2020 - Taylor Dart)

We had seen yet another strong week for silver (SLV) with the metal up 16% last week, and years of underperformance vs. gold (GLD) are now a thing of the past.

In the past three weeks alone, the gold/silver ratio has dropped from 130 to 1 to 70 to 1, and this massive outperformance has contributed to near-record optimism in silver currently.

As of Monday’s close, the 14-week moving average for silver’s sentiment was sitting near 83% bulls, which tells us that there are 8.3 bulls for every bear in silver on a trailing-three-month basis.

Even more worrisome, we’ve seen nine readings above 90% bulls for silver in the past 15 days, and even a single day of 90% bullish sentiment is typically a red flag.

Given the extreme exuberance levels we’ve seen, I continue to see this as a terrible time to be chasing the metal, as it rarely pays to chase an asset when everyone else is piling. Let’s take a closer look below:

As we can see from the first chart above, the silver/gold ratio has seen a near parabolic spike over the past month, and one of the most dramatic spikes in the past decade. While this certainly bodes well for silver long-term as it tends to perform better when it’s leading gold, it’s a red flag short-term.

The other issue is that the silver/gold ratio is now running straight into a multi-year resistance level dating back to 2016, and it’s unlikely it’s going to head through there with some difficulty.

Therefore, I would argue that at a gold/silver ratio of 65, silver’s outperformance is likely getting a little ahead of itself.

If we take a look at silver from a sentiment standpoint, we’ve been in the danger zone (red box) for over two weeks now, and any time silver has visited this zone, it has rarely ended well.

In fact, in the past three instances, silver corrected by over 15% over the following two months from the time that it entered the danger zone above 79% bulls. Assuming this were to play out similarly, we would expect silver to trade down to $22.60 before the end of September.

There’s no reason to believe that the correction has to be this deep, but I would be quite surprised if we didn’t head down to at least $24.50/oz by early October. Typically, when there are this many bulls in a trade, we need a significant correction to shake them out, so we’re going to need at least a 17% correction from the $29.50/oz highs to begin to cool off sentiment.

Unfortunately, the other issue we have with silver is that it has charged higher in a parabolic fashion since June, with zero pauses along the way. This is an issue as parabolic rallies rarely unwind in a gradual fashion; instead, they correct violently as there are no support levels to catch them.

While this doesn’t mean that we have to head back to the $22.00/oz level breakout on silver, it is certainly an outside possibility and a worst-case scenario. Therefore, while some investors might be tempted to buy this micro-dip to $28.50/oz, I would argue that it’s probably not the best idea.

Ultimately, I would expect some more pain short-term before silver puts in a meaningful low.

So, what’s the best course of action?

As noted last week, I had taken quite a bit of profit in my silver miners, and I continue to wait patiently for some fear to enter the market to repurchase my positions. At this time, we don’t even have the slightest hint of fear, and we have the most overbought reading in years on silver, so I have zero interest in adding new positions here.

If we could see a pullback to the $25.00/oz level or a drastic shift in sentiment, I would consider adding some more exposure. For now, I believe investors would be wise to be patient and allow the correction to run its course.