Can Silver add a Contrarian Shine?

Silver is looking ugly--but a turnaround is likely

   

Silver prices are plunging, there’s no denying that. The technical picture in silver is indeed ugly, a point expertly made by my InvestorPlace colleague Serge Berger in his piece, “Silver: Ugly, and Getting Uglier.”

Yet I’m a contrarian by nature, so given the latest drop in silver prices, I start to ask myself how I can take advantage of the downtrend. Is there a “blood in the streets” buy here in the space? I suspect so.

Earlier this week, I noticed that the Commitment of Traders report in silver continues to signal that there isn’t a risk of an impending washout. Here the “net long” position of speculators in silver is now at just 1k contracts, down from a high of 36k in October.

My friend, and veteran commodities trader extraordinaire Tom Essaye, Editor of The 7:00’s Report (a publication I strongly recommend to all traders), told me that the number of shorts in the market is the highest he’s ever seen it, at 22k contracts.

“This may be just coincidence, but the last time the number of shorts was anywhere near this high was in the July 24, 2012, COT report, which pretty much marked the low in silver for 2012,” said Tom. He then told me, “Interestingly, within eight weeks of that high in the numbers of shorts in silver, the metal had traded from $26.81 on July 24 to $34.77 on Sept. 13, a gain of 30%.”

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I don’t know if this can happen again this time, but historically speaking, when the silver market becomes this short, the chances of a continued decline are small.

If the risk here of a further silver decline is small, then adding some silver to your trading portfolio could end up being a very shiny trade. This can be done in a couple of ways. First, you can buy the metal via the iShares Silver Trust (NYSE:SLV), an ETF pegged to the spot price of silver. Or, if you are a more aggressive trader, you can buy call options on SLV.

If you go the SLV route, then you should buy silver at the market, and set a stop-loss about 10% below your buy price. If history is any judge, we could see silver begin a climb from here to the low-$30 range, and that would be about a 30% upside from current levels.

For those a little more risk tolerant, calls on SLV are probably about as cheap as they’ve been in a very long time. I’m currently looking at as far as October, with the SLV Oct 2013 29.00 call, which last traded at 70 cents.

At the time of publication, Jim Woods did not hold a position in any of the stocks mentioned here.


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