It’s been a volatile 3-week stretch far for the precious metals sector, but after a tense battle at the $22.00/oz level, the bulls seem to finally have the upper hand in the silver (SLV) trade. This is since silver has recovered nearly all of its 7% loss in September, up nearly 8% month-to-date. The recovery is partially attributed to the fact that bullish sentiment readings continue to sit at their lowest levels in years. When we see extremes in sentiment, markets are very prone to violent moves in the other direction. The other potential boost to the silver price is the most recent inflation reading, with the annual inflation rate coming in at a 13-year high at 5.4%. In inflationary environments with negative real rates, precious metals typically perform well, and this is certainly the environment we’ve found ourselves in currently.

This strong fundamental backdrop combined with extreme pessimism can breed strong forward returns; hence a buy-the-dip strategy makes sense as we head into a stronger seasonal period for the metal. Let’s take a closer look below:

(Source: EquityClock.com)

As noted in prior updates, bullish sentiment remains near multi-year lows in the silver trade, with complete despondency among market participants. This is evidenced by a reading of just 20% bulls in the silver market over the past three months, suggesting that we have four bears for every one bull in the market.

In the early October update, I noted that this was likely to lead to a buying opportunity if weakness persisted, especially with silver typically making its low in early October. As shown in the above chart, silver is so far tracking its Q4 seasonality, with a low in early October followed by a strong rally into year-end. However, while the average rally from the October low to the December high typically amounts to just 5%, the bulls have a major tailwind at their backs, which is the possibility for more bulls to enter the trade after a mass exodus from the trade during Q3. So, if silver rallied 10% in Q4 to finish the year above $25.00/oz, I would not be surprised in the slightest.

(Source: TC2000.com)

One worry heading into October was a continued degradation in the silver/gold ratio, with the ratio plunging from 0.16 to 0.128 and nearly breaking below its long-term moving average (white line). However, as shown above, this ratio found support exactly where it needed to, bouncing at its key support level, with a continuation to the rally this week. The last time we saw this moving average regained after a multi-year downtrend was in September 2010, with silver enjoying one of its strong yearly returns on record in the following 12 months.

Obviously, history does not have to repeat itself, but the recent bullish reversal in the silver/gold ratio is encouraging, as is the fact that it continues to hold above its key moving average after a multi-year bear market. The above chart clearly shows that the 2016 rally above this key level was a false start, and the moving average did not provide support during the pullback. So far, this is a change of character, pointing to a higher probability that this 13-month correction in gold (GLD) and silver is a shake-out in the precious metals space and not the start of a new bear market. Let’s take a look at the technical picture:

(Source: TC2000.com)

As the chart above shows, silver has broken out above a multi-month downtrend line, after a false breakdown below its $22.00/oz support level. This is a positive development, and false breakdowns can often produce very strong moves to the upside. At a current price of $23.80/oz, the bulls still have work to do to regain upside momentum on the daily chart. However, this is a large step in the right direction. Moving to the long-term chart, though, we can see that the picture continues to remain bullish, with silver breaking out a multi-year base to 6-year highs and finding support just above its breakout level ($21.00/oz to $22.00/oz). As long as this support zone continues to hold,  the benefit of the doubt will go to the bulls. So, while it’s easy to be negative when so many others are throwing in the towel and pessimistic, I believe it’s best to remain open-minded, given how impressive the below yearly chart is, which portends much higher prices ahead.

(Source: TC2000.com)

With silver remaining bullish on its long-term chart and recently breaking above its short-term downtrend line, the technical picture is improving, combined with a sharp recovery in the silver/gold ratio. For this reason, I believe the best course of action is leaving orders below the $22.60/oz level to buy the dip, given that I expect the $22.00/oz level to hold as strong support if re-tested. If silver fails on this rally and breaks below $21.00/oz, the $22.60/oz buy zone provides for a relatively tight stop below $21.00/oz.

Having said that, with most of the weak hands now out of the trade and sentiment at its worst levels in years, I see a high probability that we have seen the low for the next 12 months. In summary, I would not be surprised at all if silver regained the $27.00/oz level in the next 12 months.

Disclosure: I am long GLD

Disclaimer: Taylor Dart is not a Registered Investment Advisor or Financial Planner. This writing is for informational purposes only. It does not constitute an offer to sell, a solicitation to buy, or a recommendation regarding any securities transaction. The information contained in this writing should not be construed as financial or investment advice on any subject matter. Taylor Dart expressly disclaims all liability in respect to actions taken based on any or all of the information on this writing.

SLV shares were trading at $22.53 per share on Wednesday afternoon, up $0.64 (+2.92%). Year-to-date, SLV has declined -8.30%, versus a 22.08% rise in the benchmark S&P 500 index during the same period.

Taylor has over a decade of investing experience, with a special focus on the precious metals sector. In addition to working with ETFDailyNews, he is a prominent writer on Seeking Alpha. Learn more about Taylor’s background, along with links to his most recent articles.

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