Rethinking the Unthinkable

Rethinking the Unthinkable by PRZEMYSŁAW RADOMSKI, CFA for Sunshine Profits

Crude oil was just trading below 0. Well, not completely, but the nearest futures contract was trading below 0 for the first time ever. Ridiculous, right? Well, yes, and no. It’s not that ridiculous if you take into account bigger supply due to earlier OPEC+ disagreement and lower demand due to Covid-19. Producers have to produce crude oil on a daily basis, because shutting down production is costly. One cannot store oil just anywhere and the facilities designed for it were already getting full. This means that people were unwilling to buy it, because it was not really possible to store it. To encourage people to buy it (and take delivery) anyway, producers paid extra instead of charging per barrel – more than $30 per barrel.

Sure, it was just the May contract, which expires today and the delivery is next month. The following futures contracts (the ones that expire in the following months) are priced at about $20 or higher. But will they be able to remain as high? The market thinks that the situation will somehow be resolved within a month. But will this really be the case? If not, we could see something similar once again.

Crazy times, and economic history in the making.

Why are we starting today’s Gold & Silver Trading Alert with remarks about crude oil? For two reasons. First, the above is the news that gained the spotlight yesterday, so you might have wanted to read a quick explanation. Second, this is a clear message to all investors and traders worldwide:

The unthinkable in the markets can happen, and it can happen overnight.

If anyone still thought that silver below $10 (or $9) is impossible, they probably no longer think so to. And this means that support at these levels will be much weaker, and the odds that these levels will be breached, just increased.

Actually, silver is also primarily produced as a by-product (in copper mines). As copper is produced, they also have to extract silver. This is an oversimplification, but it will be sufficient for this discussion. The point is that since the new silver supply will keep on coming anyway, the price might decline substantially if the demand doesn’t match it.

Of course, there will be huge demand for silver bullion as the price moves lower… But, if the mints can’t produce enough to satisfy the demand, we could see relatively high silver bullion prices while at the same time seeing a big decline in silver futures. Well, we already see this today, but based on what we saw in crude oil, it’s obvious that the premium for silver could increase substantially.

The actionable part of the above is two-fold:

  1. If one has silver stored as insurance, we don’t suggest selling it based on the likelihood of the upcoming decline, as the premium on these silver coins or bars could increase, making up for some of the decline. At the same time, it might be particularly difficult to get back in the physical market at the bottom (as described by the futures market).
  2. The decline in the futures market and other proxies for the precious metals market other than the physical, tangible ownership could be severe (which is in tune with what we’ve been expecting to see anyway).

Having said that, let’s turn to charts, starting with the USD Index.

In short, the self-similarity to the early-March continues, which means that our previous comments on the above chart remain up-to-date:

The USD index soared after forming an intraday reversal. It then declined, rallied back up, and declined quickly once again – all just as it did in early March.

The final 4-hour decline was sharp and it took place as the USDX broke below the rising support line that was based on the early intraday lows. We saw the analogous decline on Friday, and the USD Index has been moving slowly up since that time. Both situations are very similar from the pattern point of view.

Back then, the analogous price action triggered further upswings, which translated into lower prices of the precious metals. The bearish implications remains in place at this time as well.

Please note that the recent price action also almost created an inverse head and shoulders pattern (we’ll have H&S patterns in other markets as well). Once the USD Index breaks above the mid-April highs, the pattern will be complete, and it would like result in a rally to about 102 level.

How could the above translate into a gold price prediction?

It would simply be likely to make gold slide. Quite likely in tune with its 2008 decline.

The full version of today’s analysis includes details of our currently open position as well as targets of the upcoming sizable moves in gold, silver and the miners.

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