Chart of the week: Rally not over

Fresnillo slips back - for now

On 3 May, I updated the silver miner Fresnillo, which was one of my star buys last winter. In the first few months of the year, silver prices have shot up from around $13.50 per ounce to a recent high of $18 - a major move of around 33%.

Naturally, when silver rockets on that large a scale, silver mining shares do even better than the metal and I managed to catch this move from a low of around £6 to a high of almost £12 - a move of nearly 100%.

But, as I pointed out last time, both gold and silver have been transformed from winter no-hopers to springtime beloveds. Yes, precious metals have been totally embraced by investors and traders alike.

In fact, according to the Commitments of Traders (COT) reports of the futures holdings of the three groups of participants, hedge funds are holding the record largest net long position ever. They have never been this bullish since records began.

And that ran up a big yellow flag to me, bullish as I have been. Hedge funds are doing what they always do - they are herding. And we know what happens to herds when they get too large - they get picked off by the bears.

Hedge funds are mostly trend-followers. They have never seen a trend they do not fall in love with! It doesn't matter what the market is, they will follow it.

That consideration was foremost in my mind in early May when I warned the rally to the £12 region was likely to be a major high.

But crucially, during May, hedge funds have been taking profits on their long bets in style. According to the latest COT data (as of May 24), hedge funds reduced their longs (and the commercials reduced their shorts) at a record clip.

This means that today the position is not so lop-sided and further setbacks could be well contained.

This was the chart I showed then:

The Elliott waves were quite clear. From the winter lows, the market was rising in a series of impulsive waves with the latest wave being at or near the end of the small-scale purple fifth wave, which was also the end of the red third wave.

The implication was clear - get ready for a pull-back. This is what I wrote then:

But when wave five terminates, I expect a hefty decline - hopefully in a classic A-B-C. There is major resistance up ahead in the £12-13 zone (currently £11.15), which would be a suitable area for the current rally to exhaust.

Odds are high that upside progress is limited from here and the "easy" money has been made.

With a near-100% gain in the shares, and the wave patterns appearing textbook, the end of this stage of the rally was nigh.

So how has my prediction worked out? Here is the updated daily chart:

In fact, the high was attained on 17 May at the £11.60 level - right up against my cited resistance zone of £12-13. And since then, the shares have fallen back to the £10 area.

And the whole rally from the wave three high to the wave five top was a very weak one, with momentum losing strength steadily all the way up. That was another clear warning the rally was on borrowed time.

Naturally, with a clear setup last time to expect a pull-back, traders were getting ready to take major profits and, with the gap opening on 19 May, that surely was a clear indication that the pullback was getting started.

I now have a very good tramline pair working (blue lines), with the lower line sporting two good prior pivot points, making this line a reliable line of support.

Outlook

With the market now on short-term support, I expect a bounce from near current levels, but the current decline may not be over. The dip may be wave A of an A-B-C down with the C wave low to come. A break of the lower tramline would herald a further dip.

But longer-term, the rally in silver (and gold) and the miners is not yet over. In the months to come, I expect new highs in silver above the recent $18 high - perhaps towards the $25 area, and that will drag Fresnillo up well above the £12 high - perhaps close to the £20 region, which is the area of the major highs in 2011 and 2012.

This article is for information and discussion purposes only and does not form a recommendation to invest or otherwise. The value of an investment may fall. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment adviser.