Potential precious metals trade

Spot gold and silver have been sold heavily of late and it’s interesting to see how influential the USD is in driving price.

Source: Bloomberg

If we go back to mid-August, the USD had seemingly little influence, with the USD basket (a weighted basket of major currencies against the USD) holding a low correlation with both commodities. If we look at present conditions, we can see spot silver and the USD basket now holds a negative 81% correlation, which is the highest influence of the year. In this regard, strength in the USD is putting downside pressure on the precious metals complex.

From a pure fundamental perspective, I still like the USD higher, but technically I feel the USD is overbought and therefore due for a pullback from that I expect traders to support. With this in mind, I feel silver and gold could face less headwind in the short term.

With the USD overbought, it’s interesting to see just how oversold spot silver is. On the daily chart, the nine-day RSI is currently at 11.67, while stochastics are also at extreme lows. Still, if we look at the set up on both the weekly and daily chart, silver has broken through some key horizontal support and looks bearish. It looks set to head to much lower levels.

The question is whether new short positions should be added at current levels or wait for short covering to kick in?

My preference would be to sell rallies in the commodity, while traders who are more aggressive could look to buy at current levels – putting a stop loss around 1760 for a move back to the June 2013 lows of 1820.

While the more aggressive approach looks compelling, it’s worth bearing in mind the downtrend is strong and there aren’t any major reversal signs on the daily chart. However, I certainly wouldn’t be putting new money to work on the short side.

So it’s a tough one, but given I see a high prospect of a pullback in the USD while silver is so oversold, I feel selling rallies is clearly preferred. Given the aggression behind the selling on Friday (see Friday’s candle), it’s logical to see upside corrections confined to the 1820 area.

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