Silver’s young bull market got off to a typically-slow start, lagging gold’s own new bull. But recently the white metal surged to catch up in a record summer rally. That left silver very overbought and facing near-term correction risks led by a record futures selling overhang and weak late-summer seasonals. But this strengthening bull still has a long ways higher to run yet before silver prices reflect prevailing gold levels.
Silver is something of an enigma. By the global supply-and-demand numbers, it’s inarguably another industrial metal. According to the venerable Silver Institute which gathers the world’s best fundamental data, industrial fabrication accounted for 50.3% of total demand last year. That was followed by coins and bars at 25.0% and jewelry at 19.4%. Most of the silver mined is consumed, not hoarded for investment.
On the supply front, the Silver Institute found that only 30% of global silver mine supply in 2015 came from primary silver mines. The great majority of silver produced is simply a byproduct from mining base metals and gold. These byproduct miners often think so little of silver that they sell the upside on their production to silver-streaming companies at relatively-low prices. That doesn’t sound like a precious metal.
Yet contrarian investors still love silver with a zeal unparalleled in all the markets. Silver is a tiny market with extreme volatility, so investors can earn fast fortunes when this metal periodically soars higher. At 2015’s average silver price of $15.68, the Silver Institute’s 1170.5m ounces demanded was worth just $18.4b! That’s a rounding error compared to the size of global capital markets, giving silver huge upside potential.
It doesn’t take much capital inflows through new investor buying to catapult silver higher. And usually the catalyst that rekindles silver demand is gold powering higher. Gold has always driven silver, as the silver investors and speculators take their trading cues from gold. They only flood into silver after gold has powered high enough for long enough to convince them its upside is sustainable. So silver lags gold.
That certainly happened in its young new bull. Back in mid-December around the Fed’s first rate hike in 9.5 years, gold and silver carved major 6.1-year and 6.4-year secular lows within days of each other. No one wanted anything to do with the precious metals, they were left for dead. I argued otherwise late last year, pointing out silver’s deep undervaluation relative to gold. Silver was languishing at stock-panic levels.
If such extremes weren’t sustainable in late 2008 in that epic maelstrom of fear spawned by the first stock panic in a century, they certainly couldn’t last without panic-grade fear. And indeed silver soon started to rally, but it really lagged gold’s initial advance in the early months of 2016. By early March as gold entered formal bull-market territory with a 20.1% gain off its secular low, silver had merely rallied 15.0% at best.
That was terrible relative performance, as silver’s far-smaller market size enables it to leverage advances in gold. Per the World Gold Council, total gold demand in 2015 ran 4193.1 tonnes. At gold’s average price last year of $1159, that works out to a market size of $156.3b. That is 8.5x larger than silver’s! So every dollar of investment capital that flows into silver has 8.5x the upside price impact of a dollar into gold.
By early April gold had rallied 21.0% at best from its secular lows but silver was only up 16.1% at best, not even in a new bull market yet. Some silver investors were getting discouraged, but they didn’t have to worry. Silver lags gold, and was wound like a coiled spring ready to explode as I outlined at the time. Silver finally started outperforming in April, taking its bull-to-date gains to 30.1% versus gold’s 23.1% by month-end.
Following that dazzling April surge into official bull-market-dom, silver was overbought and retreated in May. I didn’t expect much from summer, as silver has a long history of drifting sideways to lower during June, July, and early August even in the strongest bull-market years. Yet silver bucked this summer-doldrums trend to soar in June and early July! By mid-July it had blasted 48.7% above its recent secular low.
By that point gold was up 29.9% at best in its own young bull, so silver’s upside leverage to gold was only running 1.63x. That’s still pretty weak, as silver tends to amplify major moves higher in gold by 2x to 3x. The former is typical, while the latter occasionally flares up when silver grows popular enough to capture investors’ and speculators’ imaginations. While silver hasn’t hit 2x yet, it’s definitely catching up.
With a lot more excitement about silver now than back in early April, traders are wondering where silver is heading next. After such a strong counter-cyclical run, silver is certainly very overbought. So a healthy mid-bull pullback or correction is probable. But from a longer-term perspective, silver’s young new bull market is barely getting started. And silver’s greatest gains historically come late in bulls, not early on.
There are two major short-term risk factors for silver. The most-pressing one is the positioning of silver futures speculators who are exceedingly long. The secondary one is silver’s weak seasonals this time of year. Let’s start with those. By July 13th, silver had rocketed a spectacular 27.7% higher since its final close in May! That’s a radical new bull-year record utterly dwarfing everything that’s come before.
Between November 2001 and April 2011, silver skyrocketed 1104.7% higher in a mighty 9.4-year secular bull. In 2012 silver consolidated high, not collapsing until the Fed’s gross market distortions spawned by the wildly-unprecedented QE3 began in early 2013. Between 2001 and 2012 which were amazing years for silver, on average by July’s same 8th trading day silver was actually down 1.9% summer-to-date.
Nothing like this year’s incredible 27.7% summer-to-date gains have ever been witnessed before. Silver tends to make a major seasonal low in mid-August, where it averaged 4.0% summer-to-date losses in that bull-year timeframe between 2001 and 2012. There’s definitely a risk silver will soon see some of this year’s massive record upside summer-performance delta erode back down toward normal seasonal levels.
Unfortunately investment demand didn’t play a big role in silver’s anomalous summer strength. That leading SLV iShares Silver Trust silver ETF is the best daily proxy available for investment capital flows into and out of silver. Its managers have to respond to differential SLV-share buying or selling pressure by buying or selling actual real physical silver bullion, or else SLV will decouple from silver and fail its mission.
Between the end of May and silver’s latest mid-July peak, SLV’s holdings merely grew by 3.8% or 12.8m ounces. That’s far from enough to explain silver’s enormous upside breakout. It wasn’t stock investors who’ve been aggressively buying silver, but silver futures speculators. The hyper-leveraged bets that these guys make necessitate an extreme-short-term focus, they are momentum players who buy and sell as a herd.
This chart looks at the total long and short silver futures contracts held by speculators over the last 3.5 years or so. Their long bullish upside bets are shown in green, and their short bearish downside bets in red. Silver’s summer surge and its entire young bull have largely been driven by extreme long-side silver futures buying by speculators. That ramped their total longs to record levels, for a record selling overhang.
Silver futures positions collectively held by speculators are published each Friday afternoon by the US Commodity Futures Trading Commission in its famous Commitments of Traders reports. As of the latest data available when this essay was published, speculators held 141.0k long silver futures contracts. This is the highest in our dataset going back to early 1999, and almost certainly a new all-time record peak!
Major interim highs in silver, in bull markets and bears alike, tend to arise when speculators’ upside bets grow excessive. Their very buying forces silver higher, but the moment something spooks them they are quick to rapidly exit these risky positions as a herd. That hammers silver lower until the futures selling storm passes. Silver-futures traders are forced to have a radically-shorter time horizon than normal investors.
Every single silver futures contract controls 5000 troy ounces of silver. At $20 an ounce, that’s worth $100k. But the minimum cash margin required to trade each contract is only $5250. So speculators can run leverage on silver futures up to 19.0x! The legal limit in the stock markets has been 2.0x for decades for good reason. At 19.0x, speculators risk getting wiped out by relatively-small adverse moves in silver prices.
A mere 5.3% move in silver, which is nothing in this volatile market, would obliterate 100% of the capital risked by fully-margined speculators who bet wrong on its near-term direction! Even if they were only running half the maximum leverage at 9.5x, a 10.5% silver move against them would force total losses of their capital bet. These guys can’t afford to be wrong for long, they have to exit fast when silver moves against them.
We recently saw this happen in May. By early that month, silver futures speculators’ longs were up at a then-all-time-record 134.9k contracts. Then a gold selloff on Fed hawkishness spooked silver traders into selling in sympathy. Over the next several weeks, speculators liquidated 16.9k long contracts or merely 1/8th of their peak holdings. This forced silver 6.7% lower, which is well into formal pullback territory.
Today speculators’ silver futures longs are even more extreme at that all-time-record 141.0k contracts. To put that into perspective, it represents leveraged upside bets on a whopping 705m ounces of silver! That is the equivalent of fully 4/5ths of the entire world’s mine production in 2015. And because of the risks inherent in hyper-leveraged futures trading, these positions will be unwound fast when silver turns.
Within a span of weeks speculators could sell 1/8th, 1/4th, or even a 1/3rd of their record silver futures longs which would really hammer prices. If they sell and close 1/3rd of their excessive longs, that would still leave their total position at a lofty 94.0k contracts which still remains far above the 2009-to-2012 average of 63.9k. Those were the normal years between 2008’s stock panic and 2013’s dawn of the Fed’s QE3 distortions.
Over the 7.0-month span of silver’s new bull market seeing that 48.7% gain, silver futures speculators added 46.6k long contracts while covering 22.5k short ones. That works out to around 233m ounces and 113m ounces respectively, serious buying. If these guys are forced to rapidly exit even half of these new silver-bull positions alone, we are looking at 173m ounces of silver selling slamming the markets within weeks.
That’s simply too much for normal demand to absorb. In all of 2015, which is the last comprehensive fundamental data available, global silver coin-and-bar investment demand ran a record 292.3m ounces. That averages out to just 24.4m ounces per month. Even if silver investment demand has doubled this year, which is likely far too optimistic, the amount of potential silver futures selling will temporarily dwarf it.
So just like gold, silver faces a record futures selling overhang today. Last week I explained gold’s own record futures selling overhang in great depth. So check that out if you’d like a deeper background on why excessive speculator long positions are a major near-term threat even within the mightiest of bull markets. All bull markets flow and ebb, and futures speculators’ collective bets often control the timing.
But mid-bull corrections are a great boon to investors and speculators alike. They help keep sentiment balanced, which is essential to ensuring a healthy bull market enjoying a long lifespan. And they also provide the best relative buy-low opportunities within ongoing bull markets! Traders looking to add to their silver or silver-stock holdings should rejoice when corrections near, and get ready to deploy more capital.
Despite silver’s near-term downside risks from futures speculators’ excessive longs and the potential for this year’s record summer rally to mean revert down towards more normal performance, silver’s young bull has far from run its course. Silver’s vast upside potential from here is most apparent when looking at the silver price relative to its primary driver gold’s. The telling Silver/Gold Ratio remains super-bullish.
Since gold drives silver to a dominant degree historically, prevailing silver price levels can be considered overvalued or undervalued relative to gold. If silver is exceptionally low relative to gold prices it remains a strong buy, which is certainly the case today. As of the middle of this week, it took 68 ounces of silver to equal the value of a single ounce of gold. That level of SGR is still quite low by modern standards.
Before 2008’s incredible stock panic cast silver into that brutal maelstrom of fear, the SGR averaged 54.9x. Silver generally traded in a fairly-tight range around 1/55th the price of gold. But since silver is so highly speculative and subject to traders’ collective greed and fear, it was pummeled so low that the SGR briefly averaged just 75.8x in the stock-panic months. But as I argued at the time, such extremes weren’t sustainable.
Indeed silver soon started soaring relative to gold, actually becoming so popular in 2011 it entered a speculative mania. When investors and speculators really get excited about silver and start pouring capital in, this metal’s upside is mind-boggling. Still over that entire 2009-to-2012 normal-year span between the stock panic and the Fed’s gross QE3 distortions, the SGR averaged a very similar 56.9x level.
During the large majority of its bull-market years between 2005 and 2012, silver tended to trade in range between 1/55th to 1/50th the price of gold. But let’s call a 55x SGR normal to be a little conservative here. At this week’s prevailing gold price of $1315, a 55x SGR puts silver at $23.90. That’s another 24% higher from this week’s levels, which is a considerable gain from here. Silver is too low relative to gold.
And silver easily has the potential to head a heck of a lot higher than that before its young bull market gives up its ghost. Gold is in a major new bull market of its own driven by massive investment buying. Gold should easily at least mean revert back up to its pre-QE3 levels like 2012’s average price running $1669. Plug a 55x SGR into that and it yields a juicy silver target of $30.35, another 57% higher from here.
But this is pretty conservative as well on two fronts. Gold is likely to not only mean revert after seeing extreme lows driven by epic fear in recent years, but to overshoot proportionally towards the opposite extreme. The higher gold goes in its mighty new bull, the more upside potential silver has. And the greater the coming bull-market gains in gold and silver, the more likely they will grow increasingly popular.
When investors and speculators get excited about silver, they can bid it far above normal levels relative to gold. That stunning late-2010-early-2011 episode where silver entered a speculative mania to climax its last bull is a great case in point. Traders got so excited about the tiny silver market rocketing vertically that they bid silver high enough to temporarily see an SGR under 35x. Such extremes are great selling opportunities.
At relatively-low non-overshoot $1669 gold, again 2012’s average price, an SGR of 35x implies a silver price way up at $47.70. That’s another 147% higher than this week’s levels, a heck of a bull run from here! Personally I suspect gold will head much higher before this new bull fully runs its course, so the potential gains silver could see are much greater. You can plug in your own SGR numbers to suit your outlook.
So even though silver faces a healthy near-term correction, its bull-market upside remains vast. Those record excessive silver-futures longs held by speculators will be considerably unwound over a relatively-short span, and silver will soon pass through its weak summer seasonals. Investors and speculators alike should be preparing their buying lists and readying their capital for the big opportunities coming.
Silver’s next interim low will likely be first signaled by futures speculators’ collective bets, so all traders interested in adding positions should watch them closely. That will likely prove the most-advantageous time, the lowest prices, at which to add silver bullion, SLV shares, and silver-mining stocks for a long time to come. Far from being a threat to this young silver bull, a correction is a great boon for everyone riding it.
The bottom line is this young silver bull faces a healthy correction. Silver futures speculators have ramped their longs to extreme record levels, igniting a record summer rally counter to normal seasonal weakness. This has left silver very overbought, at risk of a considerable near-term selloff once something inevitably spooks the hyper-leveraged futures speculators into unwinding their excessive longs.
But far from being threats, mid-bull corrections are great opportunities. They rebalance sentiment which is necessary to keep bulls healthy and long-lived. And they offer investors and speculators the lowest buying prices seen within ongoing bull markets. So if you want to ride silver’s young bull much higher in the coming years, now is the time to research and prepare for the coming smorgasbord of relative bargains.
Courtesy: Adam Hamilton
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