Silver has had a
rough year, slumping to major new secular lows. After sliding on
balance for years now, even the diehard silver bulls are losing
faith in their metal. But despite its vexing slumber, silver?s
price-appreciation potential from today?s levels remains enormous.
Between radical underinvestment and very-high speculator
silver-futures shorting, silver is poised to see massive buying as
gold recovers.
Silver has proven
very disappointing in 2015. Late last year, it was battered down
near $15.50 as gold plunged into the $1140s on
extreme futures
shorting. That looked to be a decisive low, as silver spent
the next 8 months forming a strong technical base around $16.
But unfortunately in early July, silver fell to new lows near $15 as
gold was crushed by an epic
futures-shorting
attack. Silver was collateral damage.
Despite silver?s
unique and compelling investment merits, it has always been
slaved to gold.
Investment demand on the margin is the dominant driver of silver?s
price, despite only being around 1/5th of total global demand. The
4/7ths of silver?s demand from industrial fabrication, and 1/5th
from jewelry, is relatively stable year in and year out. The only
demand category that shifts dramatically comes from
investors.
And their silver
buying and selling is overwhelmingly driven by the fortunes of
gold. Capital floods into silver when gold is strong,
catapulting the white metal higher. And investors flee when gold is
weak, pummeling silver lower. Thanks to this ironclad sentiment
link, silver is simply a leveraged play on gold technically.
The correlation
between silver prices and gold prices has proven incredibly high
historically.
So with gold weak
so far in 2015, silver had the deck stacked against it. By late
August when silver hit a major 6.0-year secular low just above $14,
it was down 9.9% year-to-date. Over that same span, gold had fallen
5.0%. That 2x ratio of silver?s price movement relative to gold?s
is actually the dominant rule of thumb historically. Silver tends
to double the gains and losses in gold, and gold hasn?t fared
well this year.
But interestingly,
silver?s vexing slumber is par for the course for this volatile
metal. Historically, silver?s price action has been characterized
by long spans of sideways consolidations followed by explosive and
massive moves higher. Investors and speculators with the mental
toughness to ride out silver?s long periods of inactivity are richly
rewarded with huge wealth-multiplying rallies. And the next one
is overdue.
The last time
silver was this down in the dumps and universally despised was
during 2008?s epic stock panic, when silver was pummeled under $9.
You couldn?t give silver away back then, just like today traders
were totally convinced silver was doomed to spiral lower
indefinitely. Yet out of that very despair, a monster bull was
stealthily being born. Over the next 2.4 years, silver would
skyrocket 442.9% higher!
Over that span,
the benchmark S&P 500 stock index merely gained 80.8%. Silver was
one of the best investments on the planet after the inexorable
market cycles finally turned favorable again. And since the
financial markets are forever cyclical, I strongly suspect
silver is on the verge of another one of its mighty uplegs. After
plunging 70.8% in 4.3 years between April 2011 and August 2015, a
trend change is coming.
It will be fueled
by the overdue mean reversion higher in gold, which is
starting to recover from the most extreme speculator
gold-futures-shorting episode ever witnessed. Gold?s coming
upleg will get both investors and speculators interested in silver
again. And once they start buying back in, they have a long ways to
go to return to normal levels of capital deployed. That?s
super-bullish for silver?s outlook.
While much silver
investment demand is small physical purchases, investors and
speculators each have one dominant venue for tracking their silver
positions. For investors it is BlackRock?s iShares Silver Trust,
which trades under the symbol SLV. SLV acts as a conduit for the
vast pools of stock-market capital to flow into and out of physical
silver bullion, and is the leading proxy of silver investment
demand.
This first chart
looks at SLV?s silver-bullion holdings held in trust for its
shareholders and the silver price over the past several years or
so. Since SLV is very transparent and publishes its silver holdings
daily, it offers an excellent window into investors? silver
exposure. And it is super-low now, which means there is much room
for capital to return as silver inevitably returns to favor again.
Investors? buying potential is immense.
The biggest
mistake traders are making on silver today is assuming these
exceptionally-weak conditions are normal and righteous. But nothing
could be farther from the truth! Back in early 2013, the US Fed
spun up its third quantitative-easing campaign to full steam.
Unlike QE1 and QE2, QE3 was completely open-ended with no
predetermined size or end date. This Fed used this ambiguity to
manipulate traders? psychology.
Whenever the stock
markets started to sell off, Fed officials were quick to step up and
declare that they could increase the size of QE3 if necessary. So
all dips were quickly bought, short circuiting normal market
behavior. This
created gross
distortions in all kinds of markets, including stocks and the
leading alternative investment that moves contrary to them of gold.
With stocks magically levitating, gold was abandoned.
And naturally
silver followed gold lower. Silver?s average price in 2012 before
the Fed?s manipulative QE3 debt-monetization campaign greatly skewed
everything was over $31! Given the extreme market conditions
of the QE3 era, those pre-QE3 silver prices are much more
representative of righteous fundamental silver-price levels than
today?s. As QE3?s vast distorting influence fades, silver will
return to normalcy.
One key driver of
silver?s powerful mean reversion higher will be the return of stock
investors to the white metal via SLV. In 2012 when silver averaged
near $31, SLV?s holdings averaged 313.2m ounces. So that equates to
stock-market investors having an average daily silver exposure of
$9.8b. While SLV silver holdings have grown on balance since in
these Fed-distorted years, capital investment has still fallen.
With silver?s bear
market slashing its prevailing price levels, SLV?s holdings are
worth a lot less in 2015 than they were in 2012. So far this year,
SLV?s holdings have averaged 324.6m ounces or 3.6% over 2012?s
levels. But with an average price just above $16, silver is 48.4%
lower. That puts 2015?s average daily silver investment by American
stock traders at $5.2b, just over half the levels seen in
2012 before QE3.
So silver
investment today is undeniably very low, which is not surprising
given silver?s discouraging price action in recent years. That
means there is great potential for big investment buying as gold
mean reverts higher and silver follows over the coming years. While
the value of SLV?s holdings has fallen with silver, they have
actually enjoyed a strong uptrend in recent years despite lower
prevailing silver prices.
Several times in
both 2013 and 2014, the heart of the extreme Fed-QE3 market
distortions, investors bought enough SLV shares to catapult its
silver bullion holdings way up to the overhead resistance line seen
in this chart. And there?s no reason not to expect another surge
back up to resistance, which is up near 351m ounces today. With
SLV?s holdings now near 322m, this would require another 29m ounces
of buying.
And that?s a lot
of extra silver investment demand! According to the venerable
Silver Institute, global bar-and-coin demand ran 196m ounces in
2015. That averages out to just over 16m per month. American stock
investors have the potential to essentially double that demand
alone as they return to SLV in the months ahead! It usually
only takes a couple months for SLV?s holdings to surge from support
to resistance.
Since SLV is a
tracking ETF, differential buying and selling pressure on it has to
be directly shunted into underlying physical silver bullion. When
stock traders buy SLV shares faster than silver is being bought,
this ETF?s price threatens to decouple to the upside and fail its
tracking mission. Thus SLV?s custodians have to issue new ETF
shares to meet and offset this excess demand, and use the proceeds
to buy silver.
So whenever SLV?s
bullion holdings are growing, it translates directly into growth in
global investment demand for silver. And naturally as silver?s
primary driver, that really boosts its price. And provocatively
even when SLV?s holdings revisit their 351m-ounce resistance, at
2015?s average silver price just over $16 its holdings would still
only be worth $5.6b. That remains far below the pre-QE3 average in
2012 of $9.8b.
In order to regain
those kinds of SLV-investment levels at 351m ounces of holdings, the
silver price would have to surge an incredible 73% higher
from this year?s average! That would take it back up to $28, which
is certainly not extreme in pre-QE3 terms. Back in April 2011 the
last time silver was popular, it skyrocketed above $48! This metal
can really soar when investors and speculators return in a major
way.
While SLV is the
dominant venue for tracking investment positions in silver,
American silver futures are the best place to track speculators?
silver bets. And just like SLV, they reveal lots of room for buying
in the near future. This is especially true on the short side.
Speculators? silver-futures short positions remain very high
historically, and they are guaranteed near-future buying as
silver mean reverts higher.
The Fed?s
manipulative QE3 era greatly distorted speculators? silver-futures
positions too, particularly on the short side. Between 2009 to
2012, the last normal years before QE3, speculators? downside bets
on silver averaged 21.5k contracts. Each contract controls 5000
ounces. Yet since QE3 started enticing capital away from
alternative investments, speculators? silver-futures shorting has
skyrocketed to record extremes.
The peaks in
speculator shorting have grown since QE3?s launch, most recently
hitting an astounding 81.6k contracts in early July! This was the
highest level seen since at least 1999, the extent of our
silver-futures data, and almost certainly ever. Speculators
effectively borrowed all that silver that they didn?t own, and sold
it. So they were legally and contractually obligated to buy that
silver back to repay their debts.
And indeed major
short covering out of those recent extremes has already happened.
In the 8 weeks since early July?s all-time record peak of
speculator silver-futures shorting, they have bought to cover 25.3k
of these contracts. So much short covering should have fueled a
strong silver rally, but that didn?t happen in recent months. The
reason is speculators? long positions paradoxically mirrored
their short ones.
Normally in
futures markets, speculators? long and short positions move in
opposition. When they grow bullish as a herd, they both add
longs and reduce shorts to bet on further upside. When they become
bearish, they cull longs and grow shorts. So it is very odd to see
speculators? longs and shorts move in unison. Yet that?s exactly
what?s happened in silver futures for the better part of a year now,
since last autumn.
At the same time
American speculators bought to cover 25.3k short-side contracts in
recent months, they liquidated 17.1k long-side contracts. Thus over
2/3rds of the upside silver-price influence by the short covering
was completely offset by long liquidations! This unnatural
correlation will end as soon as silver mounts a rally decisive
enough to convince speculators that normalcy is finally returning to
this battered market.
But more exciting
and bullish is the silver-futures short covering of recent months
remains far from running its course. During these
Fed-QE3-stock-market-levitation years starting in early 2013, the
speculators? silver-futures short positions have had support near
27k contracts. As this chart reveals, even within these
QE3-distorted years speculators? total shorts have already returned
to this level 5 separate times!
So there?s little
doubt that the next silver rally will drive speculators to cover
their shorts down to that 27k-contract support level again soon.
And that will require another 29.3k contracts of buying from
the latest levels, more than the 25.3k contracts already covered
since that extreme record peak. And that is a heck of a lot of
silver buying, the equivalent of 146.5m ounces over the couple
months or so short covering takes!
Again global
investment demand for silver averaged 16m ounces per month last
year. If the rest of the silver-futures short covering takes
speculators two months, we are looking at marginal new demand over
73m ounces per month! That would more than quadruple normal
silver investment demand while that short covering is underway,
catapulting silver prices higher and ending the offsetting long
liquidation.
Just as investors
are radically underinvested in silver, speculators are still
radically short it today. Since 1999, speculators have only had
higher silver-futures short positions 3% of the time. So
odds are they are going to have to cover aggressively out of these
extremes. Even a minor silver rally will spark this self-feeding
process, which is guaranteed by the extreme leverage inherent in
silver-futures trading.
Today futures
speculators are required to have margin of just $6k for each
silver-futures contract that controls 5000 ounces of silver. Even
at the dismal $15 price levels today, that is worth $75k. So
silver-futures speculators can run leverage up to 12.5x on silver,
dwarfing the decades-old legal limit in the stock markets of 2x. At
12.5x, a mere 8% silver rally will totally wipe out 100% of the
capital risked shorting!
And once silver
finally awakens from its long periods of consolidation slumber and
starts moving, it tends to rally fast. Speculators have to
rush to cover shorts or be annihilated, and the more buying they do
the faster silver rallies. This frantic speculator short covering
usually provides the initial spark that ignites new uplegs. Then as
silver rallies, long-side speculators and investors return to
accelerate its gains.
These investors
and speculators alike flock back to this metal with a vengeance once
gold paves the way, and odds are that day is rapidly nearing. There
are a variety of powerful factors that are aligning today to ignite
a strong gold upleg, this metal?s long-overdue mean reversion higher
out of recent years? artificial price levels from Fed manipulation.
Once that gets decisively underway, silver will amplify its gains.
With the first
Fed-rate-hike cycle in nearly a decade on the verge of launching,
these overvalued
and overextended
Fed-levitated stock markets are due to roll over hard. That will
really stoke demand for prudent portfolio diversification through
alternative investments led by gold, which will lead to serious
silver buying. And contrary to the popular myth today,
Fed-rate-hike cycles are not bearish for gold at all.
Last week I
published an essay exploring
a comprehensive
study I did on gold during all Fed-rate-hike cycles since 1971.
In 6 of these 11 cycles, gold rallied dramatically by an
average of 61%! The bigger the rate-hike cycle, the better gold
performed. And in the other 5 where gold lost ground, the rate
hikes always started when gold was near a secular high. That
certainly isn?t the case today at these dismal lows.
Fed-rate-hike
cycles are bullish for gold and silver because they inflict such
great damage on stocks and bonds, leading investors to seek
alternative investments. Adding to the gold and silver bullishness,
the precious metals are both overdue for
strong seasonal
rallies running into February on Asian demand. Not surprisingly
since the gold price drives silver,
silver?s
seasonals closely mirror gold?s own seasonals.
Silver?s coming
dramatic mean reversion higher can be played in physical bars and
coins as well as the SLV silver ETF. But investors and speculators
alike can get far more bang for their buck in the battered stocks of
silver miners. Today these stocks are priced as if silver is going
to grind lower forever, ignoring the profitability of many silver
miners even at today?s low silver prices. These stocks will
skyrocket as silver recovers!
As hardcore
contrarians at Zeal, we?ve long specialized in precious metals.
While this has been a tough sector thanks to the extreme Fed
policies of recent years, that is all due to reverse as the Fed
starts the long
road to normalization. As the gross market distortions of QE3
and ZIRP are gradually unwound, there is no doubt gold and silver
will mean revert to normal levels. The gains to be won in this
sector are vast.
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The bottom line is
silver looks poised to awaken from its vexing slumber. The brutal
bear market it has suffered due to the Fed?s extreme market
distortions is ending as policy normalization begins. Silver is set
up for lots of buying as gold?s recovery encourages traders to
return. Not only are investors radically underinvested today, but
speculators remain heavily short which provides guaranteed
near-future buying.
Like all markets,
silver is forever cyclical. It perpetually meanders from in favor
to out of favor and back again. And after falling on balance for
years as QE3 sucked capital and interest away from portfolio
diversification with alternative investments, silver is way overdue
to reverse into its next major bull. The brave contrarians willing
to buy silver and its miners low before this becomes widely apparent
stand to earn fortunes.
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