Silver has suffered a lackluster year so far, really lagging gold’s
upleg. Sentiment is still reeling following silver’s crushing
selloff from mid-April to mid-May. But that plunge was largely
driven by extreme silver-futures selling by speculators, including a
blistering spike in short selling. The resulting excessive shorts
have left silver with excellent near-term potential for a short
squeeze, which would catapult it rapidly higher.
Technically, silver ultimately acts like a leveraged play on gold.
The yellow metal has long been silver’s
dominant primary
driver. Investors and speculators alike flock to silver when
gold is rallying, forcing this tiny market to surge dramatically.
But when gold sentiment is weak due to lackluster price action,
silver demand from traders dries up. Thus silver drifts listlessly
or grinds lower, compounding bearish psychology.
As
of the middle of this week, silver was only up 8.9% year-to-date.
That actually bested the beloved S&P 500 broad-market stock index,
but it’s still considered pretty weak. That’s because gold has
rallied 10.3% YTD. Silver’s gains and losses over any given span
often about double gold’s, since the silver market is
radically smaller. This is readily apparent in the latest world
fundamental data for both metals.
Last
month the Silver Institute published its World Silver Survey 2017,
the definitive read on global silver supply-and-demand fundamentals
in 2016. It reported total physical silver demand last year of
1027.8m ounces. At last year’s average silver price of $17.12, that
was worth just $17.6b. That’s a rounding error in the
financial markets, a mega-cap stock like Apple can gain or lose that
much market cap in a single day!
Meanwhile according to the latest global gold fundamental data from
the World Gold Council, last year’s gold demand ran 4315.0 metric
tons. At 2016’s average gold price of $1250, that was worth
$173.4b. So the global silver market is merely 1/10th the size
of the world gold market per the newest available data! That makes
capital flowing into and out of silver an order of magnitude more
potent in moving its price.
Earlier this year when traders were growing excited about gold,
silver was normally amplifying its upside. By early March, silver
was up 15.6% YTD to gold’s 8.6%. But as gold enthusiasm faded in
subsequent weeks, silver soon deflated. By mid-April its 16.2% YTD
gains were only running 1.36x gold’s 11.9%. And that relative
outperformance collapsed after silver plunged 12.6% on a mere 5.1%
gold pullback into mid-May!
It’s
very unusual to see silver disconnect so sharply from gold, so
traders looked for explanations. One of the main rumors surrounded
Asia’s largest commodities trader, the Noble Group. Its
stock trading on the Singapore Exchange has literally imploded this
year, as it faces a huge liquidity crunch from credit-rating
agencies downgrading it on default fears. Rumors swirled that NG
was a big forced seller of silver.
Many
of NG’s commodities positions were apparently illiquid, unable to be
sold to raise cash without triggering serious losses on those very
trades. But silver of course is highly-liquid and
readily-marketable worldwide. Over 17 trading days between
mid-April and mid-May, silver fell for 16 and the only respite was a
trivial 0.1% bounce. That extraordinary span of consistent selling
often defying gold was rumored to be NG.
Whether the Noble Group was unloading huge silver positions to raise
desperately-needed cash or not, American futures speculators were
dumping in concert. Maybe the Noble rumors triggered their serious
selling, maybe they would’ve sold anyway. Either way, silver was
blitzed with a withering assault of silver-futures selling. Given
silver’s tiny market size, this mass exodus of capital quickly
brutalized silver prices.
Due
to that order-of-magnitude market-size differential, capital flowing
into and out of silver commands up to 10x the price impact of
the same capital moving in gold! And this is in outright terms,
assuming silver is fully-owned with no leverage. But silver-futures
speculators wield great leverage, further amplifying the impact of
their collective trading on silver’s price. So heavy silver-futures
selling drives sharp losses.
Every silver-futures contract controls 5000 troy ounces of this
white metal. At $17.25 per ounce, that is worth $86,250. But this
week, the minimum maintenance margin required to trade each
silver-futures contract is only $5000. This means futures
speculators can choose to run leverage up to 17.3x on silver
futures! That dwarfs the decades-old legal limit in the stock
markets of 2x. 17x is extreme and hyper-risky.
So
the capital futures speculators bet on silver’s near-term price
action can have up to 17x the price impact of the same amount of
investment in silver owned outright. When this enormous leverage is
mixed with a tiny market, the result is naturally incredible
volatility. At 17x leverage, speculators can’t afford to be wrong
for long on silver’s price moves. A mere 5.9% adverse move against
their bets results in 100% losses!
Every Friday afternoon, the Commodity Futures Trading Commission
publishes its famous Commitments of Traders report that details what
speculators are collectively doing in silver futures. Their buying
and selling as a herd is the overwhelmingly-dominant driver of
short-term silver price action. That doesn’t negate gold’s power
over silver, as these silver-futures traders mostly look to gold’s
fortunes for trading cues.
This
chart illuminates why silver enjoys excellent potential for a major
short squeeze catapulting its price rapidly higher. It shows
speculators’ total silver-futures long contracts in green, and total
short contracts in red. Silver along with some of its key moving
averages are superimposed on top. The silver-futures selling since
mid-April has been torrential, including extreme shorting.
Those shorts have to soon be covered.
In
futures trading, buying is buying and selling is selling. The
upside price impact on silver of buying a new long contract or
buying to cover an existing short contract is identical. Rising
longs and falling shorts are equally bullish for silver. The
opposite is also true. Selling an existing long contract or selling
to open a new short contract is identical in silver-price impact.
Falling longs and rising shorts are equally bearish.
Futures speculators’ collective price impact on silver is fueled
by their total trading on both the long and short sides. Buying
from either side pushes silver higher, selling from either side
forces it lower. The key differences are the long side is much
bigger, and long-side trading is voluntary. Once traders
effectively borrow silver futures they don’t own to short sell them,
they are legally obligated to soon buy them back.
Those debts must be repaid, so silver-futures contracts sold short
are offset and closed by buying long contracts. This involuntary
dynamic along with the extreme leverage inherent in silver futures
is what creates short squeezes. Speculators short silver
futures face potentially unlimited losses if silver rallies, so once
it starts climbing they have to rapidly buy longs to close their
shorts. This quickly becomes self-feeding.
Not
that long ago in mid-April, silver was faring pretty well. It was
trading just under $18.50, up 16.2% YTD. In the weekly CoT report
right after that interim high, silver-futures speculators held
154.2k long contracts and 37.4k short ones. Those longs were
actually really high, just off their highest levels seen in the 18.3
years since early 1999! That’s the limit of this dataset, but that
was almost certainly an all-time record.
Futures speculators’ collective bets are a powerful contrarian
indicator. Despite their sophistication to trade at such
extreme leverage, these guys are always wrong as a herd at trend
turning points. The record longs showed they were super-bullish on
silver. That’s not necessarily an immediate risk alone, but if
silver turns south that big selling overhang can really compound its
downside. That happened in late 2016.
Days
before gold’s own interim high in mid-April, and over a week before
gold’s own selling intensified enough to suck in silver, silver
started falling relentlessly. It looked like some large trader was
trying to unload large amounts of silver-futures long contracts as
quickly as it could without crushing the silver price. That would
adversely impact its own exit, so that position was unwound over
weeks instead of hours.
If
the troubled Noble Group was indeed involved in silver’s unnatural
selloff between mid-April and mid-May, it was in this major long
liquidation. CoT reports are current to every Tuesday close, so we
only get weekly Tuesday reads on them. From mid-April to mid-May,
29.5k silver-futures long contracts were dumped by speculators.
That was nearly 1/5th of the total longs from that record high seen
in mid-April.
Since silver futures are so hyper-leveraged, their speculators’ time
horizon is measured in hours or days on the outside. No one running
17x can afford to be a long-term trader, the risks are too great.
So there is no doubt short-side speculators immediately noticed that
relentless liquidation of longs. Their ears are always to the
ground, so they certainly heard these same numerous rumors of a
Noble Group forced liquidation.
True
or not, there was some big seller desperately trying to exit an
enormous silver-futures long position. So the short sellers jumped
on this bandwagon and started piling on. If the large seller was
being forced to liquidate to raise cash, there would be more selling
for the shorts to ride. Remember on the short side the profit
incentive is reversed. Short sellers borrow to sell high, in the
hopes of buying back low later to profit.
Speculators’ silver-futures shorts were on the low side into
mid-April, just 37.4k contracts. But once they smelled blood in the
water, a shorting feeding frenzy erupted. In just 4 weeks,
silver-futures shorts exploded an astounding 34.5k contracts
higher! That was nearly a double, a truly-extraordinary surge in
such a short time. By mid-May, total spec shorts hit 71.8k
contracts which is a super-high level historically.
It
wasn’t just a 21.4-month high for speculators’ bearish bets on
silver, which would itself be a very bullish contrarian indicator.
Mid-May’s 71.8k wasn’t far under the all-time record high of 81.6k
spec shorts seen back in early July 2015 when silver plunged to just
over $15 per ounce. Such high short levels, driven by such fast
shorting spikes, are very rare. And they are usually contrarian
indicators signaling major bottomings.
These bearish speculators were way out over their skis with such
epic shorts. If they were betting on that huge long liquidation, it
appeared to cease in mid-May. If they were trying to leverage the
simultaneous sharp gold pullback, that too ended within a day of
that relentless long selling. So these short sellers had no choice
but to start aggressively buying to cover to close out the extreme
shorts they’d quickly amassed.
That
likely largely-involuntary silver-futures buying to cover drove
silver sharply higher, even without new long buying which hasn’t
materialized yet. The latest CoT report before this essay was
published, which is current to May 23rd, showed massive short
covering already underway. Silver-futures speculators’ total shorts
plunged 13.5k contracts last CoT week, or nearly 1/5th of their
total shorts at that recent peak!
And
indeed silver surged on that short covering, enjoying multiple big
up days way out of proportion to gold’s own. But it still only
rallied 1.5% in that CoT week seeing all the short covering,
suggesting there is still selling out there retarding silver’s
upside. Some rumors claim the Noble Group not only sold silver
futures, but physical metal positions it owned. Perhaps that hasn’t
finished, or other Asian traders are still selling.
At
any rate, silver is set up for a big short squeeze. So far
the shorts have been very lucky, they’ve been able to buy to cover
without silver rallying too much. That’s largely because other
speculators have not yet returned on the long side. But once gold
rallies consistently and materially for a few trading days, they
will come flooding back in to play the upside. Then the shorts will
frantically cover to get out of harm’s way.
In
the first quarter of 2017 before April’s strangeness, specs’
silver-futures shorts averaged just 32.0k contracts. Based on the
latest CoT available, that means traders would have to buy to cover
another 26.3k contracts to mean revert back down to normal short
levels. That’s nearly twice as much as the short covering already
seen last CoT week. In other words, 2/3rds of the total short
covering is still coming!
That
is mandatory near-term buying. These traders effectively
borrowed silver futures they didn’t own to sell them, and they are
legally obligated to soon buy them back to repay those debts. This
has real potential to drive silver sharply higher in the coming
weeks, especially if spec longs are also rising greatly ramping the
pressure on shorts to cover fast. The most-likely catalyst to
ignite this would be a gold surge.
As
discussed in depth in our recent newsletters, today’s situation
in gold futures
is actually much more bullish than even silver futures’ current
one! On the gold side, longs are very low. That means they
have vast room to buy back in and propel gold sharply higher. Big
gold-futures buying could be triggered by anything that implies
lower future Fed-rate-hike odds, including weak economic data or the
FOMC itself.
Despite gold
thriving in past Fed-rate-hike cycles, futures speculators
remain irrationally terrified of higher rates. The day
before the last Fed rate hike in mid-March, both gold and silver had
slumped to major interim lows. The FOMC indeed hiked as expected,
but gold and silver still soared that afternoon and over the
subsequent weeks! Why? The FOMC’s outlook on future rate hikes
wasn’t as hawkish as expected.
So
even if the Fed hikes again in mid-June as universally forecast,
that could yet again prove a very bullish catalyst for
speculators to flood back into gold and silver futures. If the FOMC
members’ famous dot plot, their predictions for future
federal-funds-rate levels, moderates, gold and silver will likely
again be bid sharply higher. That’s a huge risk for the silver
shorts, who weren’t willing to make that gamble in mid-March.
The
day before that last Fed rate hike, spec shorts slumped to just
29.3k contracts. Even without short covering, silver still surged
2.7% higher on rate-hike day due to long buying. I doubt today’s
speculators heavily short silver will want to take the risk that the
FOMC’s FFR projections due at its mid-June meeting won’t be
hawkish. So odds are the short covering and potential short squeeze
will come before June 14th.
There is nothing more bullish for silver in the near term than
excessive silver-futures shorts. These are guaranteed
near-future buying! And staying short heading into a likely
rate hike after silver has surged after recent Fed rate hikes is
like playing Russian roulette. So the pressure on these guys to
cover soon is big and growing. Their short covering will likely
push silver high enough to entice longs to return en masse too.
Don’t underestimate the silver upside when shorts are covering and
longs are buying! Silver hit a major 6.4-year secular low in
December 2015 two days before the Fed’s first rate hike in 9.5
years. Then over the next 7.6 months, silver rocketed 50.2%
higher! That was driven by speculators buying like crazy, adding
55.6k silver-futures long contracts while covering 30.0k short
ones. Similar short covering is likely soon.
Again to mean revert back to Q1’17 levels, speculators still need to
buy to cover another 26.3k short contracts. That could happen any
day with the next major FOMC meeting looming, one of the every-other
ones that includes future rate projections. So investors and
speculators alike should position for some silver upside,
potentially big, in the coming weeks. The stars are aligning for
silver buying returning in a major way.
This
imminent short covering can be played with silver itself, or its
leading SLV iShares Silver Trust silver ETF. But the best gains by
far will be won in the great silver miners with superior
fundamentals. Their profits and thus stock prices really
leverage silver’s upside. And as I discussed in depth just last
week, their Q1’17
fundamentals remain strong despite the bearish prevailing
sentiment weighing on stock prices.
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The
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The
bottom line is silver is set up for an imminent potential short
squeeze. A likely forced liquidation of a huge long position
enticed speculators to flood into silver-futures shorts between
mid-April and mid-May. That fueled a massive shorting spike,
leaving shorts exceptionally high despite some covering buying
since. These remaining shorts must soon be covered by buying
offsetting longs, driving silver sharply higher.
Given the extreme leverage inherent in silver-futures trading, these
speculators can’t mess around with the next FOMC meeting looming.
Silver has surged sharply after all three previous Fed rate hikes in
this latest cycle! So major buying to cover is actually highly
likely before mid-June’s universally-expected next rate hike. This
short covering will probably entice in long buying, amplifying
silver’s near-term upside. | 
