Head of Commodity Strategy
Summary: Frenzied silver buying has accelerated following a weekend of intense focus on social media. The price has raced above $30/oz to its highest level since 2013 with retail traders, following their successful attack against short sellers in US small cap stocks, now targeting banks who they believe hold large naked short position in the futures market. In this we take a closer look at the narrative behind the move and what may happen next.
I have rarely seen a weekend where the social media has been so busy focusing on silver. The white metal has now rallied by more than 16% since last Wednesday when the rWallStreetBets group on Reddit began focusing on silver as another potential candidate for a major short squeeze. The reason being the expected existence of a massive bullion bank short in both gold and silver futures that for years and allegedly supported by central banks has helped keep the price down. This due to the narrative that rising gold and silver prices would reflect an increasing lack of confidence in the financial system and specifically in the dollar. This driving a belief held by many, that the big banks work with the Federal Reserve in maintaining confidence in the dollar and the system at large by suppressing the price of precious metals.
I believe this is a false narrative but whether or not it is true does not matter in the short term. The belief that it is possible to push the market has taken hold and so far today the COMEX silver future trades up more than 10% and in the process it has taken out the high from last August. Momentum, especially in silver can drive the market very far within a short period of time. Last year silver experienced three bear market moves of 39, 21 and 25 percent and three bull market moves of 156, 23 and 29 percent. With this in mind silver could easily extend its current gains, especially if the hedge funds start joining the bid, especially following the break $28/oz, the high from early January.
The long term chart is pointing to some resistance on spot silver at $30.5/oz, the 50% retracement of the 2011 to 2020 sell-off. Above that level, the next major level of resistance is not before $35/oz. Failure to forge higher, however could see a dramatic turnaround with the market then focusing on closing the gap to Friday's high at $27.65/oz.
In the week to January 26, the day before the short squeeze in the now famous GME and AMC tickers helped send the broader market lower and the VIX index sharply higher, the open interest in silver futures, the real target for this onslaught, was split as per the chart below. The bullion banks belong to the swap category and as of last Tuesday they held a net-short of 22k lots, a very manageable 20% of the daily turnover in Comex silver futures. Swap dealers offer hedges to all sorts of market participants, including producers and they often find themselves being long the cash market which is then being offset in the more liquid futures market.
The irony of trying to hurt the swap short is that a rally will put millions of dollars into the pockets of hedge funds and other large money managers who ahead of last weeks surge held 44.3k lots long, a long that since Wednesday have netted them a profit close to 900 million dollars. The biggest net short of 57.2k lots was held by producers and they are unlikely to buy back their short as they are hedging future production and will deliver physical silver against their short obligation.
The surge in silver has left gold stranded and still trading within its established range. This development has resulted in the gold-silver ratio (Ticker: XAUXAG) collapsing to a 6 1/2-year low below 63 and well below the long-term average closer to 70.
Apart from an unprecedented pick up in retail demand for silver coins and small bars, the biggest pickup in demand has come through exchange-traded funds. The number of shares in the largest ETF, the iShares Silver Trust (Ticker: SLV:arcx) saw its biggest one-day increase on Friday. The ETF is backed by physical silver held in vaults, meaning it needs to buy the precious metal when the number of shares grow.
Silver has seen its fair share of market surges and short squeezes with the most famous being the Hunt Brothers attempt in 1979-80 to corner the market by accumulating billions of dollars worth of silver. The price saw a four-fold increase before collapsing straight back to the starting point after the brothers were sanctioned for market manipulation.
Another major rally unfolded between 2008 and 2011 which resulted in the price almost reaching $50/oz before another spectacular collapse unfolded. The rally back then was driven by the aftermath of the global financial crisis which saw metals rally on a combination of quantitative easing, surging demand from China and the weaker dollar. Silver in addition went through a period of tightening supply which all supported the rally before its spectacular collapse from where it has now managed to recover half.
Last week we released our Quarterly Outlook and in it we described the reasons for our positive precious metal outlook: “Silver has returned to its long-term value against gold with the prospect of a further upside depending on the strength of both industrial and investment demand. The green transformation could spark a surprise in terms of industrial demand with the photovoltaic (PV) market expected to be strong as many countries embark on renewable energy projects. Based on our forecast for gold to reach $2200/oz, silver’s high beta should encourage a continued outperformance with the gold-silver ratio heading towards the low 60s during 2021, thereby driving the price of silver towards $35/oz.”
Conclusion: No matter if the “bullion bank short” is true or not, silver has by now received so much attention and interest that we are likely to see it as well as silver mining stocks and ETF’s trade bid for a while. In order to proper gauge the overall impact on the markets ability to function and with that also the speculation about a futures short squeeze, it is important to watch the spread between physical silver and the futures price. Any signs of stress with regards to shorts getting hurt would see the spread, also called the Exchange for physical (ETP) blow out. So far today, the spread has widened from around flat to a current futures premium of 45 cents/oz. Any further widening will point to stress in the market with increased need to borrow silver to cover short commitments.
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