Battered silver remains deeply out of favor, recently plumbing miserable new lows after drifting sideways for most of 2014. This metal’s relentless and oppressive weakness continues to break the wills of long-suffering contrarians. But professional investors are taking advantage of the epically-bearish psychology plaguing silver. They’ve been steadily accumulating positions all year long in massive stealth buying.
Silver certainly wasn’t always a loathed market pariah. Back in early 2011, silver blasted up above $48 on widespread enthusiasm from investors and speculators. It was one of the 2000s’ greatest bull markets, up an astounding 1105% during a 9.4-year span where the benchmark S&P 500 limped to a 20% gain. The brave contrarians fighting the herd to buy silver low in the early 2000s greatly multiplied their wealth.
But in spring 2011, silver was getting very overbought and euphoric. As I warned at the time, it needed to suffer a sharp correction to rebalance sentiment. And it did, plummeting in a near-crash which is typical for this exceptionally-volatile asset. But that left silver very oversold so it soon stabilized. This white metal averaged about $35 in 2011 and $31 in 2012, and contrarian investors maintained sizable positions in it.
But silver’s primary strength and weakness is it has always been slaved to gold’s fortunes. Silver traders look to gold for their trading cues, so the white metal leverages the yellow metal’s upside and downside. And unfortunately due to a major support failure and mind-boggling gold-ETF liquidations, gold suffered its worst quarter in 93 years in 2013’s second quarter. Silver was sucked into this maelstrom of gold selling.
By late June 2013, silver had plummeted 39% year-to-date! And that happened while the S&P 500 was able to surge 13% higher thanks to the Federal Reserve’s third quantitative-easing campaign. Investors and speculators alike abandoned silver in droves after this horrendous performance. Bearishness was off the charts, and silver essentially just drifted sideways near the summer of 2013’s lows until this past month.
Then lingering precious-metals bearishness combined with a surging US dollar and levitating US stock markets to motivate American futures speculators to borrow and sell gold futures at extreme levels. But while gold’s strong support since the summer of 2013 held, silver’s failed. Silver is gold’s best sentiment gauge, amplifying both greed and fear in the yellow metal. And the latter emotion has been suffocating lately.
So with silver now super-low and despised, it seems like no one wants anything to do with it. There is a widespread belief that silver is no longer cyclical, that it is doomed to spiral lower forever. Not even the majority of contrarian investors, who claim they like buying out-of-favor assets cheap, will touch silver with a ten-foot pole. It has been left for dead, starved for capital in a parched wasteland of hyper-bearish sentiment.
But provocatively, such extremes are exactly what major bottoms are made of. Bearishness is finite, at some point everyone susceptible to being scared into selling low has already dumped their silver. And there are only so many futures speculators willing to make leveraged short bets against it near 4.5-year lows. Once bearishness and selling inevitably peak, a major new upleg is born as bargain hunters start returning.
Though you wouldn’t know it from this year’s demoralizing silver-price action, that shift to buying has already begun. And it is not individual investors leading this charge, but professional investors with big capital including funds. 2014 has already witnessed extraordinary stealth buying of silver through the flagship silver ETF and silver futures. Individual investors generally prefer physical bullion, not “paper silver”.
This first chart looks at the dominant iShares Silver Trust silver ETF, which trades under the symbol SLV. It is the premier way for American stock investors and speculators to quickly and efficiently gain silver-price exposure in their portfolios. Here the SLV price in blue is superimposed over this ETF’s silver bullion held in trust for its shareholders in red. SLV shares have actually seen big differential buying in 2014!
When this year dawned, silver was trading near $19.50 and SLV’s bullion holdings were 320.2m ounces of silver. As of this week, silver prices had drifted about 12% lower but SLV’s holdings had grown by 7.3% to 343.4m ounces! This is quite amazing, exactly the opposite of what one would expect in light of silver’s atrocious performance and epic bearishness. Someone was buying SLV shares despite silver’s swoon!
And this stealth buying wasn’t trivial, adding 23.2m ounces to SLV’s holdings so far this year. At silver’s average price of $19.72 year-to-date, this SLV bullion build equates to $458m of stock-capital inflows. This is considerable as silver is such a tiny market. Its small size is the primary reason silver’s gains are so spectacular when investors and speculators start getting interested again, a little bidding catapults it higher.
Naturally interest in silver peaked at its stellar April 2011 high near $48, so that’s when SLV’s holdings crested at 366.2m ounces. At their recent 350.1m-ounce high at the end of September 2014, they were merely 4.4% lower than that all-time high compared to silver being down nearly two-thirds! While SLV shares are worth far less today with silver prices so low, SLV’s holdings surging near records this year is still quite remarkable.
SLV’s bullion has actually been in a strong contrary uptrend since mid-2012, when silver’s normal and healthy post-peak correction ended. And last year’s extreme once-in-a-lifetime gold selling anomaly did not even threaten to break this uptrend. SLV acts as a critical conduit for the vast pools of stock-market capital to flow into and out of physical silver. And rising holdings mean stock capital has been migrating back in.
SLV is a tracking ETF designed to mirror the silver price. But this mission can only be accomplished in one way since SLV shares’ supply and demand at any given time isn’t likely to perfectly match silver’s own. Excess SLV-share supply or demand has to be shunted directly into the underlying physical silver market. If this capital-flow mechanism didn’t work, SLV would soon decouple from silver prices and fail.
Whenever SLV shares see differential buying pressure above and beyond what silver is witnessing, its custodians are forced to equalize this into silver bullion. They execute this by selling enough new SLV shares to meet the excess demand, providing enough supply to keep SLV’s price tracking silver. And all the cash they earn from issuing these new shares is then immediately plowed into physical silver bullion.
So SLV’s holdings, which are reported in great depth down to individual silver bars’ serial numbers every day, rise. Stock-market capital has been flowing into SLV shares on balance since mid-2012, despite the very weak silver-price action. Either stock investors have been stealthily buying SLV shares faster than silver was being bought, or they were selling SLV shares slower than silver was being sold. More likely both.
When silver prices fall faster than SLV shares, this ETF threatens to decouple to the upside. So SLV’s custodians have to act to provide sufficient share supply to maintain silver tracking. They do this by selling new shares, putting downward pressure on SLV’s price. And once again the proceeds of this are plowed back into physical silver bullion boosting SLV’s holdings. Slower selling is almost as bullish as new buying.
When stock investors dump SLV shares slower than silver is selling off in the futures markets, they reveal an increasing concentration in strong hands. After such a calamitous couple of years in silver, the silver investors still standing are the toughest of the hardcore. The stock investors still owning SLV shares now obviously have a strong contrarian belief that silver prices are forever cyclical and long overdue to reverse.
I suspect slower SLV-share selling is what drove that massive SLV-holdings spike of the last couple months. Silver follows gold, and with American futures speculators recently shorting gold at some of the highest levels ever seen, silver futures were dumped in sympathy. But stock traders weren’t as keen to sell silver low as futures traders, as selling at extreme lows is the height of folly. That’s when smart investors want to buy.
This hardcore remnant of SLV shareholders will likely be quick to add to their positions as silver inevitably mean reverts out of its extreme selloff. And since they are mostly institutional traders, the resulting large gains in their SLV positions will prompt other institutional traders to jump onboard and accelerate the differential SLV buying pressure. The resulting stock-capital inflows into silver bullion will really boost silver’s price.
Back in the middle of 2013 after those initial extreme gold-driven silver lows, SLV shares witnessed a surge in differential buying pressure on new buying as silver rebounded. I suspect the same thing will happen again as silver selling exhaustion mean reverts to new buying in the near future. Interestingly, any major SLV differential buying pressure from its current holdings levels will quickly lift them to new record highs.
But that’s nothing to fear. Back in April 2011 at SLV’s original peak holdings, they were worth $17.2b at those lofty prevailing silver prices. Today they are only worth $5.9b, lots of room to run higher. Silver is such a little market that not much capital returning can make a huge price difference. As of the end of last month, the S&P 500 stocks were collectively worth $18,518.7b. That is 3139x larger than meager SLV!
If only one-tenth of one percent of stock-market capital started chasing the next silver upleg, that $18.5b would drive silver stratospheric. But it’s not only stock traders who are going to be buying silver via SLV shares, futures speculators will join them. And like SLV’s holdings, specs’ total long-side silver-futures exposure has already been enjoying a strong contrary uptrend in 2014! This is despite parallel record shorting.
This next chart looks at speculators’ total long and short silver-futures positions as reported in the CFTC’s weekly Commitments of Traders reports. Total longs are shown in green, and total shorts in red. SLV’s share price is superimposed over the top for reference. The contrast between strong spec long buying on one side and record spec shorting on the other is extraordinary, and shows why silver is overdue to rocket higher.
While SLV shares are mostly held by institutional traders, silver-futures trading is dominated by them. This highly-leveraged game is exceedingly unforgiving. A single silver-futures contract controls 5000 ounces of silver, which is worth $85k at $17. But the margin required today to maintain this position is merely $5500, yielding maximum leverage of 15.5x. That is vastly riskier than stock trading’s legal limit of just 2.0x.
Silver has always been exceptionally volatile, and at 15.5x leverage a mere 6.5% adverse move would wipe out 100% of the capital risked by these futures speculators. They can’t afford to be wrong for long, or they’ll soon be bankrupt. So speculators must have really high conviction that their near-term bet on silver prices will soon prove correct to willingly take on such extreme risk. And that makes this year’s behavior fascinating.
Since last autumn, massive stealth buying has also been underway in silver futures. Speculators have catapulted their total longs from just 47.5k contracts in late September 2013 to an 8.6-year high of 90.3k in early July 2014. And despite silver’s support failure and drift lower since then, these leveraged long-side bets have only retreated 7.5%. They are still near support of the strong spec-total-longs uptrend channel.
The 42.8k long silver-futures contracts speculators added over that 9.4-month span was enormous. That is the equivalent of 214.0m ounces of silver! According to the venerable Silver Institute, total worldwide mine production last year was 819.6m ounces. It takes a lot of contrarian conviction that silver is overdue to rally in a big way to put on leveraged upside positions equivalent to over a quarter of global silver production.
If futures speculators are already this bullish on silver with it languishing near major lows, imagine how much they are going to flood in once it starts decisively rallying again. And the catalyst for that will almost certainly be a short squeeze. Among futures speculators there is another faction of traders heavily short silver futures. Their total shorts hit their highest level in 15.7 years if not ever in late September 2014!
That recent massive red spike of extreme silver-futures shorting mirrors a parallel one in gold I discussed last week. I’ve been trading for decades, and can’t understand the allure of making leveraged downside bets on anything that is already very low and deeply out of favor after falling for a long time. Selling low isn’t the way to build wealth, buying low is. But futures speculators are notorious momentum players.
They always want to assume prevailing trends are going to last indefinitely, that markets aren’t cyclical. So they ramp their gold- and silver-futures shorts positions to highs right when the precious metals are carving major bottoms. As silver starts rallying out of these lows, the specs are soon forced to cover their dangerous leveraged downside bets. The resulting frantic buying usually propels silver dramatically higher.
Speculators buying to cover their excessive shorts is the initial spark that ignites major new uplegs in the white metal. And the sheer number of shorts they need to cover today near such extreme levels is truly staggering. As of the latest CoT week ending last Tuesday, American futures speculators held the short side of 67.3k silver-futures contracts! Their normal-year average between 2009 to 2012 was merely 21.5k.
So simply to mean revert back down to normal levels of spec shorting, not even overshoot, specs need to buy to cover a whopping 45.8k contracts. That is the equivalent of 228.9m ounces of short covering alone, or 28% of last year’s global production! And since silver tends to climb so fast once it gets moving and other traders pile on, this coming enormous futures short covering will be compressed into a short span.
If this spec-short-covering silver rally triggers major stock-market-capital inflows to SLV and more long-side silver-futures buying, this left-for-dead metal is definitely going to catapult higher. And that big institutional buying’s major upside impact on silver’s price will entice individual investors to return too, lighting a fire under the traditional silver-bullion market. The resulting silver upleg will likely prove the biggest in several years.
Today’s abnormally-low silver prices can only be rationalized with the false belief that the global financial markets are no longer cyclical, that gold and silver will fall forever while stock markets rise forever. With even the most rudimentary knowledge of market history, that fallacy is laughably silly! Prices perpetually rise and fall, and the longer any prevailing trend is in force the more likely it is overdue for an imminent reversal.
Silver is certainly no exception to this universal market rule. And I suspect that’s why 2014 has enjoyed massive silver stealth buying by professional investors. While individuals and most professionals have succumbed to the bearish groupthink and capitulated, there is a growing minority of traders who see vast opportunities in buying dirt-cheap silver low. And these guys have been steadily accumulating all year.
That is definitely the high-probability-for-success contrarian bet to make at such low-priced and bearish extremes. The best time to buy low is when no one else wants to, when a sector has been abandoned. And that describes silver to a tee today. After multiplying their wealth by twelve times during silver’s last secular march higher in the 2000s, smart contrarians are positioning for silver’s next life-changing run up.
Why not join them in buying silver low? As hardcore contrarians at Zeal, we’ve certainly done that. Wall Street constantly propagandizes to convince investors to buy high and sell low, to add stocks near record highs and sell precious metals near extraordinary lows. All Wall Street cares about is continuing to take its percent-of-assets-under-management fees by keeping capital in the stock markets, not about clients’ wealth.
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The bottom line is silver has experienced strong stealth buying by professional investors all year long. These contrarian traders are fighting the extreme bearishness plaguing this metal because they know well that markets don’t move in one direction forever. Everything is cyclical, even silver. And after such a long miserable decline to such brutal lows, silver’s next major move is going to be a massive new upleg.
This rally will initially be sparked by speculators rushing to cover their record silver-futures shorts. These highly-leveraged bets are exceedingly dangerous, and will have to be closed rapidly when silver starts climbing. This silver surge will entice in much new capital on the long side. And with stock investors and another group of futures speculators already accumulating cheap silver all year long, they’re ready to flood back in.
Adam Hamilton, CPA
October 24, 2014
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