By Ivan Y.
Hedge funds have been significantly increasing their short position in silver futures since the beginning of February. This past week the short position in silver for large speculators (i.e. hedge funds and managed futures funds) reached a record of 31,806 contracts. Please note that I am referring to the number of futures contracts shorted. On a net basis, the hedge funds are still slightly long. Since each contract represents 5,000 ounces of silver, the short position is about 159 million ounces. Let's put this in perspective.
- At the beginning of February, the hedge funds had a short position of 6,588 contracts (about 33 million ounces). This was the lowest number since 2010. Hedge funds have increased their short position by almost 5x since then.
- Mine supply of silver in 2012 was 787 million ounces, according to the Silver Institute. The short position is thus 20% of annual mine supply.
- The largest silver ETF (NYSEARCA:SLV) has about 321 million ounces of silver in its inventory. So the hedge fund short position in the futures market is almost 50% of SLV's inventory.
Implication For Investors
So what does the record short position by the hedge funds mean for silver investors? This can be good news or bad news. The good news is that these short positions need to be covered eventually and the silver price will get a boost when that happens. The bad news is that hedge funds could continue to pile on the shorts and drive silver down below $20. Silver is a battleground between the hedge funds and the commercials (i.e., bullion banks like JPMorgan). While the hedge funds have been significantly increasing their short positions in silver since February, the bullion banks have been significantly increasing their long positions in silver since December. On December 4, 2012, the bullion banks were long 38,410 contracts. This past week, they were long 68,438 contracts. So you can see that silver is a battleground between the hedge funds and the bullion banks. The retail investors and the physical buyers really have little impact on the price of silver. So who should you bet on? The hedge funds or the bullion banks? Give the hedge funds credit because they have been right so far, but historically, the bullion banks usually win, which means that the odds favor an increase in the price of silver. It may not happen now. It may not happen next week. But over the next several weeks and months, I would expect the price of silver to increase as the hedge funds cover their short positions.
What Will Spark A Rally?
Of course, the hedge funds need a reason to cover their shorts, so something is needed to spark a rally. What are the possible catalysts for silver going forward? In my opinion, the two catalysts that are most likely to spark a rally are an increase in inflation and a postponement of QE tapering by the Federal Reserve. I will discuss the inflation aspect and leave the QE predictions for the experts on CNBC. Gold and silver bulls have been disappointed that QE 1-4 have not triggered any significant inflation in everyday prices. Asset prices have been boosted up, but have prices for everyday goods like bread and eggs gone up significantly? I would say not really. Give credit where credit is due. Bernanke and the Fed have been able to print money without triggering massive inflation in everyday goods so far. But can this be sustained? I've heard people say that inflation comes in two stages. The first stage is good inflation and the second stage is bad inflation. Good inflation is the rise in asset prices like stocks and housing. When that happens, people feel wealthier and have more money to spend. Bad inflation is the rise in everyday goods like food and gas. When that happens, everyone complains. We've been experiencing the good inflation. Stock prices are up and housing prices have increased. But we haven't really seen the bad inflation yet. I believe that when evidence of bad inflation starts making the headlines, gold and silver will rally. Precious metals investors may have to be patient and wait for that to happen.