From its low-close on June 27 of $18.59 (Comex front-month basis) through its high-close on August 27 of $24.70, silver jumped 32.8% in just 42 trading days. Using today's Comex close of $23.12, silver is up 24.4% from its June bottom. Many investors are wondering if this has been a dead-cat bounce off an oversold bottom or if a new bull trend has begun. Based on all of the fundamental and technical data that I monitor, it would appear to me as if silver put in a definitive bottom in late June and is poised to resume its long-term bull market trend. I would further opine that it is likely that we'll see silver (and gold) hit a new all-time high in price before we get another big correction like the one the metals just went through.
The inflation-adjusted all-time high for silver is $140/oz. This number is derived by compounding silver's high of $50 in 1980 using the Government-reported CPI rate. While I don't expect silver to reach that inflation-adjusted high on this next bull-cycle move, I would not be surprised if silver hit $100/oz before the next major price correction. I see both technical and fundamental factors which will drive this type of move in price and I'll review those below.
First, let's take a look at long term chart of silver:
This chart shows the Comex continuous contract over the last seven years. I wanted to capture the previous bull cycle price correction. In that correction silver dropped 56% from top to bottom. It then embarked on a 2 1/2-yr bull move that took it almost to $50. The majority of the move occurred when silver broke out of an 11 month consolidation pattern at the $18.20 level (green circle on the left). The correction that followed has been a 25 month, 62% sell-off that took silver, interestingly, right back down to the previous breakout area (green circle on the right), where has seemingly bottomed. I actually know a couple of long-time metals market investors (as in, from the 1970's) who thought a pullback of this magnitude of was a strong possibility.
On a technical/chart analysis basis, the case thus can be made that the big silver price correction that began in late April 2011 is over, silver has bottomed and it is headed higher. So let's take a look at a couple fundamental factors that should fuel the next move big bull.
First is the sheer size of global demand for physical silver. 1 billion ounces of silver is produced annually from mine production and recycling. Of that, roughly 900 million is consumed in industrial use (Silver Institute data). That leaves roughly 100 million ounces for investors.
So far this year through this week, the U.S. mint has sold 34.2 million 1-ounce silver eagles. With 3 1/2 months remaining in 2013, total silver eagle sales should hit at least 42 million. That's 42% of the annual amount of silver that is available to investors. The Royal Canadian Mint is projecting that sales of 1 oz silver maple leafs will hit 24 million this year. Between the U.S. and Canadian mints, that's 66 million of the 100 million ounces produced and not used for industrial purposes in 2013.
But what about China and India? Because of the restrictions put on gold imports by the Indian Government for most of 2013, Indian imports of silver have soared vs. 2012. In just the 1st half of 2013 (for which I have a data source), India imported 3,000 tonnes of silver, which translates into about 103 million ounces. It's safe to say based on the trend in India that India will import over 200 million ounces this year. Much of the silver imported into India is for investment purposes. China, based on the latest figures I could find, imported 991 tonnes of silver through the end of May so far this year. That's a little less than 200 tonnes per month. Let's assume China will import 2400 tonnes this year. That's another 82.5 million ounces of silver.
As you can see, just counting the U.S. and Canadian mints plus India and China imports, well over 251 million ounces of silver demand are accounted for. To be sure, part of the silver imported into India and China is for industrial use. But in total, just for the those four countries, investors will likely buy significantly more than the 100 million ounces of silver produced by mines in 2013 that does not go to industrial users. In other words, demand from both industrial users and investors will exceed the amount of silver produced this year by a considerable amount. That fact alone means the price of silver will have to rise from here just balance out current supply and demand.
The second fundamental factor I look at is the silver open interest structure on the Comex. You can review the numbers as of Tuesday's Comex close here: Comex open interest report. Currently the total silver open interest is 112.2k contracts. The open interest range over the 13-yr bull market has varied roughly between 80k contracts and 166k contracts. Over this period, silver has hit a price top when the open interest is at a high level and it has hit a bottom when the open interest is low. For instance, in April 2011 before silver hit $50, Comex open interest peaked at 166k contracts.
As you can see, the silver open interest is moving toward the lower bound of its open interest range. In fact, until the last couple of weeks, the silver open interest had been stubbornly persisting in the 140k +/-5k contracts, even when silver hit what I'm calling its bottom at $18.59. Interestingly, the silver open interest has quickly shed over 20k contracts over the last couple of weeks as the price has bounced. This tells me that the Comex silver shorts have been motivated to cover their short positions rather quickly.
Historically, the hedge funds have been the Comex players who have driven the price of silver to the up-side. But by the end of June, when silver bottomed, the hedge funds were driving the price lower by amassing a big short position. You see that data here: End of June Commitment of Traders report. Fast forward to the latest Commitment of Traders report, and you'll see that the hedge fund "managed money" category has taken its short position in Comex silver from 24.4k oz. in June to its current 10k. The hedge funds went from being net long 2900 silver contracts in June to 17.7k currently. For comparative purposes, at the end of March 2011, right before silver spiked up close to $50, the hedge funds were net long close to 30k contracts.
To put this kind of size in the context of global supply/demand dynamics as discussed above, 30,000 Comex contracts equates to 150 million oz. As you can see, the hedge funds currently have a significant amount of capacity to take on a big long position in Comex silver contracts - the kind of capacity that can really drive the price higher.
One last point about the current Comex silver open interest. As of Tuesday's close, the current front-month delivery contract for Comex silver, the December contract, had 78,258 of open interest. This translates into 391.3 million ounces of silver. But as of yesterday, there were only 42.2 million ounces of silver that were "registered" for potential delivery: Comex silver stocks. The "registered" warehouse stock category is the silver that has been designated by the owners of the silver and certified by the Comex as being available for delivery. So in other words, if a little more than 10% of the longs decide they want to hold for delivery, the Comex will be wiped out of silver. This has "short-squeeze potential" written all over it. Historically, no more than 1 or 2% of contract holders have ever stood for delivery. Probability theory says the risk of 10% doing so now is quite low. But the potential for a short squeeze is there and even if 3-4% of the longs hold for delivery, it will put a huge dent in the amount of silver on the Comex and send the kind of message to the market which will lead to a big move higher in the price of silver.
Finally, yesterday Pan American Silver (NASDAQ:PAAS) made a very interesting announcement. PAAS reported that it had decided to close all of its outstanding gold and silver production hedges. What's interesting about this is that it had announced the implementation of these hedges only three weeks earlier. The hedge on silver represented 20% of its estimated forward production. A mining company will hedge production when it expects the price of silver (or gold) to decline for an extended period of time. But if the company sees the potential for the price to rise significantly, it will go unhedged in order to maximize shareholder value. In fact, depending on the size of a company's hedge relative to their overall volume of production, a large enough rise in the price of silver (or gold) can actually cause that company to lose money.
PAAS is the 6th largest silver mining company in the world. There can be no other explanation for PAAS to remove silver production hedges this large, and stunningly so quickly after it put them on, than that they see what's going on first-hand with the supply and demand of silver worldwide and decided that the price of silver is going much higher.
As I have laid out from both a technical and fundamental perspective, I am convinced that not only did silver bottom out from its two-year price correction at the end of June, but the price of silver has started a long-term move that could take it to new all-time high prices (nominal price, not inflation-adjusted). As I discussed in an article I posted about two weeks ago (Taper or no taper, buy gold), even if the Fed announces a tapering of its QE next week after its FOMC meeting, the metals stand poised to move a lot higher. The safest way to play silver is to buy 1 oz U.S. minted silver eagles and keep them under your own lock and key. If you want to "index" the price of silver for a shorter term trading play, I recommend buying SLV (iShares Silver ETF). If you want to leverage SLV you can always buy call options on it. More aggressive traders can get long AGQ (ProShares Utra Silver ETF, 2x silver) or USLV (VelocityShares 3x Long Silver ETN). I also have some interesting silver mining stock ideas that I will publish in the near future.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article. The fund I co-manage is long physical silver, silver futures and USLV.