Commodity Outlook: Silver

Aug.25.14 | About: iShares Silver (SLV)


There seems to be price stabilization due to the cost of production for the industry.

Possible arbitrage play: sell gold, buy silver based on statistical correlation.

Although silver price action resembles a bearish descending triangle, speculators suggest this is a multiple bottom formation and excessive selling should stall.

Buffett and Gates have previously invested in silver.

Personally, I am not one to invest in metals given that buyers can be few and far between and it is environment that appears to be subject to shady activity. Moreover, I am a value investor, so I tend to stick with equities; however, I do hold an interest in commodities so here is my current perspective.

Silver (NYSEARCA:SLV) is viewed as the secondary precious metal to gold (NYSEARCA:GLD). Even though both of the precious metals continue to trade at multi-year depressed levels, they appear to be much safer given recent price stabilization. I think silver, however, presents a stronger opportunity given some underlying assumptions outlined below.

Cost Of Production

In the commodities market, highlighting speculators, people assume that the average cost of production for silver is around $16-18 (others say the consensus is closer to $20) and gold is measured around $1200. Obviously, these figures varies between continents (more or less easily attainable) and higher quality companies (that have more efficient logistics). However, many current businesses continue to suffer, as they implement intensive cost cutting measures in attempt to have a profitable bottom line. As of right now, both are sitting at $19.41 and $1281, respectively. George Soros stated back in 2011, as gold was ripping to new highs, that it would not reach $2000 nor would it break below $1000. This was a fairly bearish call, where he assumed a bottom would ripen towards the lower end of that range. Interestingly enough, it panned out exactly as he said. Many believed this was a cost of production based hypothesis. Moreover, traders assume that the metals are dramatically influenced by institutional positioning (not just players like China or India) to sustain an elevated spot price. Some say these manipulative tactics are an attempt to destroy varied companies' market share positions. Simply put, if a given business can not sustain operations, how can it control a position in the market? It's essentially forced downsizing at the cost of smaller players. Basically a long-term play for a select few.

The Trade

I never trade commodities or precious metals so take what I have to say with a grain of salt. Statistically, over the last decade there has been a silver to gold ratio of 45-60 to 1 (60 being the cheapest extreme). Since early February of 2014, that gap has grown to a 63-65 figure, and it has widened by more than 6% to date. This is the second largest spread it has seen in more than a decade. Early June happened to be the biggest thus far, but it was quickly closed by an intense 10+% rally in the following three weeks of trading.

Arbitrage defined: "the simultaneous buying and selling of securities, currency, or commodities in different markets or in derivative forms in order to take advantage of differing prices for the same asset."

So, the simple play here is to go long silver and short gold based on the assumption that this 65 ratio gap should close over the next few years toward a more normalized target of 55. If both metals tank or rally, theoretically your allocation should be protected. Keep in mind that arbitrage plays and hedging strategies require extended periods of time.

Side note: Although gold has historically outperformed silver, this is not the case over the last 5 years. Typically, when the prices are almost directly aligned, both metals experience a rally, while silver tends to be the leader.


So, over the few years we have seen multiple descending triangles which continuously broke to the downside, and it was easy put money for the bears. Although now it appears that the bearish run is over, where both silver and gold are experiencing a one-year consolidation phase.

I know professional traders use complex geometric shapes, involve ATR analysis, overlay multiple indicators, but I just like to keep it simple. We have support around ~$18 and ~$18.50. Stochastics RSI is extremely oversold sitting at 0.00 and the MACD oscillator is reverting towards the zero level as well. Although current action is bearish, I think a breakout to the upside isn't far away in the short term. At current prices, it looks like a decent buy. Tech traders will say, however, that $18 is the "Alamo" where people should ditch long positions (given disproportionate market imbalances) if we see a break below that level.

Silver Wins?

The attributes of silver, including its strength, malleability, and conductivity, will explain the array of applications it has spanning computer chips, filters, medical uses, generators, and so forth. It's obvious that silver has more uses than gold does. Excluding aesthetics, it holds more intrinsic value than gold by a long shot, and that is why I like silver more. People may attempt to deny this but it's the honest truth. Furthermore, both Buffett and Gates have previously made investments into silver and made a pretty penny. Overtime, I think silver and gold should increase in value, not simply because it is viewed as an inflationary and economic hedge, but people in the future will view it as a "more scarce" material. The take away here is that two brilliants minds, particularly those who traditionally stay away from non-productive assets, have actually owned silver and to me that is noteworthy. I'm not going to mention the implications that solar energy will have with respect to silver, but it's quite clear that it's a rapidly growing industry, and silver is key there.

Bottom Line

Today, I think silver is getting to the cheaper side in terms of its pricing as it relates to supply and demand. The macro fundamentals and technicals appear to be stabilizing prices over the last year which is a plus. Given the underlying reasons mentioned above, I think the arbitrage play in gold and silver may pan out successfully over the next few years. Some may also consider simply going long a silver ETF.

Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.