As a follow-up to an article published two weeks ago, this is an update to data that leads me to believe that silver is gearing up for its next breakout due to bullish structural changes in the weekly COT reports, Bank Participation Reports, supply and demand dynamics, backwardation and the corresponding convenience yield. I covered the most recent COT report in another article but I will post the fully adjusted data for the sake of simplicity.
- Supply - Demand Dynamics
As I have said numerous times in various articles, Silver boasts one of (if not the best) supply-demand dynamics in the commodity world. It is a double edged sword as it possess a very unique blend of Industrial uses (being used in more and more applications) as well as a monetary component, like gold being as real money for thousands of years.
Note: 2010 numbers are projections and have yet to be released.
(Click charts to enlarge)
- Commitment Of Traders Report
- Backwardation and Physical Constraint
As I explained in a previous article "We are back to early 2009, when the futures market showed backwardation, an extremely bullish signal. Soon following this backwardation, silver rose rather substantially (over 30% in a rather short period of time). The current backwardation is most likely a factor of the constraints in the physical market for silver, as it indicates people are willing to pay more for silver now relative to twelve months in the future."
I took the futures curve one step further in this update, using the convenience yield (see below), using the computed yield of 5% as an annual discount rate. Doing this, we can get a better grasp on the shape of the futures curve, which is for illustration purposes only.
"To better understand the above curve, a theoretical explanation may help. The following diagram is the convenience yield, which implies that those with inventories will not be willing to lend the commodity to an arbitrageur for a lease rate to compensate for the loss of this yield. If the current supply of a commodity is large relative to its demand, the yield will be low as producers desiring to use the commodity can always access it through the market. If spot supplies are tight relative to demand, the convenience yield is large. The latter is what is currently taking place as the convenience yield is in excess of 9%."
The physical tightness, at least from what we can derive via the futures market, has slightly moderated from 2 weeks ago albeit remaining very high relative to the norm. I still contend we won't see a significant decrease in the convenience yield/backwardation until we have witnessed a material breakout.
- Gold To Silver Ratio - Though I in no way believe gold will retreat as continued currency debasement runs rampant, even assuming gold settles at a long term price of $1,000/oz, using the historical gold to silver ratio of 15:1, silver should still see $66/oz in the future or $50/oz using a 20:1 ratio.
- Physical Gold and Silver (Or ETFs) such as (PSLV) or (PHYS) - whose shares are redeemable for the physical bullion or (SLV) and (GLD).
- Royalty Companies - A leveraged play in the equity arena with greatly reduced mining risk: Royal Gold (RGLD), Silver Wheaton (SLW), Franco-Nevada (FNNVF.PK) and Sandstorm Resources (SNDXF.PK).
- Mining Companies - (Personal favorites include Atna (OTC:ATNAF), Gammon (GRS), Aurcana (OTC:AUNFF), Alexco (AXU) and Bear Creek (OTC:BCEKF), among many others).