Gold And Silver: 2 Different Markets

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Includes: AGQ, DBS, DGL, DGLD, DGP, DGZ, DSLV, DULL, DZZ, GEUR, GHE, GHS, GLD, GLDI, GLDW, GLL, GTU, GYEN, IAU, OUNZ, PHYS, PSLV, QGLDX, SGOL, SHNY, SIVR, SLV, SLVO, UBG, UGL, UGLD, USLV, USV, ZSL
by: Simple Digressions

Summary

It looks like the silver / gold futures markets are at different stages now.

The silver futures market is overcrowded now and big speculators are very optimistic about silver prices. On the other hand, the speculators in gold futures are rather pessimistic about gold.

However, despite pessimism among big speculators, gold prices draw a bullish, short-term pattern.

In my opinion, these developments support my bullish thesis on gold and silver prices.

It is a well-known rule that gold and silver prices go in tandem. However, the patterns delivered by gold / silver futures markets show a large divergence. And although I hate stating that this time something is different (at the end of the day such a "brave" thesis is, in most cases, false), it really looks like this time the gold and silver markets are different. In this article I am trying to explain this thesis.

Let me start with the Commitments of Traders reports (COT reports).

COT reports

The charts below show the total open interest attributable to gold and silver futures:

Source: Simple Digressions and the COT reports

Note that now the amount of contracts available in the game called "silver futures" is very close to its record (the circle marked in red). This record was set in early August 2016 when as many as 225 thousand contracts were in the game. According to the last COT report (dated February 21, 2017), the total open interest in silver futures was standing at 208 thousand contracts (7.6% below the record level).

On the other hand, now the total open interest in gold futures is very far from the record readings (look at the two green circles). In the beginning of July 2016 the total open interest in gold futures was standing at 633 thousand contracts (the highest in history). Now it stands at a mere 427 thousand contracts (32.5% below the record reading).

Simply put, the silver trade seems to be overcrowded again while its gold counterpart looks as if nobody is interested in it.

Interestingly, in the beginning of 2009 the investors could spot a similar pattern:

Source: Simple Digressions and the COT reports

At that time:

  • The open interest in silver futures was standing at its highest level in history (189 thousand contracts - point A)
  • The open interest in gold futures was standing at around 350 thousand contracts (point B) which was 41% below its record level (established in the beginning of 2008)

What happened then? Both gold and silver prices had started their huge rally.

Further, contrary to the gold market, now the silver futures speculators (Money Managers) are holding very large net long positions:

Source: Simple Digressions and the COT reports

Note: I measure the size of a position held by a group of players in gold and silver futures against the total open interest.

As the chart shows, now the Money Managers are holding a net long position amounting to 37.2%. It is only slightly lower than the record reading of 43.9% (July 2016). In other words, these speculators are very optimistic about silver prices.

Now look at the gold market:

Source: Simple Digressions and the COT reports

Here the Money Managers are holding quite a small net long position in gold futures (18.3% - point B), compared to the record reading of 45.6% (early September 2016 - point A). Putting it differently, Money Managers are rather pessimistic about gold prices.

Summarizing, despite the old rule that gold and silver prices go in tandem, gold and silver futures markets are drawing different patterns. What is more, history teaches that it is the silver market that may drive the prices of gold and silver (refer to my discussion of open interest in silver and gold futures in 2009).

Gold is very strong now

Although the gold futures market does not show any particular strength at the moment, the pattern drawn by gold prices is very bullish:

Source: Simple Digressions

The chart shows the inverted US dollar index and gold prices, starting from middle December 2016 (for clarity, I have plotted the inverted US Dollar index instead of the US dollar index itself).

As a rule, when the inverted US dollar index goes up, the prices of gold go up as well. It means that when the inverted US dollar index makes a new high, the price of gold should make a new high as well. And vice versa.

Now look at the chart above. On February 9, 2017 the inverted US dollar index broke below its support (the horizontal line marked in violet and the point B). According to the old rule, the price of gold should have broken below its support as well (the horizontal line marked in violet and the point A). However, it did not. What is more, gold prices continue their march up and last week they established their new local top. In my opinion, it is a sign of the gold's inner strength.

A short update on silver fundamentals

In my previous articles I was presenting a thesis that it was the so-called silver race between JP Morgan (NYSE:JPM) and the Shanghai Futures Exchange (NYSE:SFE) that was standing behind strong fundamentals of silver. This year the SFE continues accumulating silver rapidly. Since the end of 2016 it added 7.9 million ounces of silver to its vaults (an increase of 13.2%, compared to the end of 2016).

JP Morgan has been even more aggressive and has added 8.6 million ounces of silver to its vaults at the COMEX (an increase of 10.5%, compared to the end of 2016).

On the other hand, the largest private holder of silver, iShares Silver Trust (NYSEARCA:SLV), slightly reduced its silver holdings from 341.3 million ounces at the end of 2016 to 335.3 million ounces (as of February 24, 2017). However, this decrease (6.0 million ounces) was fully covered by JP Morgan and the SFE (a total increase of 16.5 million ounces).

Interestingly, JP Morgan seems to hold the largest position in precious metals in its modern history:

Source: Simple Digressions

As the chart shows, now the bank holds precious metals worth $3.3 billion (silver: $1.7 billion; gold: $1.6 billion).

Note: Due to the fact that JP Morgan is also an active player in gold / silver futures, its exposure to precious metals is much higher than the market value of its physical holdings.

Summary

This year the silver and gold paper markets behave in a different way. It looks like the silver futures market is overcrowded now. On the other hand, the gold market, with big speculators being rather pessimistic about gold prices, is still at its initial stage of a bull phase.

However, in my opinion, both markets draw a bullish pattern. The silver market, with its strong physical demand, seems to be a leading one. The gold market, despite pessimism among big speculators in gold futures, is supported by a bullish pattern delivered by gold prices.

Disclosure: I am/we are long GDXJ.

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.

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