Silver: 'Don't Worry Be Happy'

by: Simple Digressions


Despite quite low silver prices, the North American silver futures market is overbought now.

The physical demand for silver is growing rapidly. Two big players, JPMorgan and the Chinese, are heavily accumulating silver.

It looks like the silver market is hot now but I would not worry about it.

Quite contrary, I believe that silver may be at the beginning of an unprecedented price rally.

The silver market is getting hot. Despite the fact that silver prices are quite far from the last top (established in the beginning of August 2016), the demand for silver is accelerating. Interestingly, both the paper and physical markets are sending a bullish message.

The paper market - COT Reports

The US silver futures market is starting to look overcrowded now. The total open interest of 197.6 thousand contracts is very close to its record reading, printed last August (224.5 thousand contracts). In other words, the silver game is very popular among North American investors.

What is more, the game is, once again, close to its extreme indications. Look at the chart below:

Source: Simple Digressions and the COT data

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

The chart shows net positions in silver futures, held by Commercials. On February 28, 2017 (the circle marked in violet) Commercials were holding a net short position of 54.7%. It was the highest reading in the current silver bull cycle, which started in the beginning of 2016.

To remind my readers, Commercials are market makers. In other words, their role is to satisfy the demand for silver futures expressed by speculators (mainly hedge funds) standing on the other side of the trade. A very large net short position held by Commercials is equivalent to a large net long position held by speculators, which are heavily betting on higher prices of silver (the green circle on the chart below):

Source: Simple Digressions and the COT data

Interestingly, on February 28, 2017 the price of silver was 11.4% lower than in the beginning of August 2016 ($18.25 vs. $20.60 per ounce) but:

  • The net short position held by Commercials was higher than in last August (54.7% vs. 48.6%)
  • The net long position held by speculators was higher than in last August (48.3% vs. 44.5%)

In my opinion, it is the evidence that the silver futures market is getting hot or even very hot.

This thesis is supported by another occurrence - the four largest market makers (the players satisfying the demand expressed by speculators) are starting to dominate the silver futures market once again. Let me remind the definition of the so-called "Concentration ratio":

"The report shows the percents of open interest held by the largest four and eight reportable traders, without regard to whether they are classified as commercial or non-commercial…The "Net Position" ratios are computed after offsetting each trader's equal long and short positions. A reportable trader with relatively large, balanced long and short positions in a single market, therefore, may be among the four and eight largest traders in both the gross long and gross short categories, but will probably not be included among the four and eight largest traders on a net basis"

In my article dated January 24, 2017 I stated that the big market makers were scaling down their short positions in gold futures. It was a sign of an incoming end of the last correction in gold prices (initiated last summer).

However, the silver futures market is different from its gold counterpart. The size of the net short position, held by the biggest four market makers, has been in an upward trend since late 2014 (the green arrow on the chart below) and now it stands near its record readings in the current silver cycle:

Source: Simple Digressions and the COT data

What does it mean? I would summarize this discussion in the following way:

  • The silver futures market is overcrowded now
  • To satisfy the high demand expressed by speculators betting on higher prices of silver, the Commercials are pressured to increase their short positions in silver futures
  • The main burden of this increase is shared by the largest players among Commercials. Hence their higher participation on the short side of the trade

Now, the point is that the silver paper market is sending very bullish signals. I would even say that the state of this market indicates its overbought condition - too many speculators betting on higher prices of silver. Usually, the patterns discussed above would make me saying that a correction in silver prices is incoming. However, the patterns delivered by the gold futures market draw a different picture. As I discussed in my last article, the gold paper market is still at its initial bull market phase. Such measures as the net short position held by commercials, the net long position held by speculators and concentration ratios are not elevated at all. The last time the market patterns were similar to these drawn now was in the beginning of 2009. It was the time when gold and silver prices were starting their huge rally.

The physical market

I closely follow the Shanghai Futures Exchange (NYSE:SFE) reports on its silver holdings. As my readers surely know, since middle 2015 the Chinese have been rapidly accumulating silver bullion. At the end of January 2017 the amount of silver held in the SFE vaults hit its new record of 64.1 million ounces (the horizontal, red line on the chart below). Since that time the SFE has been further increasing its silver holdings, which now stand at 68.7 million ounces:

Source: Simple Digressions

Interestingly, JPMorgan (NYSE:JPM) is actively accumulating silver as well - look at the table below:

Source: Simple Digressions and the SFE and COMEX data

Since the end of 2016 JPMorgan has increased its silver holdings by 9.4 million ounces, slightly above the increase reported by the SFE (9.0 million ounces). It looks like both entities, due to some undisclosed reasons, compete with each other for silver. In my opinion, it is a very bullish sign for silver prices in the long - term.

On the other hand, North American speculators are not so eager for silver. The iShares Silver Trust (NYSEARCA:SLV), the largest world's private holder of silver bullion, reports outflows of silver from its vaults. Since the beginning of 2017 its silver holdings decreased by 8.6 million ounces. Interestingly, the SPDR Gold Trust (NYSEARCA:GLD), a large holder of gold bullion, increased its holdings by 592 thousand ounces this year. It is another indication that gold and silver markets, contrary to gold / silver prices, are not going in tandem anymore.

As the old Chinese saying has it: "May you live in interesting times"…

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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