Silver Volatility On The Horizon

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Includes: AGQ, BLNG, CEF, DBP, DBS, DGL, DGLD, DGP, DGZ, DSLV, DULL, DZZ, GEUR, GHE, GHS, GLD, GLDI, GLDW, GLL, GLTR, GTU, GYEN, IAU, JJP, OUNZ, PALL, PGM, PHYS, PPLT, PSLV, PTM, QGLDX, SGOL, SHNY, SIVR, SLV, SLVO, SPPP, UBG, UGL, UGLD, USLV, USV, ZSL
by: Andrew Hecht

Summary

Silver is following gold.

Silver is crawling higher - Higher lows in 2017.

Open interest at all-time highs.

Silver loves to surprise.

Shock and awe ahead.

Silver is a commodity that likes to confuse market participants. Gold's little brother has a penchant for extreme volatility at times, but it also can sit and torture those waiting for a move.

Speculators not only love volatility, but they also thrive in markets with a high degree of price variance. Silver has had two journeys to the $50 per ounce level over the past thirty-seven years. The first took the price to $50.36 in January 1980. The next came within a hair of the half-century mark when silver rallied to $49.82 in April 2011.

After the first trip in 1980, silver fell to lows of under $4 per ounce in the 1990s; however, since its most recent journey to highs, the lowest level for the precious metal has been $13.635 in December 2015. As of Tuesday, April 18, the price of silver was around the $18.30 per ounce level. At times, silver is a leader in the precious metals sector. When speculators pile into the silver market, the price tends to outperform gold. However, these days, gold is taking a leadership role in precious metals as uncertainty and fear have caused buying in the yellow metal. While silver has moved higher in 2017, events in Syria, Afghanistan, and North Korea have put strains on the U.S. relationships with China and Russia. In a world of uncertainty, it has been gold that has been the star performer in precious metals over recent weeks. Meanwhile, after almost forty years of trading in the precious metals markets, I have learned that it will eventually be silver that moves the most aggressively on a percentage basis, and we could be on the verge of that kind of move right now.

Silver is following gold

Silver and gold often take turns leading rallies and dips in the precious metals sector. The best way to gauge which of the lustrous metals is currently holding the leadership baton is to watch the price action in the silver-gold ratio.

The ratio dates back to the first Egyptian Pharaoh, Menes, who stated that two-and-one-half parts silver equal one part gold in around 3100 BC. Menes' proclamation on value was the first statement about the value relationship between the two precious metals on record. Over the course of the past forty years, the average level of the ratio has been around 55:1, and the value spread tends to return to that level as a mean reversion pattern. During bull market periods in precious metals, the ratio tends to move lower, and when prices are weak, it moves higher. In 1980, when silver traded to highs, the ratio was around 16:1. In 2011, it traded to 38:1.

On a short-term basis, the ratio is the best method of ascertaining whether gold or silver is leading the precious metals sector and the action so far in 2017 has been frenetic. Gold and silver prices have been moving higher throughout 2017. Source: CQG

As the daily chart of the price of gold divided by the price of silver shows, from the beginning of the year through March 1, 2017, silver led gold to the upside as the ratio fell. Then, from early March through March 22, it was gold that took the leadership baton only to hand it back to silver in late March through the very beginning of April. Since then, it has been gold leading the charge as the ratio has increased from 68.6:1 on April 6 to 70.5:1 on April 19. Right now, silver is following gold, although it has a long history as a more speculative and volatile metal when it comes to price action.

Silver is crawling higher - higher lows in 2017

While gold has been leading silver over the past two weeks, neither metal has been doing badly. Source: CQG

As the daily chart of COMEX silver futures shows, the price has been making higher lows and higher highs throughout the year, which is a constructive and bullish pattern. However, daily historical volatility in silver at 16.48% is on the low side for the metal that traditionally measures variance above the 25% level.

Silver has been crawling higher in 2017, but there is substantial evidence that the precious metal continues to attract lots of interest.

Open interest at all-time highs

Open interest is the number of open long and short positions in a series of futures contracts. Higher levels of open interest are signals of liquidity and market participation. Source: CQG

As the quarterly chart dating back all the way to 1971 illustrates, the current level of open interest in COMEX silver futures at 227,984 contracts is the highest in history. The total number of long and short positions is north of 1.14 billion ounces of the precious metal with a value of over $20.7 billion.

I view the record interest in the silver futures market as bullish and believe that those holding long positions are resilient and strong holders. Source: CQG

As the daily chart illustrates, open interest has been climbing with price throughout 2017, which is a technical validation of the bullish price trend.

Silver seems set to surprise on the upside, particularly given the price action in gold. After all, recent world events, a lower dollar and falling long-term interest rates over recent trading sessions could be setting up a perfect bullish storm for gold and silver alike. Fear and uncertainty have dominated the market action and the precious metals, which are historically safe-haven assets, tend to thrive in just this kind of environment.

Silver loves to surprise

Anyone who has traded silver for decades will tell you that a constant theme is to always expect the unexpected. Silver moves to the up and downside tend to come out of the blue. All of a sudden, the price of silver is $1 or $2 higher or lower. Another feature of the silver market is the head-fake. Silver often dips and looks terrible just before an explosive rally or moves higher and looks like it is going to the moon before the price absolutely tanks.

It took silver one year, from January 1979 to January 1980 to rally from $8.53 to $50.36. Then it took the metal three months to fall to $10. The move that resulted in the peak in 2011 was slower, but silver halved in value over a six-month period after reaching its most recent high six years ago. Silver takes the elevator down; sometimes it takes the elevator up as well. There has not been a $1 trading range from low to high in silver so far in 2017, and it is starting to feel like that sort of price action is overdue for the silver market. The last three times silver moved over a buck in a day were all on the downside - in October, November, and December 2016. During that period, silver was making lower highs and lower lows, as it descended from highs of over $21 per ounce in July 2016.

Shock and awe ahead

Each day I look at the silver price over recent weeks, I expect shock and awe from the metal with a penchant for extremes. The price pattern is perfectly set up for an explosive move to the upside. The downside price action in silver on April 18 when it dropped to $18.065 and recovered back to almost $18.30 per ounce was the perfect type of head fake I have seen in silver many times over past decades when the price is getting ready for a significant move.

A perfect storm is brewing in the silver market, and it may only be a matter of time before volatility returns to the precious metal. The price action and current market environment lead me to conclude that volatility is on the horizon and the move to the upside will not only shock some market participants it will leave others in awe with their mouths hanging open by the time it is all over.

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Disclosure: I/we 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.