- Silver's trading range will eventually break to the up or downside.
- Three reasons odds favor the upside.
- Silver bullion is the best bet.
- SLV is a medium-term investment vehicle.
- USLV is for market timers and short-term traders, but it could turbocharge results.
Silver is the most volatile precious metal that trades on the futures exchange. When it comes to the four precious metals, silver tends to move more on a percentage basis, over short periods, than gold, platinum, or palladium. Silver's penchant for a high degree of price variance comes is the result of speculative interest as herds of buyers or sellers tend to embrace the metal when a price tend develops. Since the late 1970s, on two occasions the price of silver exploded to around the $50 per ounce level. In 1980, the price of nearby COMEX silver futures peaked at $50.36 per ounce, and in 2011 it got up to a high of $49.82.
Memories of fantastic rallies in the precious metals in those two years have remained in the heads of many market participants. Silver last traded below $10 per ounce back in 2008, which is now a decade ago. It has not dipped below the $13.635 level in the COMEX futures market since December 2015 and is currently sitting around the $16.50 level.
Silver's trading range will eventually break to the up or downside
Since the beginning of 2017, the price of silver traded in a range of $15.15 per ounce to a high of $18.655, a band of $3.505. So far, in 2018, the precious metals range has narrowed to $16.13 on the lows and $17.705 on the highs, and the $1.575 spread is less than half its level over the past over fourteen months.
As the monthly chart of COMEX silver futures highlights, the narrowing trading range has caused monthly historical silver volatility to drop to its lowest level in years at 12.92 percent. The price of silver has experienced a prolonged period of consolidation that has prevented the precious metal from breaking to the up or the downside.
I have been trading this volatile metal since the early 1980s, and I have learned to always expect the unexpected from the silver market. As silver lulls investors and traders to sleep with its price action these days, there are three significant reasons why I believe when it decides to break from its narrowing price band, it will be to the upside.
Three reasons odds favor the upside
The first reason is that silver, like gold, has a long history as a monetary asset. While central banks no longer hold silver as a reserve asset, the world continues to view the metal as gold's sibling. If gold analogous to bank notes, silver represents the change that adds up to the currency unit. Since the financial crisis in 2008, central banks have deflated currency value through historically low interest rates via short-term monetary policy and other tools like quantitative easing. The stimulus resulted in a virtual tidal wave of liquidity in markets which served to devalue paper currencies. Without the backing of gold or silver over past decades, the world's reserve currencies depend only on the full faith and credit of the governments that print notes and mint coins. Increased supply of currency and swelled levels of money supply has a devaluing impact on government-issued currency instruments. Therefore, silver as a hard asset has gained value as currency instruments declined in worth and its path of least resistance continues to point to a higher price.
The second reason is that monetary policy has been highly inflationary as more currency floating around the markets eats away at the value of money. In the United States, January CPI and PPI numbers indicated that inflationary pressures are rising. Silver and other precious metals and commodities are traditional safe harbor instruments when it comes to protecting wealth from the devastating impact of inflation. While the U.S. Fed is in the midst of a tightening cycle when it comes to credit, it is likely that the gradual pace has put the central bank behind the curve. Moreover, in Europe and Japan, short-term rates remain at historic lows and in negative territory. A resurgence of inflationary pressures around the world is a reason for silver to eventually break to the upside out of its narrowing trading range.
Finally, in 2017 the wild price volatility in the digital currency markets drained potential speculative interest from the silver market. Opportunities in Bitcoin, which moved from $1,000 to over $19,000 caused many to turn away from the silver market for the cryptocurrency and many other tokens that have unprecedented price variance captured market share. So far, in 2018, the digital currency asset class has calmed, and that could mean a return of some market participants to the silver market once they believe it offers new and exciting opportunity.
For those reasons, and more, I believe that the downside price potential for silver is small while the upside could become explosive when the herd returns to the silver market. The resignation of Gary Cohen from the administration late yesterday could be another spark for volatility in markets and could take silver higher in coming days.
Silver bullion is the best bet
When it comes to the world of commodities, the most direct route for investment is always in the actual raw material. I like to look at the commodities market as a pyramid, at the very top is the physical asset which has a 100% correlation with the price.
Silver bars and coins offer market participants the ability to both hold the physical metal and realize the daily price changes. Holding actual silver in a safe or one's home allows the investor to have total control over the asset at all times. However, the drawback is that liquidity often makes the bid/offer spread wider than other silver-market instruments. Bullion dealers tend to charge premiums for bars and coins, and when it comes time for investors to sell, they can trade at discounts to the prevailing price.
COMEX silver futures are the next step down on the pyramid as they do an excellent job replicating the price action in the physical silver market. Moreover, the delivery mechanism in the future market allows participants to make and take delivery of the underlying commodity. When it comes to COMEX deliverable silver, liquidity is less of a concern than when dealing with dealers who buy and sell bars and coins.
SLV is a medium-term investment vehicle
The next step down on the pyramid in the silver market is the SLV ETF product. SLV is an instrument that is not actively managed; rather it receives silver deposited with it in exchange for the creation of baskets of shares. The ETF has an expense ratio of 50 basis points, which means it tends to trade at a discount to the price of silver over time as it must exchange silver to raise money to pay for expenses. However, it does an excellent job tracking the price of the precious metal over time.
As the chart of SLV dating back to 2006 shows, when silver traded to a high of $49.82 in 2011, the ETF product peaked at $48.35 per share. When silver fell to its bottom at $13.635 in December 2015, the SLV traded to a low of $13.04 per share. At $15.78 on March 6 with the price of nearby silver futures trading at the $16.75 level, the ETF is a reasonable proxy for the price of silver on a medium and even longer-term basis.
USLV is for market timers and short-term traders, but it could turbocharge results
As the chart of the USLV vehicle shows, since September 2017, it traded in a range from $9.07 to $14.96 per share and closed at $10.78 on Tuesday, March 6. Keep in mind, that the triple leverage means that USLV employs futures and options contracts to allow for price performance that seeks to move three times the amount of the underlying price on a short-term basis. Aside from silver's price risk, buyers are also at risk for theta or time decay with the USLV product which tends to move lower over time even if the price of silver remains stable.
I believe that an upside break in the silver market is coming sooner rather than later and have been trading in and out of the USLV product over recent sessions. I rarely hold positions in this vehicle more than for a day or two. At times, I will buy it early in the day, and sell later in the session, only to return on the long side the next day. Trying to catch a rally in the silver market can be a challenge, but I have found that a contrarian approach tends to offer the best results. When it comes to catching a break to the upside, patience and perseverance are needed, but if silver really starts to move the payoff will likely be worth all of the aggravation.
As a highly leveraged vehicle, USLV is like a silver lotto ticket, but the payoff can be considerable for those who time the market well.
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This article was written by
Andrew Hecht is a 35-year Wall Street veteran covering commodities and precious metals.He runs the investing group The Hecht Commodity Report, one of the most comprehensive commodities services available. It covers the market movements of 20 different commodities and provides bullish, bearish and neutral calls; directional trading recommendations, and actionable ideas for traders. Learn more.
Analyst’s 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.
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