Silver: The One-Year Anniversary Of A Flash Crash

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About: VelocityShares 3x Inverse Silver ETN (DSLV), Includes: AGQ, BAR, DBS, DGL, DGLD, DGP, DGZ, DZZ, GHS, GLD, GLDI, GLDW, GLL, IAU, IAUF, OUNZ, PHYS, PSLV, QGLDX, SGOL, SHNY, SIVR, SLV, SLVO, UBG, UGL, UGLD, USLV, USV, ZSL
by: Andrew Hecht
Summary

Ugly action in Asian trading hours.

A break below $16.

Silver has outperformed gold.

Is silver waiting for an elevator?

Things could get ugly if gold makes a lower low.

The silver market has been relatively calm in 2018. The rallies have taken the stairs to the upside, and even the most recent elevator ride lower on June 15 did not create too much havoc.

The move that took September COMEX silver futures to a high of $17.43 per ounce on June 14 fell short of the first technical target on the upside at the April 19 peak at $17.51. Silver put in another lower high, the third of 2018, and the pattern of lower peaks has been in place since the post-Brexit July 2016 high at $21.095 per ounce.

Silver always has a potential to move appreciably higher or lower, and it is typically sentiment that drives the price of the precious metal. Silver’s volatility causes speculative interest to flock to the market, and those speculators often enhance price variance. Therefore, volatility in the silver market is a chicken-and-egg dilemma. One year ago, this month, the price of silver plunged when a significant selling order hit the market during a time of the day when liquidity tends to be absent.

Ugly action in Asian trading hours

In early July 2017, while the majority of the silver market was not watching, the price plunged. During Australian trading hours after the U.S. market closed and before Asian trading got underway, a large sell order hit the silver market at a time when liquidity was insufficient. The price of the active month silver futures contract on the COMEX division of the CME plunged. Initially, the price of silver moved below $15 per ounce. However, during the wild frenzy of selling silver had become a hot potato and the price action violated resting buy orders below the market. The exchange raised the low to $15.15 per ounce which still stands as a critical technical support level for the precious metal.

Source: CQG

As the weekly chart highlights, silver recovered from the July 2017 low. The following week, silver was back above the $16 per ounce level. While silver fell below $16 again last December when the Fed hiked interest rates and precious metals fell to lows for the third consecutive year, silver made a higher low at $15.555 per ounce. Just like in July, silver quickly recovered and was back above $16 the next week and had not traded below that level until the final week of June this year.

A break below $16

After rallying to a high of $17.43 on the September futures contract on June 14, silver declined as gold could not manage a rally, the dollar moved higher, and commodities prices fell under the weight of the tariffs issues.

Source: CQG

September silver futures broke below $16 per ounce once again on June 28, and on July 2 they reached a low at $15.80 per ounce on the active month September COMEX futures contract. On the nearby July contract, the low was at $15.73, which was higher than the December 2017 low. On the daily chart, the precious metal declined to deeply oversold territory. Open interest, the total number of open long and short positions in the silver futures market dropped from 232,754 contracts on June 14 when silver was on its most recent high to 208,174 contracts on July 2. The decline of 24,580 contracts or 10.6% in less than one month is a sign that longs exited risk positions during the July-September roll period. However, in futures markets, declining open interest when the price is falling is not typically a technical validation of an emerging bearish trend in a futures market. On Tuesday, July 3, September silver futures settled at $16.043, but the July contract remained below the $16 level with a settlement of $15.952 per ounce. Time will tell if silver will hold and the pattern of higher lows since last July will remain intact. However, silver is vulnerable as gold fell within $2.30 of its critical support level on July 2 when the price of the yellow metal traded to a low of $1238.80 on the August futures contract.

Source: CQG

As the weekly chart illustrates, to keep the pattern of higher lows dating back to December 2015 intact, gold will need to hold its December 2017 bottom at $1236.50 per ounce. Gold rejected its most recent attempt to break that level on July 3 as it rebounded to close at $1253.50 on the August contract. Meanwhile, the yellow metal is not out of the woods as the path of least resistance has been lower.

Silver has outperformed gold

The silver-gold ratio has been around for thousands of years since the first Egyptian Pharaoh Menes declared that two and one-half parts silver equals one part gold. However, in modern times, the level of the price relationship between the two precious metals has been at a much higher level.

Source: CQG

As the quarterly chart dating back to 1974 shows, the median level of the relationship stands at 54.325:1. In 1979 the ratio fell to its modern-day low at 15.47, and in 1990 it rose to highs of 93.18:1. Therefore, on a historical basis, when the number of ounces silver value in each ounce of gold value is below the 54.325:1 level silver is expensive compared to gold, and when it is above, the volatile precious metal is cheap compared to the yellow metal. Silver has not traded below that level since 2012.

Source: CQG

As the daily chart shows, the ratio was trading at the 78:1 level on July 3, so silver remains inexpensive compared to gold on a historical basis. However, the relationship has been making lower highs and lower lows since early April when it traded to 81.64:1.

Additionally, over the past four decades, the precious metals sector tends to move higher when the ratio declines and lower when it moves to the upside. On a short-term basis, the ratio could be telling us that gold and silver prices are close to lows, but these metals always look the worst when they are at or close to bottoms and best at tops.

Is silver waiting for an elevator?

The price action in the silver futures market has been particularly gruesome since the June 14 high. Even though silver bounced from its low on July 2, it is possible that the anniversary of the flash crash last July will bring another elevator ride to the downside for the precious metal.

There are signs that silver could be a compelling market from the long side at below $16 per ounce. Silver failed to make a higher high in June, and it would be logical to assume that it will fail to make a lower low from its current level. The decline in open interest as the price has been falling is not a bearish sign, and the price action has sent silver into oversold territory on the daily chart. However, on the weekly, monthly, and quarterly charts silver crossed to the downside, increasing the potential for more selling and the change of a ride to the downside in an elevator shaft like we witnessed in those early hours in Australian trading last July. Moreover, other metals prices have experienced pressure over recent sessions. Platinum fell to its lowest level since December 2008 on Tuesday, July 3, when the price of the nearby contract hit $796.90. Copper is threatening to violate its pattern of higher lows that has been in place since January 2016 as the price traded to a low of $2.8970 on July 3. Both platinum and copper recovered from their lows, but the pressure on precious and industrial metals continues to be a reason for concern when it comes to the volatile silver market.

Things could get ugly if gold makes a lower low

I will be keeping my eyes on gold for clues about the path of least resistance of then volatile silver market. Gold has made lower lows since June 15 when the price was last above the $1300 per ounce level. The yellow metal came close to a challenge of the December 2017 critical support level at $1236.50 on July 3, but it turned higher during the pre-holiday session. If gold breaks to the downside, things could get very ugly in the silver market fast.

As I have been writing, while the price action in the precious metals sector has been ugly, this area of the commodities market always looks its worst before it turns higher. The most direct route for trading silver is via the futures and options on futures contracts on the COMEX division of the CME. However, for those who do not trade in the futures arena, the USLV and DSLV triple-leveraged ETN products are vehicles that are available to all market participants via their equity accounts.

The coming days will tell us if silver and gold can recover from the current challenge of their critical technical support levels. When it comes to silver, the recent price action brings back memories of last year’s flash crash and other times when the price variance in the silver market became wild. I suggest extreme caution when it comes to stops in the silver market these days. Excessive volatility can make executions of those protective stops as ugly as the recent price action in the silver market. There are bullish and bearish factors at play in the silver market these days. I was standing on the sidelines on Tuesday but will likely dip a toe in the water on the long side on Thursday after the holiday.

I have traded silver since the early 1980s and decades of volatility has taught me to always expect the unexpected in the silver futures market. Last year’s price action during the most illiquid time of the trading day was another reminder that trading silver is not for the faint of heart.

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.

Additional disclosure: The author always has positions in commodities markets in futures, options, ETF/ETN products, and commodity equities. These long and short positions tend to change on an intraday basis.