Silver: The Ultimate Bottom

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

Summary

Silver prices have cascaded lower by almost 20% over the past 3 months.

Futures traders haven't been this bearish on silver in at least 10 years, possibly ever, and the trade is extremely one-sided now.

Yet, the fundamental factors surrounding silver appear to be substantially more favorable than the price action suggests.

Also, the gold to silver ratio is at an extreme level, witnessed only several times over the past 30 years.

The ultimate bottom in silver may be near.

Source: LiveTradingNews.com

Silver: The Ultimate Bottom

Silver/iShares Silver Trust (SLV) has been in freefall ever since prices broke down in mid-June. After the Fed’s decision to raise rates, and the subsequent failed breakout, prices collapsed by nearly 20% in under 3 months.

SLV 1-Year Chart

Source: StockCharts.com

However, despite the abysmal price action, the fundamental image surrounding silver appears quite strong. The U.S. economy is expanding at its fastest pace in years, there’s ample inflation, silver demand is outpacing supply, the dollar’s strength could prove to be transient, and other fundamental factors suggest higher silver prices are likely going forward.

Additionally, the “sell silver trade” has become incredibly one-sided in recent months. In fact, it appears that collectively, traders in the futures market have never been more bearish on silver. Also, the gold to silver ratio is at an unprecedented level, which has served as a trustworthy precursor to significant silver rallies in the past. Ultimately, it appears that silver could be building a sustainable bottom here, and is likely to go substantially higher over the next several years.

About SLV

SLV is an exchange-traded fund that is designed to give investors a cost-efficient way to gain access to the silver market without having to buy silver futures or the physical metal. The SLV ETF fund is engineered to mimic the spot price of silver. Each share owned by an investor represents a fractional ownership in the fund, which holds over 325 million ounces of physical silver worth roughly $4.83 billion.

SLV is an efficient and convenient trading vehicle, as it mimics silver's spot price, yet investors do not need to deal with exchanges that facilitate futures contracts, and do not have to pay prices over spot to procure the physical asset. It is also very liquid and can easily be bought and sold like any other highly liquid stock or ETF. In addition, SLV has very attractive options that can be traded with great ease.

Since SLV mimics silver’s price almost exactly, I will use SLV and silver interchangeably throughout this article.

Silver Sentiment May Have Bottomed

It’s possible that sentiment has never been this bad surrounding silver. In fact, it’s so bad, you might think silver will cease being used as jewelry, or will be replaced in the industry by another metal tomorrow. These scenarios are extremely unlikely, but last week the CFTC speculative silver net positions were at -29.0K. In fact, this is the fourth week in a row the report has been negative. The -29.0K is the lowest number by far in the last 10 years, and possibly ever. This implies that traders have never been this bearish on silver, and this trade has become extraordinarily one-sided. This is usually a bullish counter indicator, and suggests a sharp reversal in price is very likely soon.

CFTC Silver speculative net positions

Source: Investing.com

There’s No Deflation, but There is Plenty of Inflation

Typically, silver and other commodities do poorly in times of deflation, and do well in times of inflation. And right now, there is plenty of inflation in the U.S. economy. GDP growth has been very robust in recent quarters, CPI inflation is at 2.9%, multi-year highs, PPI final demand goods is at around 4%, also amongst the higher levels in recent years, and other inflation indicators are flashing red warning signs. Inflation is getting hotter, and this is partly why the Fed continues to raise rates.

Source: TradingEconomics.com

Source: BLS.gov

Despite the recent increases, and likely September and December rate hikes, the Fed is expected to substantially slow its rate hike trajectory next year. These rate hikes have been very well telegraphed, so silver likely has the upcoming rate hikes factored into its price by now. Also, inflation is likely to persist despite the rate increases, and thus, the Fed’s rate hikes could have a limited, transitory effect on silver prices. The recent collapse in price is indicative of something that would occur in a deflationary time period, yet we appear far from such a scenario. Therefore, silver could get repriced aggressively to the upside going forward.

Silver’s Supply and Demand Dynamic

Silver is not simply used in jewelry or as an investment vehicle. Silver is also an incredibly important metal to various industries. Did you know that almost every computer, mobile phone, automobile, and appliance in the world has silver in it? It does. Due to its conductivity and durability, silver is essentially the perfect substance to coat electrical contacts with. In fact, silver is the best thermal and electrical conductor of all the metals, and is widely used in numerous crucial industries. Therefore, demand has been, is, and is likely to remain extremely robust.

Also, supply appears to be very tight in the silver market. For instance, last year’s world silver supply was about 991.6 million ounces. Yet, worldwide silver demand came in at about 1,017 million ounces, outstripping supply for the fifth straight year. Given the facts, the extraordinarily bearish view portrayed in the futures market seems preposterous when we look at the physical market.

Source: Silverinstitute.org

Gold to Silver Ratio

The gold to silver ratio is at about 85 now, which is largely unprecedented. In fact, the gold to silver ratio is about as high is it has been in nearly 30 years. The noticeable time it was higher in recent history was in the early 1990s, around the time silver reached its long-term bottom below $4. The only other time the ratio was at this level was in October 2008 as silver was bottoming around $10. There have been a few other instances where the gold to silver ratio has shot up to around 80, most notably in 2003 and 2015, an instance which also led to substantial price appreciations in later months and years.

Gold to Silver Ratio 20 Years

Source: Goldprice.org

Silver Price 20 Years

Source: SilverPrice.org

Gold’s Performance

Silver’s extreme selloff is atypical relative to gold’s performance. Gold is down just 8% since the June highs, yet silver is down by almost 20%. Moreover, gold made a distinct intraday low in mid-August, and has moved substantially higher since the low. Yet, despite making a similar low in mid-August, silver has cascaded lower while gold has gone higher. This unusual divergence is not likely to last long, and silver prices could surge soon as the metal rebounds to recapture its traditional correlation with gold.

Chart GLD data by YCharts

The Bottom Line

Several key indicators are signaling that silver is likely oversold here, and the trade that has pushed prices lower in recent weeks and months may be decoupled from the fundamental reality surrounding silver. Silver’s supply and demand dynamic is tight, there is ample inflation in the U.S. economy, yet the COT report shows that traders are the most bearish they have ever been, making this an incredibly one-sided trade. The oversold conditions are also highlighted by the sky-high gold to silver ratio, that is currently at one of its most elevated points ever. Ultimately, silver is likely at or near a long-term bottom here, and may begin the next stage of a multi-year uptrend at any time.

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Disclaimer: This article expresses solely my opinions, is produced for informational purposes only, and is not a recommendation to buy or sell any securities. Investing comes with risk to loss of principal. Please always conduct your own research and consider your investment decisions very carefully.

Disclosure: I am/we are long SLV.

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.