Silver Weekly: This Is Just The Beginning

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About: Aberd Std Silvr Shs (SIVR), Includes: SLV
by: Boris Mikanikrezai
Summary

Silver continues its rally at the start of 2019 after enjoying a solid gain of 9% last December.

Speculative short-covering was substantial in December, according to the latest CFTC statistics.

ETF investors remain cautious toward silver despite the solid rally, Fastmarkets shows.

Silver's positioning remains too light despite the massive bout of short-covering.

The profitable "pain trade" is on the long side.

In the beginning, Lorenzo Luciani (Saatchi Art)

Introduction

Welcome to my Silver Weekly.

I would like to wish you all a happy New Year. I hope 2019 will bring you everything you wish.

In this brief report, I wish to discuss my views about the silver market through the Aberdeen Standard Physical Silver Shares ETF (SIVR). SIVR is directly impacted by the vagaries of silver spot prices because the fund physically holds silver in London.

To do so, I start by analysing the changes in speculative positions in Comex silver futures contracts (based on the CFTC statistics) and ETF holdings (based on FastMarkets' estimates) in order to draw some interpretations about investor and speculator behavior. Then, I will discuss my global macro view and the implication for monetary demand for spot silver prices and SLV. I will conclude the report by sharing my trading positioning.

Speculative positions on the Comex

The CFTC statistics are public and free. The CFTC publishes its Commitment of Traders report (COTR) every Friday, which covers data from the week ending the previous Tuesday. In this COTR, I analyze the speculative positioning, that is, the positions held by the speculative community, called "non-commercials" in the legacy COTR (which tracks data since 1986).

It is important to note that speculative activity rarely involves physical flows. In fact, it is very uncommon for speculators who trade silver futures contracts to take delivery of the physical on the futures contracts they trade. Speculative activity can have a significant impact on spot silver prices due to the great use of leverage taken by speculators. The changes in speculative positions in silver futures contracts tend to be much greater than the changes in other components of silver demand like industrial demand although the latter accounts for roughly 50% of total silver demand.

Accordingly, the impact of speculative flows on silver spot prices tends to be relatively more important and volatile, which, in turn, affect the value of SLV because the latter physically holds the metal in vaults in London and therefore, have a direct exposure to spot silver prices.

Silver-ETF positions

The data about silver ETF holdings are from FastMarkets, an independent metals agency which tracks ETF holdings across the precious metals complex. FastMarkets tracks on a daily basis a total of 15 silver ETFs, whose silver holdings represent the majority of total silver ETF holdings. The largest silver ETF tracked by FastMarkets is the iShares Silver Trust ETF (SLV), whose holdings represent roughly 50% of total silver ETF holdings.

Speculative positioning

Source: CFTC

Due to the US government shutdown, the latest Commitment of Traders report (COTR) available provided by the CFTC was released on December 21, 2018, covering data for December 11-18.

Over this latest reporting period of December 11-18, non-commercials lifted markedly their net spec length by 1,334 tonnes, marking a first straight week of increase. Short-covering of 885 tonnes continued to be the driving force.

The net spec length climbed 4,789 tonnes over November 27-December 18, 2018 (3 weeks), reflecting 966 tonnes of fresh buying and 3,824 tonnes of short-covering.

The fact that short-covering remains the driving force of the increase in the net spec length means that the speculative normalization process is still in its initial phase. In the second phase, fresh buying will drive the increase in the net spec length.

Therefore, this suggests that there is plenty of room for net long speculative positioning in Comex silver to grow despite the significant surge in the net spec length since September 2018 when speculative sentiment reached an extreme low.

The second phase of the spec normalization should push Comex silver spot prices and thus the Aberdeen Standard Physical Silver Shares ETF much higher in the first quarter of 2019.

Investment positioning

Source: FastMarkets

ETF investors slashed notably their silver holdings in the first week of 2019, according to FastMarkets' iterations.

ETF investors have cut their silver holdings by 105 tonnes since the start of the year after liquidating 324 tonnes in December. Last year, silver ETF holdings tumbled 647 tonnes, a 3.2% decline.

The wave of silver ETF selling in spite of a 9% rally in Comex silver spot prices signals a prevailing negative investor sentiment. Because ETF investors do not believe in the sustainability of the rebound in silver prices, they prefer to sell any rally and secure gains/minimize losses.

However, I am of the view that the continued strength in Comex silver spot prices is set to produce a positive swing in investor sentiment, similarly to what happened in 2016. While Comex silver spot prices bottomed in mid-December 2015, ETF silver holdings bottomed later in early February 2016.

In our present case, Comex silver spot prices appear to have bottomed early in December 2018, which suggests that ETF investors may resume their buying by the end of the month.

A renewed wave of silver ETF buying would underpin the rebound in silver prices.

Macro analysis

The short-covering rally in Comex silver spot prices last December was triggered by a marked decline in US real rates, as the chart below illustrates.

https://static.seekingalpha.com/uploads/2019/1/7/8476581-15468748887910657.png

Source: St. Louis Fed

It is interesting to note that, meanwhile, the dollar, the other chief macro driver of silver prices, did not depreciate meaningfully; rather, its strength paused somewhat, as can be seen below.

https://static.seekingalpha.com/uploads/2019/1/7/8476581-1546874888671902.png

Source: St. Louis Fed

It is important to understand that the magnitude of the silver rally was possible only because silver's positioning had been extremely short. Silver was poised to rebound sharply because "short silver" had become an overcrowded trade.

At this juncture, I would no longer qualify "short silver" as an overcrowded trade due to the recent normalization in its speculative positioning. However, silver's positioning remains too light judging by historical standards and therefore, suggests that there is plenty of upside for silver prices in near term.

Trading view

Long-term investors, looking to capture silver's attractive value, may consider ETFS Physical Silver ETF - SIVR

The ETFS Physical Silver ETF - SIVR - Review

SIVR is an ETF product using a physically-backed methodology. This means that SIVR holds physical silver bars in HSBC vaults.

The physically-backed methodology prevents investors from getting punished by the contango structure of the Comex silver forward curve (forward>spot), contrary to a futures contract-based methodology.

SIVR has $323 million in assets under management while the average daily volume is $1.7 million. Its average spread (over the past 60 days) is 0.08%, which allows financial markets to get in and out of their positions at a cheap cost. Its median tracking difference (over the past 12 months) is -0.28%, which is fairly accurate.

For long-term investors, SIVR seems better than its competitor SLV, principally because its expense ratio is lower (0.30% for SIVR vs. 0.50% for SLV), which is key to making profit over the long term.

For the sake of transparency, I will update my trading activity on my Twitter account.

Disclosure: I/we have no positions in any stocks mentioned, but may initiate a long position in SIVR over 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.