Silver Sits And Contemplates The Next Move

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About: VelocityShares 3x Long Silver ETN (USLV), Includes: AGQ, DBS, DSLV, PSLV, SHNY, SIL, SILJ, SIVR, SLV, SLVO, SLVP, USV, ZSL
by: Andrew Hecht
Summary

Probing below $15 after testing above $16.

Fundamentals mean nothing in silver.

The short-term technical picture.

The silver/gold ratio remains ugly near the highs.

Odds favor a recovery - levels to watch and trading with USLV and DSLV.

Silver has traded in a range from $14.86 to $16.20 per ounce so far in 2019. After trading to the lowest price since early 2016 at $13.86 in mid-November 2018, the price of silver recovered. Silver has been underperforming gold, and last year then price action is silver lagged the trading pattern in the yellow metal. Gold traded to its low for last year in mid-August when the price fell to $1161.40 per ounce which was $115.20 or 9.9% above the critical technical support level for gold which was at the December 2015 bottom at $1046.20 per ounce. Silver waited until November to fell to its low which was just 22.5 cents or only 1.6% above its level of critical support at the December 2015 bottom at $13.635 per ounce.

Silver has consistently underperformed gold since 2016, and in late 2018, when silver hit its most recent low, the price relationship with gold rose to the widest divergence in twenty-five years. The precious metal has settled into a $15 to $16 per ounce range in 2019 with periods where the price threatens to break higher or lower. With silver trading at the lower end of the trading bank in early Q2, trading silver has been the optimal approach to the market. Selling silver when it looks like it is about to explode and buying the metal at times when a price implosion appears in the cards has paid dividends. For those who do not trade in the silver futures market on COMEX, the Velocity Shares 3X Long Silver ETN product (USLV) and its bearish counterpart (DSLV) provide a leveraged alternative.

Probing below $15 after testing above $16

The price of silver has been in a bearish trend with the price making lower highs and lower lows since July 2016 when the price reached a peak at $21.095 per ounce in the aftermath of the Brexit referendum.

Source: CQG

As the weekly chart highlights, silver was hovering around the $15.10 per ounce level on Friday, April 5 near the bottom end of its trading range in 2019. Price momentum is trending lower towards an oversold condition, and relative strength is at the lower end of neutral territory. Weekly historical volatility at under 12% is at the lowest level of this year. Finally, open interest at just under 205,000 contracts is at around its midpoint. The bottom line is that technical indicators are telling us that the price of silver is going nowhere fast, and the precious metal is likely to remain within its current trading range.

Fundamentals mean nothing in silver

In the world of commodities, fundamental supply and demand analysis can offer clues when it comes to the path of least resistance for prices. However, in the silver market, fundamentals are almost useless. Since silver's production cost is not a significant factor when it comes to output, it is virtually impossible to establish a breakeven for the cost of extracting the metal from the crust of the earth. Silver is a byproduct of gold, copper, lead, and other metal production. Therefore, the production cost is almost an afterthought for the metal. On the demand side, digital photography caused a substantial decline in silver requirements for consumers, but technology when it comes to computers, cellphones, solar panels, and other products that burst on the scene over the recent decades has more than taken up the slack on the demand side of the fundamental equation.

Fundamentals do not move the price of silver, herds of buying or selling caused by shifts in investor and speculative sentiment move the precious metal.

Silver has a long history as both an industrial and an investment metal. Throughout history, both silver and gold have had roles as hard money or backing for currency instruments. However, while central banks continue to hold gold as part of their foreign currency reserves, silver's role as a reserve asset declined to a point where few if any governments hold the metal these days. Therefore, investor interest or lack thereof cause the price to move. After trading at under $10 per ounce from 1985 through 2005, silver has not traded below that level since 2009.

The short-term technical picture

It appears that the current state of sentiment in the silver market is enough to keep the price well above $10 per ounce, but not robust enough to drive it to a level where it would threaten the bearish price trend that has been in place since 2016.

Source: CQG

The daily chart of COMEX silver futures shows that at the bottom of its recent trading range, the price of silver is in oversold territory and open interest is flatlining at the middle of its range. When the open interest metric falls to the 170,000-contract level on the downside, it tends to trigger a recovery rally.

Conversely, when it rises to the 225,000-contract level or higher, it tends to reverse to the downside. While these levels in the metric that measures the total number of open long and short positions in the silver futures market are not hard and fast and it is possible for them to rise on the downside and fall on the upside, the open interest data has been a reasonable guide over recent history. The current short-term technical position of the silver market tells us that while the price remains susceptible to a short-term spike to the downside, the odds favor an eventual visit to the upper end of the trading range.

From a longer-term perspective, silver is historically inexpensive compared to gold these days.

The silver/gold ratio remains ugly near the highs

The silver-gold ratio dates back to 3000 BC when the first Egyptian Pharaoh Menes stated that two and one-half parts silver equal one-part gold. In modern times, the median level for the number of ounces of silver value in each ounce of gold value is around the 55:1 level. Since 1974 the ratio traded in a range from 15.47:1 to 93.18:1. When the reading is below 55:1, silver tends to be historically expensive compared to gold, and when it is above the median level, silver is inexpensive compared to the yellow metal. The most recent reading in the ratio shows that it is a lot closer to its historical high than its low making silver cheap these days on a relative basis.

Source: CQG

As the quarterly chart shows, at 85.41:1 at the end of last week, silver is at its lowest level against gold since 1993. The lowest price for silver in 26 years means that sentiment is likely driving buying to gold and silver is sitting on the sidelines waiting for a sign which is likely to come from the technical metrics that drive investors and speculators to the silver market.

Odds favor a recovery - levels to watch and trading with USLV and DSLV

Silver has been making lower highs and lower lows since July 2016 when the price rose to just over the $21 per ounce level. The pattern of trading has created the first technical resistance level at $17.35 per ounce which was the June 2018 peak. Above that price, silver would break its bearish trading trend. On the downside, the December 2015 low at $13.635 stands as the technical line in the sand. The $3.715 range between these levels is currently a dead zone for silver where the price can move higher or lower without threatening a change to the current trend from a technical perspective. The midpoint of the range stands at around $15.50 per ounce which close to the midpoint for the 2019 trading range.

I believe that the price of gold is telling us that either silver is too cheap at its current price level or gold is too expensive when it comes to a historical analysis of the metals. Therefore, I favor an eventual challenge of the highs in the silver market, but that could take some time given the price action in the silver market which has been drifting around aimlessly.

Buying dips when silver looks its worst and the short-term technical position falls into oversold territory and taking profits when the metal looks like it is ready to explode to the upside has been the optimal approach to the silver market, and that seems likely to continue. The silver futures market is the most direct route for long and short positions to take advantage of short to medium-term price volatility. For those who do not venture into the highly-leveraged and volatile world of the futures arena, the Velocity Shares 3X Long Silver ETN product and its bearish counterpart are short-term tools to take advantage of the trading range in the silver market. The fund summary for USLV states:

The investment seeks to replicate, net of expenses, three times the S&P GSCI Silver index ER. The index comprises futures contracts on a single commodity. The fluctuations in the values of it are intended generally to correlate with changes in the price of silver in global markets.

The summary for DSLV reflects a converse position that offers leveraged exposure to the downside in the silver market. Both instruments are only appropriate for short-term forays into the silver market as they periodically undergo reverse splits that destroy their respective values. The price for leverage is time decay which eats away from the value of both instruments when prices are stable. Since prices can go higher, lower, or sideways, both products lose value in two of the three scenarios, and they tend to lose more value than they gain over time when the price of silver is moving in a direction that supports gains in USLV and DSLV. However, from a short-term perspective, both can turbocharge returns for those who do a good job timing price moves in the silver market and are quick to get in and out of positions. USLV and DSLV are trading, not investment instruments.

USLV has net assets of $224.13 million and trades an average of 181,761 shares each day. Since human nature tends to favor long rather than short positions, DSLV has lower net assets of $28.81 million and trades an average of 94,995 shares each day.

Eventually silver will break out to the up or the downside, and my bet continues to be that we will see higher prices for the precious metal. In the meantime, USLV and DSLV are trading tools for those who do not access the silver futures market and want to participate in the ups and downs of price action in the silver market.

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.

The author is long precious metals