Silver: It Did Not Follow Gold Higher But Will It Follow It Lower?

Includes: DSLV, USLV
by: Andrew Hecht

Gold falls to $1270 and silver edges below $15.

Silver open interest is moving higher - A danger sign.

Gold and silver are allergic to higher interest rates.

The dollar is sitting near the high - The ratio makes a new high.

Silver futures to go with the flow - USLV and DSLV for those who do not venture into the futures arena.

Silver and gold hit their respective highs so far in 2019 in mid-February. Nearby gold futures traded to a peak at $1344 per ounce, and silver reached the $16.20 level on their continuous futures contracts.

From a technical perspective, silver can always confuse even the most sophisticated technical analyst. While the active month May futures contract rose to $16.29 in January and reached a higher high at $16.295 in February, the continuous contract did just the opposite reaching $16.20 in January while rising to a lower high at $16.195 in February. Attempting to analyze silver can be one of the most frustrating exercises in markets. The precious metal has a habit of rising above resistance and falling below support levels. It is pure sentiment that drives the silver market, and when it becomes too bullish or too bearish, the price typically reverses and hands a dose of financial pain to the largest number of market participants caught on the wrong side of the market.

The price of silver has lagged gold as the yellow metal has been outperforming silver steadily since 2011 when silver reached $49.82 and gold rose to an all-time peak at $1920.70 per ounce.

I have been trading silver for almost forty years since the early 1980s. Over that period, I have experienced long periods of no volatility, and spurts of wild price variance in the silver market. The one thing that I have learned is that when the market becomes too comfortable with a trend, silver often makes a move that defies logic. There are no fundamentals in the silver market as the metal is a byproduct of other mineral and ore output, so it is virtually impossible to arrive at an average production cost. Therefore, it is concentrations of buying or selling that determines the price direction of silver.

Recently, gold has been moving lower, and silver seems to be reluctantly following the yellow metal. Silver has not yet supplied any clues if it intends to follow gold or take a different and more confusing road over the coming days, weeks, and months.

The most direct route for trading silver is via the futures and futures options on the COMEX division of the Chicago Mercantile Exchange. For those who do not venture into the futures arena, but wish to avail themselves of similar leverage, the Velocity Shares 3X Long Silver ETN product (USLV) and its bearish counterpart (DSLV) are tools that bring the price variance of the silver market to standard stock trading and investment accounts. These products can also be employed in tax-deferred accounts, but be careful, they are not appropriate for medium or long-term investments, just for short-term forays into the silver market.

Gold falls to $1270 and silver edges below $15

On April 9, silver rose to its most recent high at $15.31 per pounce on the active month May futures contract. The following day, June gold futures traded to a high at $1314.70 which gave way to the selling that has taken gold down to the $1270 level.

Source: CQG

As the daily chart of nearby COMEX gold futures shows, the price of the yellow metal declined for five consecutive sessions and reached a low on April 18 at $1273 before closing last Thursday with a marginal gain before the Easter and Passover holiday weekend. While gold put in lower lows, the majority of the move in silver occurred on April 11 which was the day that gold plunged below the $1300 level.

Source: CQG

The chart of May COMEX silver futures shows that silver fell to a low at $14.845 on April 11 and put in a lower low on April 15 at $14.795 before closing last week at $14.955 per ounce. Both gold and silver are now down in 2019 compared to their closing prices at the end of 2018.

Silver open interest is moving higher - A danger sign

Open interest is the total number of open long and short positions in a futures market. The metric is a barometer of interest in a market, but in silver and gold which tend to move higher and low based on the market’s sentiment, the metric often falls near lows and rises near highs. When bullish sentiment indicates that there are too many longs in the market, the price of the metals often reverses course. At the end of last week, the levels of open interest in the gold and silver futures market indicate that there is a bifurcation when it comes to overall market sentiment.

Source: CQG

As the daily gold chart highlights, the open interest metric has declined with the price of the yellow metal. After hitting a high at 541,737 contracts in mid-March, the recent selling sent the measure of open long and short positions to a low at 438,429 contracts at the end of last week. Since falling price and declines in open interest is not typically a sign of an emerging bearish trend in a futures market, it is possible that the gold market will run out of selling over the coming days and weeks. In silver, the metric went the other way.

Source: CQG

As the daily silver chart illustrates the open interest metric has been rising as the price moved to the downside. On March 15, silver open interest fell to a low at 186,196 contracts when the price was at the $15.20 level and on it way higher, to $15.65 on May futures. As the price of silver failed, the metric continued to move higher and peaked at 224,783 contracts on April 16 and was at 219,907 at the end of last week. The increase in the metric and decline in price tends to be a technical validation of the current bearish trend in a futures market.

It appears that trend-following shorts have become more aggressive selling silver over recent weeks given the pattern of lower highs and lower lows since the last time the price rose above the $16 per ounce level in late February. Rising open interest in the silver market is a warning sign while falling open interest in gold could be a sign that the price will find a bottom sooner rather than later. At the end of last week, the prospects for the paths of least resistance for the two precious metals were confusing.

Gold and silver are allergic to higher interest rates

The latest Fed minutes were toxic for gold and silver prices. The Fed canceled rate hikes for 2019 and reduced the number of 25 basis-point increases in the Fed Funds rate from two to one for 2020. At the same time, the central bank told markets that the rote program of quantitative tightening to reduce its balance sheet would end in September 2019.

The market likely became overenthusiastic that the Fed would continue to capitulate to the wishes of the Oval Office and undo the “damage” President Trump has been so critical of with their 2018 rate hikes. At the same time, the recent nomination of Stephen Moore to the Fed fanned the fire for rate cuts as Mr. Moore stated he believe the FOMC should lower the short-term rate by 50 basis points immediately.

The Fed minutes contained no evidence that any members of the FOMC are considering cutting rates from the current level at 2.25-.250% on the Fed Funds rate. It is likely that disappointment lit a bearish fuse in the precious metals sector leading to the recent price declines in the gold and silver futures market.

The dollar is sitting near the high - The ratio makes a new high

The long-standing inverse relationship between the value of the US dollar against other currencies and the prices of gold and silver could also be weighing on precious metal prices. The dollar index rose to a high at 97.705 in mid-December, and while it has not put in a higher high, the index remains not far below the peak.

Source: CQG

As the weekly chart of the dollar index shows, the dollar has made nothing but higher lows since reaching a bottom at 88.15 in February 2018. However, it has not risen to a new high and has failed on each attempt in 2019, so far.

The most influential factor when it comes to the value of one currency versus another is the differences in yields. The short-term interest rate on the dollar stands at 2.25-2.50% while the euro and yen currencies continue to have negative yields. Therefore, it may only be a matter of time before the dollar index busts through the December 2018 peak and moves towards the 100 level. In early 2017, the dollar index rose to its highest level since 2002 at 103.815. The price action in gold and silver has likely been in anticipation of the stronger dollar and the disappointment that interest rates are not going lower anytime soon, if ever.

Meanwhile, on April 11, the silver-gold ratio moved to a new high at 86.85 ounces of silver value in each ounce of gold value. The last time the ratio that measures the comparative values of the two precious metals reached that level was in 1993. The all-time peak in the ratio was in 1990 at 93.2:1 and the low was in 1979 at 15.5:1. The average at around 55:1 is well below the current level which tells us that silver is historically inexpensive compared to gold at their current price levels.

Since silver is a more speculative metal, the ratio is a metric that measures sentiment and is telling us that speculators are not bullish on the prospects for silver, which could translate to gold. However, at the current level, the upside in the ratio could be limited. The differential could move lower if gold underperforms silver on the up or the downside if the precious metals are preparing for a deeper corrective move. As of Thursday, April 18, the ratio stood at 85.39:1 on the nearby futures contract. The direction of the ratio over the coming days and weeks could provide clues about the overall strength or weakness of the precious metals sector. A lower ratio is often a bullish sign, while a higher ratio tends to lead to lower prices if history is a guide.

Silver futures to go with the flow - USLV and DSLV for those who do not venture into the futures arena

If I have learned anything in markets over the past four decades, it is never to say never. While I believe that precious metals will eventually move higher, I do not discount the potential for a significant correction. After all, for over half of my trading career, the price of silver traded below $10 per ounce and gold below the $500 level.

The one factor that continues to lead me to believe that the path of least resistance of the metals is higher is the waning confidence in fiat currencies. A long-term chart of the price of gold in the dollar, euro, and yen since the turn of this century displays bullish trends. The world’s reserve currencies have been losing value when compared to the yellow metal which has a far longer history as a means of exchange than the paper foreign exchange instruments that have value based on the full faith and credit of the governments that print the notes. However, for the short term, I will go with the flow in the markets, and silver always has a habit of offering market participants the widest price variance on a percentage basis.

The most direct route for a speculative long or short position in silver is via the futures and futures options on the COMEX division of the Chicago Mercantile Exchange. For those who do not play in the futures arena, the Velocity Shares 3X Long Silver ETN product (USLV) and its bearish counterpart (DSLV) provide alternatives as they are available to anyone with a standard equity trading account. The leverage in these products comes at a price which is time decay. Both USLV and DSLV undergo periodic reverse splits which eat away at their values over time. However, they are both highly effective short-term trading instruments when it comes to capturing the price action 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.

DSLV’s summary is the exact inverse of USLV’s. USLV is a liquid tool with $224.13 million and an average of over 200,000 shares changing hands each day. Since a long position is more palatable to a broader addressable market, DSLV has lower net assets of $28.81 million and trades an average of 88,788 shares each day.

The current level of the ratio at the highest level in twenty five years tells us that silver has lagged gold on the way up which sets up a mean reversion trade when it comes to the two metals. Time will tell if silver can take a leadership role on the up or the downside over the coming days, weeks, and months. When it comes to the silver market, I will be trading futures to capture short-term price volatility as it is starting to look like a significant move is on the horizon. A break to the downside could move prices towards a test of the December 2015 lows at $1046.20 and $13.6325 respectively in gold and silver. However, a failure to follow through on the downside could lead to higher prices and a continuation of a trend in gold against the leading currencies of the world.

The USLV and DSLV products bring the ability to trade silver on a short-term basis right to your equity account. However, remember not to sit on positions too long, as these products only are appropriate for positions measures in days or at the longest weeks.

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 owns silver