Silver Sits And Waits - But The Price Action Ain't Pretty

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

Silver sits below $15 per ounce.

The ratio is near highs.

Precious metals suffer under the weight of the dollar, strong U.S. economy, and uncertainty over trade.

Levels to watch in the silver futures market.

USLV and DSLV to trade the range.

In November 2018, the price of silver traded to a low at $13.86 per ounce which was only 22.5 cents above the level of critical technical support in the silver futures market at the December 2015 low at $13.635. After rising to a peak at $16.20 on the continuous COMEX futures contract in late January and $16.195 in February, the price headed south and traded to its most recent low at $14.525 and was trading at the $14.80 level on Thursday, May 9.

Over the recent sessions, the prices of platinum group metals, copper and base metals, and many other commodities have exhibited weakness. While gold has also slipped, the price at the $1286 per ounce level on May 9 was 4.3% below the 2019 peak on the weekly chart. At $14.72, silver had declined by 9.1% over double the price move in the yellow metal. Silver remains above its technical support level at $13.86 and below its resistance level at $16.20 which has been in place since November and a range that has been in place since July 2018. If silver is going to remain in the $2.34 trading band, buying dips and selling rallies using the Velocity Shares 3X Long Silver ETN (USLV) and its bearish counterpart (DSLV) are excellent short-term trading tools to capture price variance in the silver futures market.

Silver sits below $15 per ounce

The silver market was sitting at $14.72 on May 9 as the price continued to edge lower from the January and February peak in 2019.

Source: CQG

As the weekly chart highlights, silver has made lower highs and lower lows since July 2016 when the price hit $21.095 per ounce in the aftermath of the shock of the Brexit referendum in the UK which created global uncertainty and caused buying in the precious metals sector. At $14.72 the price of silver sits $1.085 above the December 2015 low and $6.375 per ounce below the July 2016 high. At the same time, gold at $1286 was $239.80 above its December 2015 low at $1046.20 and $91.50 below its July 2016 high at $1377.50 per ounce.

The weekly chart shows that both price momentum and relative strength metrics exhibit a deeply oversold condition. Weekly historical volatility at 6.06% is at the lowest level in many years, and open interest at just under the 200,000-contract level is at its midpoint level. Technical metrics are telling us that a rally in the silver futures market is overdue, but the price action and trend remains bearish.

The ratio is near highs

Over history, gold and silver have been a means of exchange. Both metals have been currencies for thousands of years, and at times each served as a support for paper legal tender under gold and silver standards. While fiat currencies rely on the full faith and credit of the governments that issue the legal tender, the precious metals remain a store of value. However, gold has done a better job retaining value in the current environment.

The silver-gold ratio dates back over five thousand years when the first Egyptian pharaoh Menes declared that two and one-half parts silver equal one-part gold. In modern times, since the 1970s, the average level for the relationship between silver and gold has been at the 55:1 level.

Source: CQG

The quarterly chart dating back to 1974 shows that the ratio has traded in a range from 15.47:1 to 93.18:1 with an average of 54.325:1 over the past 45 years. At 87.34:1 on May 9, the price relationship is close to the high end of the range telling us that silver is historically inexpensive compared to gold or gold is overvalued compared to silver.

Central banks continue to hold gold as part of their foreign currency reserves, while few hold silver these days. Central banks have been adding to their gold reserves over the recent years with China and Russia absorbing all domestic production and buying on the international market. For many years, South Africa was the world's leading producer of the yellow metal, but over recent years, China surpassed them, and Russia had the third largest output in 2018. Demand for gold remains robust while silver has moved on market sentiment which has not been all that buoyant for gold's little brother. The current level of the silver-gold ratio is a divergence from the historical norm as it approaches the 1990 modern day high.

Precious metals suffer under the weight of the dollar, strong U.S. economy, and uncertainty over trade

Precious metals prices have been declining over recent weeks. Gold fell below the $1300 level while silver is trading under $15 per ounce. Platinum has underperformed all precious metals for years, and even the price of palladium which was the leader of the pack since 2016 has lost ground falling from just under $1600 per ounce in March to under $1300 over recent weeks.

The prices of the rare metals have moved lower as the dollar index has been strong and moved to a new and higher high at the end of April at 98.085 on the active month June futures contract. At the same time, higher interest rates in the US has caused the cost of carrying precious metals and all commodities to increase adding to the price pressure on the precious metals. The dollar is the reserve currency of the world and the benchmark pricing mechanism for precious metals which is weighing on prices as the dollar continues to appreciate.

Moreover, concerns over global economic weakness triggered by the ongoing trade dispute between the US and China has caused selling or less buying in the precious metals. China is the world's most populous nation and the demand side of the equation for most commodities, and precious metals are no exception. As wealth rises in China, 1.4 billion Chinese tend to purchase more gold and silver. Since the trade dispute is weighing more heavily on the Chinese than the US economy, the demand for gold and silver in the Asian nation is likely decreasing causing the prices to drift lower.

Silver always tends to exhibit more volatility than gold because speculators favor the silver market on the up and the downside as it offers a wider percentage price movement. In both precious metals, the path of least resistance is a function of investor and speculative demand which appears to be weak in the silver market given the price trend since the middle of 2016.

Levels to watch in the silver futures market

The line in the sand on the downside in the silver market stands at the December 2015 low at $13.635 per ounce. There is likely to be some minor support at the $14 level and at the November 2018 low at $13.86.

Source: CQG

As the monthly chart shows, the first hurdle on the upside stands at the 2019 high at $16.20 per ounce. A move above that level would end the pattern of lower highs. Above there sits lots of price congestion all the way up to the July 2016 peak at $21.095 per ounce which is a mountain that currently appears too high to climb. Silver exploded twice over the past four decades when in 1979-1980 and 2011 the price rose to the $50 per ounce level.

In the silver market, the high-odds currently favor a continuation of range trading where silver finds support at or below the $14 level and resistance at or slightly above the $16 per ounce level. Below $13.635 or above $16.20, all bets are off in the silver market.

USLV and DSLV to trade the range

Looking for a breakout or breakdown in the silver market has been a frustrating and expensive approach to the market in 2019. Buying dips and selling rallies has been the optimal strategy. The COMEX futures and futures options market is the most direct route for a leveraged position in the silver market. For those who do not venture into the world of the futures arena, the Velocity Shares 3X Long Silver ETN and its bearish counterpart provide an alternative. These leveraged instruments are only appropriate for short-term long or short positions in the silver market, but they offer market participants leverage in the form of three times leverage on price moves in the silver futures 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.

USLV is a liquid product with $224.18 million in net assets and an average of 203,785 shares changing hands each day. Most recently, silver rallied from $14.57 on May 2 to a high at $14.995 on May 2, a rise of 2.9%.

Source: Barchart

As the chart shows, over the same period, USLV moved from $57.81 to $62.82 per share or 8.7% which is precisely triple the percentage move in the silver futures market.

The fund summary for DSLV states:

The investment seeks to replicate, net of expenses, three times the opposite (inverse) of 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 has only $29.89 million in net assets and trades an average of 60,375 shares each day as market participants tend to have a long bias in markets. The price of silver futures fell from $14.995 per ounce on May 3 to the most recent low at $14.705 on May 9, a decline of 1.9%.

Source: Barchart

The chart highlights that DSLV rose from $30.97 to $32.77 over the same period or 5.8% or triple the inverse action in the silver futures market.

Trading rather than investing in the silver market is likely to be the optimal approach given the recent trading pattern. Eventually, silver will break through on the up or the downside. I continue to believe that higher silver prices are coming, one day. However, these days, USLV and DSLV could be short-term products that enhance your portfolio. Be careful not to hold these leveraged products for more than a few days as the price for the gearing is time decay. If the silver price does not move much, both USLV and DSLV will decline in value, and value-destroying reserve splits are the norm rather than the exception for these products.

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 actively trades silver from both the long and short side of the market.