While some analysts out there are busy looking for what they call "silver whales," the precious metal is sitting quietly and ticking like a timebomb. When it comes to the silver market in the current environment, it is essential to look past the confusing short-term data and attempts to figure out what others are doing. A macro approach is necessary these days as the currency markets could experience turmoil. After the markets closed on Monday, August 5, the United States declared a currency war on China. Secretary of Treasury Steve Mnuchin designated the nation with the world's second-largest economy a currency manipulator.
China is the leading holder of US debt securities. The trade dispute has evolved into a trade and currency war. Tit-for-tat moves by the US, and China will continue to destabilize markets across all asset classes.
While looking for that elusive whale, be careful not to harpoon yourself as massive volatility in the silver market could be on the doorstep. Silver and gold are hard money. Precious metals have been around a lot longer than all of the legal tender of governments in the world. Looking for answers that do not exist about JP Morgan's imaginary massive short position is not only a diversion; it has become a hallucination.
The "whale" is an illusion, as buying in silver and gold could become ubiquitous. Silver could be on the verge of an explosive move. If the price is going to blast off on the upside, the Velocity Shares 3X Long Silver ETN product (USLV) could be a nuclear weapon.
I respect the opinions of all market participants. I learn from those who disagree with my ideas all the time. However, I have no time for those who bear false witness and support conspiracy theories on a soapbox massaging data to support a bogus and sensational thesis. The silver market is full of these characters, so be careful out there when it comes to the whale watchers.
Silver is also money
I am now approaching my sixtieth birthday. I have fond memories of my grandparents. On many occasions when I spent time with my grandfather, he called the change in his pocket, silver. In his day, and when I was young, dimes and quarters contained the metal. He was not the only one on the face of the earth that referred to change as the metal.
Silver has a long history as a means of exchange. The Spanish Empire became the wealthiest in the world in the 1500s. Explorers found a motherlode of the metal in a mountain in Bolivia. Like gold, silver serves as a hard currency for thousands of years. Biblical references mention silver and gold, not dollar, euros, yen, and the other currencies that circulate through the world financial system today.
Silver has lagged gold
Central banks around the globe continue to hold gold as a reserve asset today. The International Monetary Fund reports the gold holding of countries each month and classifies the metal as part of foreign currency reserves. Over the past years, the official sector has been a net buyer of gold. China and Russia have absorbed domestic gold production to increase holdings. However, silver has not been a popular asset when it comes to the currency reserves of nations around the world. Therefore, the profile of the metal declined.
In bull markets for precious metals, silver tends to make a comeback. Silver has been "poor person's gold" for a reason. When the gold market reached a high at over $800 per ounce in 1980, silver traded to over $50 per ounce. In 2011, when gold rose to $1920.70 at its peak, silver reached $49.82 per ounce on the active month COMEX futures contract.
Silver is a speculative metal, and while it continues to underperform gold, the prospects for a significant move to the upside will rise with the price of the yellow metal. Everyone loves a bull market, and with gold at the highest price since 2013 and rising, silver's profile is likely to grow if gold continues to make upside progress.
Gold's move is a sign for silver
Lower US interest rates lit a bullish fuse under the gold market in June 2019.
As the monthly chart of COMEX gold futures highlights, the price of the yellow metal broke out of a $331.30 trading range that had been in place since 2014 in June. When the price of gold rose above its critical level of technical resistance at the 2016 high at $1377.60 per ounce, the price rose to its most recent peak at $1509.90 on the continuous futures contract. On Friday, August 9, the price was around $12 below that level. At $1497.50, the price of gold was $120 or over 8.7% above its 2016 peak. At $16.96 on August 9, silver remained $4.135 or 19.6% below its 2016 peak at $21.095 per ounce. With so much upside potential, it may not be long before a herd of buyers begins to flock to the volatile silver market. Gold has outperformed the price action in the silver market, which could lead to a sudden and violent rally.
Three reasons for an explosive move
Silver offers investors incredible value at below the $17 per ounce level. The first reason that a substantial rally in the silver market could be on the horizon is its price relationship with gold. In around 3000 BC, the first Egyptian Pharaoh Menes declared that two and one-half parts silver equal one-part gold. The statement dating back over 5000 years established a historical link with the two metals as forms of currency. Meanwhile, Menes lived at a time long before massive discoveries of the metal and the price relationship has been declining since those days as it has in modern times.
The quarterly chart dating back to 1974 shows that the average number of ounces of silver in each ounce of gold value has been around the fifty-five level. In 1979/1980 when gold and silver reached highs in bull markets, the ratio hit a low at 15.47:1. The next significant bull market in 2011, caused the ratio to fall to a low at 38:1. Dating back to 3000 BC, the price relationship has made higher lows. While that statement is a bit of a reach, the ratio recently moved to a new high from a modern-day perspective at over 94:1 surpassing the 1991 peak. At over 88.32:1 on August 9, the price relationship remains at a level where silver offers historical value compared to the price level of gold.
The second compelling reason for a rally in the silver market is the decline in the value of global currencies. Gold has not only appreciated US dollar terms, but the yellow metal has posted gains in all fiat currencies. Gold has been in a bull market in all foreign exchange instruments since the early part of this century. While the precious metal broke out to the upside in dollar terms in June, it has reached record highs in a host of currencies including the Japanese yen, Chinese yuan, Australian and Canadian dollars, as well as others over the recent weeks. In euro and Swiss franc terms, gold is closer to a record high than in dollars as of August 9. While the dollar has been the strongest currency in the world, it too displays weakness against gold. Silver's historical role as means of exchange and a speculative asset could launch a significant rally in the blink of an eye based on its current value proposition and the declining value of fiat currencies.
The quarterly chart of COMEX silver futures shows that the metal has traded in a consolidation range from $13.635 to $21.095 since 2014. The chart looks a lot like the gold pictorial did before it broke to the upside above its 2016 peak. The chart has developed a rounding bottom formation after reaching a low in late 2015. Open interest has been rising in the silver market. Price momentum is in the upper area of oversold territory, and the slow stochastic on the long-term chart appears to be crossing to the upside. At the same time, relative price strength is sitting in a neutral condition. At 12.3% quarterly, historical volatility is at the lowest level in the silver market since the early 2000s when the price took off to the upside.
If silver is going to blast off on the upside like a rocket ship, one ETN product could act as nuclear fuel for investors in the precious metals.
USLV is silver on steroids
Leveraged long ETN products can provide explosive returns, but they suffer from time decay, which eats away at value if the price does not move higher. However, when the timing is right, there is nothing better than a long-leveraged product to capture optimal returns. The Velocity Shares 3X Long Silver ETN product is like owning silver on steroids. The product summary 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 highly liquid product with net assets of $278.33 million and over 310,000 shares on average changing hands each day. The ETN charges an expense ratio of 1.65%. The price of September silver futures rallied from $15.935 on August 1 to a high at $17.26 on August 7, a rise of 8.3%.
Over the same period, USLV moved from $74.05 to $92.25 per share or 24.6%. While the return was marginally under three times the price move in silver, the ETN is only trading during US stock market hours while silver trades around the clock during the week.
I am not whale watching in the silver market these days, but I am watching the gold market. I do not believe that JP Morgan or any other financial institution is sitting on the price of silver. After all, if there were a conspiracy to hold down precious metals prices, the most significant candidate would be gold. The yellow metal is a far more critical indicator for governments around the world. Financial institutions like JP Morgan have massive physical, swap, and futures positions because of their capital bases. However, when it comes to risk, these banks take some gap risk, meaning that they lend long and to fund producer hedges and borrow short. The dealers operate a lending business that is just like those businesses in dollars and other currencies. And, yes, fractional banking techniques operate in gold and silver markets for the leading dealers, but they are subject to significant capital charges in the current regulatory environment.
Moreover, the leading precious metals dealers own vaults that store the metal for owners around the world. The dealers and banks also take arbitrage risk meaning they sell futures against metal they hold in their vaults. The dream of any massive long or short outright position by financial institutions is a fantasy and a waste of time. A government or governments around the world could hold significant positions in silver, but there is no reporting by the IMF or any other supranational institutions. The likely candidates are China and Russia, and each would view their position levels as a matter of national security. When it comes to whale watching, Providence, R.I., is a better bet.
If silver is going to follow gold, the move could be explosive. In the current environment, risk-reward favors the upside in the silver market.
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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 silver.