Silver’s New Bull Market

Silver officially entered a new bull market this week, decisively crossing the necessary +20% threshold.  Speculators and investors alike are returning as awareness spreads of how radically undervalued silver is compared to prevailing gold prices.  When silver awakens to a new bull market after a long bearish slumber, massive gains are usually unleashed.  Silver’s tiny advance so far is just the tip of the iceberg.

This Tuesday, silver surged 4.4% higher on strong Asian bidding in parallel with gold.  The catalyst was fascinating, China finally launching its long-awaited yuan-denominated gold benchmark.  China is the world’s largest gold producer, importer, and consumer, a commanding position that should grant it much bigger say in the gold industry.  The new yuan gold price will ultimately challenge London’s century-old hegemony.

The prospects of more Chinese with their deep cultural affinity for precious metals having easier price discovery and access catapulted silver into bull-market territory.  Its previous best close of 2016 about a week earlier was only 18.5% above its 6.4-year secular low in mid-December leading into the Fed’s first rate hike in 9.5 years.  Tuesday’s big Chinese silver rally boosted this young upleg’s gains to 23.7%.

That propelled silver decisively across that official new-bull-market metric of +20%.  Interestingly, silver was even faring better than gold.  While gold entered new-bull-market territory in early March, at best as of the middle of March it was only up 21.0% from its own mid-December 6.1-year secular low.  While silver got off to its usual slow start, it has already surpassed gold’s gains.  This outperformance will mount.

Silver’s new bull should surprise no one.  Late last year, I extensively discussed the anomalously-low silver prices and this metal’s resulting vast upside potential.  In early October I recommended a new long-term investment in an elite silver producer to our monthly-newsletter subscribers.  As of Tuesday it was already up 208%, a triple in less than 7 months!  I wrote about “Silver’s Deep Undervaluation” in late October.

In mid-January as gold stocks bizarrely fell to a fundamentally-absurd 13.5-year secular low, that very day I recommended multiple new silver-stock trades to our weekly-newsletter subscribers.  The best of those trades was up an astounding 293% as of Tuesday, a quadruple in 3 months!  And then as April dawned and silver remained stuck at $15, I wrote another essay explaining why “Silver Is Coiled Spring”.

The basic premise behind this research and all our recent silver-stock trades is simple.  Silver’s primary driver is gold, this white metal ultimately acts like the yellow metal’s sentiment gauge.  So when gold climbs decisively, it motivates investors and speculators alike to migrate capital back into silver.  Since silver is such a tiny market relative to gold, capital inflows have an outsized upside impact on silver prices.

The latest silver fundamental data from the venerable Silver Institute shows total global demand in 2014 of 1067m ounces, worth $20.3b at silver’s average price that year.  That compares to total world demand for gold of 4226.4 metric tons in 2014 according to the respected World Gold Council, which was worth $172.0b at gold’s average price in 2014.  That makes the world silver market less than 1/8th the size of golds.

So any dollar’s buying or selling impact on silver prices is on the order of 8x what it would be in gold!  It doesn’t take much capital at all in the grand scheme of the markets to really move silver.  And in early 2016, silver remained extremely undervalued relative to its dominating primary driver gold.  So a mighty silver bull was inevitable, like in the past silver soon had to catch up with and then surpass gold’s gains.

While that +20% new-bull-market threshold may be arbitrary, it is universally accepted and therefore has a massive impact on popular sentiment.  Assets in official-bull-market territory are viewed far more favorably by market participants, who love to chase winners.  So new capital inflows accelerate in bull markets, with buying begetting more buying.  Traders’ purchases push prices higher, enticing in more traders.

But like all bulls, silver is definitely climbing the proverbial wall of worry.  Wall Street remains pessimistic on silver, expecting this move to run another 5% or 10% higher at best before more Fed rate hikes slam silver lower again.  Never mind that history proves gold has really thrived during past rate-hike cycles, which pushes silver up!  Most professional analysts still remain very skeptical on this silver bull’s sustainability.

With silver’s new upleg shifting into bull-market mode this week, it’s very important to consider what silver speculators and investors have been up to.  Is the strong buying fueling silver’s big gains in recent months fundamentally different from what drove recent years’ major rallies that soon collapsed to new bear lows?  Very encouragingly, the answer is yes on both the speculators’ and investors’ fronts of the battle.

Let’s start with futures speculators, who had an outsized influence on silver prices in recent years with investors largely abandoning silver.  This chart superimposes silver prices over the weekly total long and short positions in silver futures held by American speculators.  Every major silver rally in recent years was overwhelmingly driven by this single group of traders buying to cover their leveraged short positions.

Despite its lumbering bear trend, silver did enjoy some major rallies in the recent dark years.  One of them, the massive bounce after silver’s 18.1% near-crash in just 2 trading days in April 2013 in sympathy with a gold panic, surged 32.6% higher.  That was far more decisively into bull territory than silver’s latest surge so far this year.  But that mid-2013 silver rally, and those that followed, were largely driven by short covering.

Silver-futures speculation is an exceedingly-risky game.  This week, a single silver-futures contract that controls 5000 ounces of silver worth $85,000 at $17 only requires speculators to keep a cash margin of $4800 on hand.  That equates to extreme 17.7x leverage at maximum margin!  A mere 5.6% silver move against speculators’ positions would wipe out 100% of the capital they risked, forcing them to add more cash.

That compares to stock markets’ legal limit of leverage of just 2.0x that’s been in place continuously since 1974.  When silver rallies even a few percent, futures speculators who’ve effectively borrowed silver they don’t own to sell it short risk total annihilation.  So they have to aggressively buy long silver futures to offset and close their existing shorts.  This short-covering dynamic fueled silver’s rallies in recent years.

But short covering is fleeting and unsustainable.  Speculators simply buy to cover silver-futures shorts because the metal is rallying and hammering their capital, not because they have any conviction that silver’s fundamentals are bullish.  This involuntary mechanical buying is also finite, limited by the total silver-futures contracts speculators hold short.  Once those are covered, that buying pressure just vanishes.

This chart shows what happened to speculators’ total silver-futures long and short contracts over the spans of every major silver rally of recent years.  Between 2013 to 2015, short covering always dominated long buying.  In that huge mid-2013 rebound out of silver’s near-crash, technically the last bull market, short covering of 20.5k contracts was the whole story as longs actually fell by 0.2k in that span!

Unlike short-side speculators who are forced to cover their hyper-risky leveraged positions, speculators on the long side voluntarily buy their equally-leveraged and risky upside exposure to silver.  They aren’t compelled to add longs, they only do it if they have high confidence that silver will continue heading higher.  There was no new silver-futures long buying in mid-2013 to take the baton from short covering.

That short-covering-dominated trend persisted in 2014, which hosted two major silver rallies of 14.6% and 14.2%.  The first one saw another 22.6k contracts of silver-futures short covering, and another slide of 1.9k longs.  The second began to see speculators make those high-conviction long buys, but the ratio of short covering to long buying was still over 1.4x.  Short covering alone can never fuel sustainable bulls!

2015’s silver surges were similar, with the initial 19.2% one early last year fueled by an enormous 41.7k contracts of short covering but only 1.6k of long buying.  That’s a staggering 26.1x ratio!  Interestingly one of the reasons I got so bullish on silver late last year was the likely all-time-record peak in American speculators’ silver-futures short positions of 81.6k contracts in early July.  Such epic shorting couldn’t be sustainable.

Our Commitments of Traders data extends back to 1999, and this was a record over that 16.5-year span and almost certainly ever.  The number of speculators willing to make hyper-leveraged downside bets on silver near multi-year secular lows was surely limited.  And indeed major short covering soon ensued as expected.  During the span silver rallied 14.4%, 19.7k short contracts were covered and 15.0k longs added.

Though that ratio of 1.3x was certainly improving, investors didn’t join speculators in buying silver so its rally soon fizzled out.  The reason was a surprise warning of an imminent new rate-hike cycle by the Fed, which caused futures speculators to savage gold with extreme new shorting.  Silver was dragged into that maelstrom of irrational gold fear.  All major silver rallies in recent years were largely fueled by short covering.

Rather ironically, speculators also added longs on balance as silver ground lower on balance in its bear-market downtrend between 2013 and 2015.  There were plenty of speculators who realized silver was an incredible fundamental bargain.  But they could never muster enough concurrent buying to break silver free of its downtrend’s resistance, which would’ve started attracting in more capital from other traders.

But this year’s new silver bull is very different from all the recent years’ silver surges.  While there were 20.9k contracts of short covering similar to recent years’ major rallies, there were also a nearly-equal 20.4k contracts of speculator long buying!  That’s almost an even ratio, unlike anything seen in recent years.  This was also more new long buying than any other rally in recent years enjoyed, which is very bullish.

While silver’s last technical bull market in mid-2013 was driven exclusively by short covering, today’s is seeing long-side speculators’ high-conviction voluntary buying already nearly outweighing the usual short covering.  And I strongly suspect this latest CoT week’s data to be published several hours after this essay will show long buying take a commanding lead.  2016’s new silver bull is far different from 2013 to 2015!

The long-side speculators are getting so bullish that their positions surged to a likely-all-time-record peak of 114.8k contracts in the last CoT week before this essay was published!  That’s at least a 17.3-year high in our dataset since 1999, and again almost certainly ever.  This strong long-side buying has driven a major silver breakout from its multi-year bear downtrend, helping to entice in more new buyers.

But futures speculators alone, despite their outsized influence on silver prices at times, can never fuel a sustainable bull market.  The group of traders willing to shoulder the extreme risks inherent in the hyper-leveraged futures realm is relatively small, and they don’t wield that much capital in the grand scheme.  Sustainable bulls only evolve when investors step in to take the buying baton from futures speculators.

Investors not only control vastly-larger pools of capital, but they use little or no leverage and are in for the long haul.  Unfortunately silver investment-capital flows are very opaque.  The Silver Institute publishes the world’s definitive source for silver supply-and-demand fundamentals, including investment, only once per year.  And 2015’s results aren’t even out yet, so we are going to have to wait over a year for 2016’s.

Thankfully there is a great proxy for silver investment demand that reports capital flows daily, the world’s leading SLV iShares Silver Trust silver ETF.  SLV acts as a conduit for stock-market capital to flow into and out of physical silver bullion.  Because SLV’s shares have their own unique supply and demand that is independent from silver’s, shunting capital into and out of silver is the only way SLV can track the metal.

When SLV’s shares are being purchased at faster rates than silver is being bought, this ETF threatens to decouple from silver to the upside.  SLV’s managers must equalize this differential buying pressure directly into physical silver.  So they issue enough new shares to satisfy the excess demand, and then use the resulting proceeds to buy more bullion.  Rising holdings show stock-market capital flowing into silver.

So SLV is a great proxy for overall silver demand available at a daily resolution, vastly superior to the delayed annual resolution of the Silver Institute’s comprehensive data.  This next chart looks at these same silver rallies over the past few years superimposed over SLV’s holdings.  Just as speculators are behaving very differently in 2016, so are investors.  They are flocking back to silver again for the first time in years!

During that big mid-2013 rebound out of silver’s near-crash that was technically its last bull, investors did indeed flood into silver driving an SLV holdings build of 22.3m ounces over that span.  But that wasn’t enough to overcome the terribly-bearish psychology that collapse spawned back then.  Ever since, every major silver rally has suffered from SLV differential selling.  Stock capital was exiting silver.

2014’s 14.6% and 14.2% silver surges saw SLV selling of 5.0m and 10.3m ounces.  Investors not only didn’t believe those silver-futures short-covering-fueled rallies were sustainable, they used them to keep lightening their positions.  This accelerated in early 2015’s large silver surge, when American stock investors sold SLV shares so aggressively that this leading ETF was forced to dump 24.1m ounces of bullion!

They jettisoned another 9.8m during late 2015’s silver rally before it was slaughtered by that hawkish Fed surprise.  Other than that initial rebound out of early 2013’s extreme plummet, investors were totally missing in action in recent years!  Every single major silver surge in 2014 and 2015 not only didn’t see investors return to silver, but they used these rallies as opportunities to further liquidate their positions.

But silver’s new bull market in 2016 has proved radically different.  While silver investors remained quite skeptical about deploying capital in January and February, they returned with a vengeance in March.  I suspect the catalyst was gold itself officially entering a new bull market early last month, its first foray into bull territory since 2011.  Investors don’t want silver until they see a convincing and decisive gold rally.

Silver only outperforms dramatically when gold is climbing on balance in bull markets.  And with a new gold bull upon us, investors began aggressively returning to silver last month.  SLV’s soaring holdings are likely a representative illustration of silver-investor capital inflows in general.  This ETF has seen its holdings balloon by 11.2m ounces over this new bull market’s span so far, unlike anything seen in years!

So while this new silver bull was initially sparked by the requisite silver-futures short covering that has been usurped by big silver-futures long buying and big stock-market capital inflows into silver via SLV.  That’s the natural evolution of sustainable major silver bulls.  They start with involuntary short covering, which motivates long-side speculators to return.  That pushes silver high enough for investors to take the baton.

Just as in gold, it’s this new silver investment buying that makes this year’s young silver bull so different from all the failed rallies in recent years.  When investors start buying again in a big way emerging out of major secular lows, that buying tends to run for at least a couple years.  Investors are strong hands buying to hold for the long term based on fundamentals, unlikely to be shaken out with little or no leverage.

In March I’d told our subscribers about the super-bullish implications of investors starting to return to silver again as evidenced by SLV’s daily-read proxy.  That led to my early-April essay on silver being a coiled spring.  This last chart was explained in depth a few weeks ago in that essay, but I had to include an update today since it reveals why silver’s upside potential is so vast and its new bull has barely begun.

Silver has always been driven by gold, as the yellow metal’s fortunes motivate investors and speculators to buy and sell silver.  So silver prices meander in great cycles relative to its primary driver’s prices, as this Silver/Gold Ratio chart shows.  Silver’s extreme undervaluation today compared to prevailing gold prices is the primary reason why investors are going to be aggressively buying silver for years to come.

Before and after 2008’s first stock panic in a century, silver averaged around 1/55th the price of gold.  It had a pre-panic average requiring 54.9 ounces of silver to equal the value of a single ounce of gold, and a similar 2009-to-2012 post-panic average of 56.9 before QE3’s gross distortions.  During 2016’s first quarter, this SGR plummeted to an extreme average 79.5.  Silver was priced at just 1/80th the price of gold!

Nothing like this extreme had been witnessed since that 2008 stock panic, when the SGR averaged 75.8.  As I warned back in early 2009, silver was due to mean revert out of those unsustainable and anomalous extremes.  And indeed that came to pass, with silver not only mean reverting but enjoying a proportional overshoot to the opposite upside extreme!  Such contrary overshoots are common after extremes.

Silver is up 23.8% in its young new bull market so far, out of SGR extremes even worse than those seen during 2008’s stock panic.  And professional analysts are already jumping on the bandwagon to claim silver’s upside is limited to another 5% or 10% from here.  History mocks that irrationally-myopic notion.  After that last time the SGR hit extreme lows, silver would skyrocket 442.9% higher over the next 2.4 years!

Silver is so celebrated, holds such excitement in traders’ minds, because once it starts powering higher it tends not to stop for a long time.  Silver will slumber for years, doing nothing, but once it awakens its mighty bulls almost always soar at least 100% higher.  Silver experienced three major bull markets between 2005 and 2011 averaging gains of 227.1%!  So the 23.8% we’ve seen so far is just the initial stirrings.

A mere double from mid-December’s 6.4-year secular low would take silver back up to $27.38.  And that is certainly not excessively high in light of historical precedent.  During all of 2012, which was a bear year for silver following its blow-off popular-mania peak above $48 in April 2011, silver averaged $31.19.  There’s no doubt silver will revisit those levels again in the coming years as its new bull gathers steam.

You can certainly play these coming massive mean-reversion gains in the awakening white metal with physical silver bullion or that flagship SLV silver ETF.  Both have advantages and disadvantages, but at best they’ll only pace silver’s gains.  Meanwhile, the beaten-down silver stocks will greatly leverage them.  One trade of ours I mentioned earlier skyrocketed 293% higher since mid-January on a 21% silver rally!

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The bottom line is silver just entered its first new bull market in at least several years.  This was driven by a combination of speculator silver-futures short covering and long buying, but most importantly major new investment buying.  Silver hasn’t seen investors start to return in years, which makes 2016’s new bull look like the real deal in contrast to recent years’ fleeting short-covering-fueled surges that soon collapsed.

And once investors take the cue from gold strength to start migrating back into silver, the resulting bull markets tend to run for years and grow to monstrous proportions.  With silver just emerging from such anomalously-low price extremes relative to gold, it’s going to take vast buying to mean revert its price back up to normal levels.  So 2016’s young bull is almost certainly just the early vanguard of a massive new bull.

Adam Hamilton, CPA

April 22, 2016

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