Silver Stealth Buying

Silver has suffered as a market pariah this year, dragging along doggedly near major lows.  Investors have seemingly abandoned it to chase the Fed’s general-stock-market levitation, an affliction plaguing most of the alternative-investment realm.  But rather provocatively, silver buying remains quite strong even in this dreary sentiment wasteland.  This stealth buying will likely explode once gold starts running.

After silver plunged 35.6% in 2013 and hit 2.8-year lows, it’s easy to understand why it remains deeply out of favor today.  With the Fed’s extreme money printing and jawboning dramatically catapulting general stocks higher, mainstreamers forgot about alternative investments including silver.  But for the brave contrarians who would rather buy low than buy high, silver remains an incredibly alluring investment.

Just this week the Silver Institute, the world’s premier authority on this metal for decades, reported all-time-record-high worldwide physical silver demand in 2013!  It was up 13% to 1081m ounces despite silver’s plunge, led by a massive 76% increase in retail investment demand.  Far from scaring away all investors, bargain hunters flocked to this cheap metal.  And that buying trend has continued into 2014.

That certainly seems rather incongruous given silver’s weak price action this year.  Other than a short-lived spike in February, this metal has languished around $19 to $20.  The primary reason is gold.  Capital only floods into silver when gold is decisively rallying, that’s always been the universal silver buy signal.  Gold is silver’s primary driver, dominating sentiment in precious-metals land.  But stealth buying is still underway.

Unfortunately physical buying is greatly fragmented, spread across many silver forms and countless venues globally.  So only an elite well-funded organization like the Silver Institute can hope to track it.  Here in the States the US Mint publishes its silver-bullion coin sales monthly, but they are just a tiny fraction of the overall silver market.  But there are two excellent proxies for American big-capital silver demand.

They are silver futures and the dominant iShares Silver Trust silver ETF, which trades as SLV.  These are the big high-profile destinations professional money managers pour capital into when silver starts moving on a gold rally.  That heavy buying leads to ballooning speculators’ long positions in silver futures, and large builds in SLV’s silver-bullion holdings.  And this data reveals 2014’s silver stealth buying.

Silver-futures positions are published weekly in the CFTC’s famous Commitments of Traders reports, and SLV’s custodians offer an even higher-resolution read by posting daily holdings data for their ETF.  But silver futures are the best place to start, as the buying and selling in that centralized market utterly dominates silver pricing.  Silver futures are revealing both stealth buying and a main reason silver remains low.

This chart looks at SLV share prices superimposed over American speculators’ total long and short silver-futures positions.  Remember futures are a zero-sum game where longs and shorts are always perfectly equal, but total positions vary between hedgers and speculators.  The former actually produce or consume silver, while the latter simply bet on its price action and end up determining a great deal of that.

While gold’s price action certainly drives silver sentiment and thus silver prices on a macro level, on a day-by-day basis silver prices are determined almost exclusively by American speculators’ buying and selling of silver futures.  No investor trying to time silver entries and exits in any vehicle from SLV to bullion coins can afford to ignore silver-futures action.  Silver prices are slaved to futures speculators’ whims.

When this elite group of traders buys, either through adding new long positions or closing existing shorts, silver surges.  This ironclad relationship is readily apparent in this chart, where the green line and red line show speculators’ total silver-futures long and short positions respectively.  When longs are rising significantly, and/or shorts are falling significantly, silver is rallying due to this futures buying demand.

A great example occurred in the third quarter of 2012, when silver and therefore SLV shares surged about 29% higher in just a couple months on strong speculator silver-futures buying.  Conversely silver’s sharp 39% plunge in the first half of 2013 was the result of heavy speculator silver-futures selling, both by exiting existing longs and adding new shorts.  As soon as this selling ceased midyear, silver stabilized.

Just like speculators’ gold-futures trading dominates gold prices, their silver-futures trading dominates silver prices.  When these guys get bullish and buy, silver rallies.  When they get bearish and sell, silver falls.  While this dynamic irritates physical-silver investors to no end, they have to respect the strength of this decades-old relationship.  Silver can’t rally meaningfully unless American futures speculators are buying.

And amazingly they have been in 2014!  This is a substantial part of the stealth silver buying underway.  Speculators’ total silver-futures long positions have climbed gradually and persistently throughout 2014, despite the low and basing silver prices.  And the latest CoT week’s read of 69.5k long-side contracts held by speculators isn’t trivial.  At 5000 ounces per contract, this represents 348m ounces of long bets.

That is the equivalent of nearly a third of last year’s record global silver demand, and is definitely on the high side by recent years’ standards.  Between 2009 and 2012, the normal post-stock-panic years before 2013’s extreme gold-selling anomaly crushed silver, speculators’ total long silver-futures positions averaged 63.9k contracts.  So by that baseline, futures speculators are actually fairly bullish on silver today!

The degree of their stealth buying over the last couple quarters is rather remarkable considering silver has merely ground lower and sideways.  Since the late-September low in their total long positions, they’ve grown these by over 50% by mid-April despite silver drifting nearly 10% lower over that span.  These guys obviously see big potential in silver, bucking its prevailing sentiment trend of hyper-bearishness.

And the risk in these bets is serious.  To hold a single silver-futures contract controlling 5000 ounces of silver worth $100k at $20, the required margin is just $9k.  So if silver merely moves 9% in the opposite direction of their bet, all their capital risked will be wiped out.  You have to have some pretty strong conviction to make bets on a super-volatile metal like silver running at exceedingly-risky 11x leverage!

And that makes the other speculators’ huge short-side bets very interesting.  These traders are holding a whopping 49.2k short-side contracts as of the latest CoT report!  That is not far from early December’s secular-bull-record 54.3k contracts, the highest level of speculator silver-futures shorting seen in at least 14.9 years.  A mere 9% silver rally, child’s play for this metal, will totally obliterate fully-margined shorts.

And I think this near-record speculator short position is the key to silver’s languishing price.  In the normal baseline years between 2009 and 2012, after 2008’s stock panic and before 2013’s effective gold panic, speculators’ total silver shorts averaged 21.5k contracts.  We haven’t seen those levels since early 2013 when silver was still way up around $31.  Speculators started shorting silver heavily soon after that.

As long as those speculator short positions remained high, silver and therefore SLV shares have not been able to meaningfully recover.  Note above that all the major silver lows including these recent ones happened when speculators’ total silver-futures short bets were around 50k contracts.  Such extreme levels of silver shorts can’t be sustained, they are simply too risky to maintain for long periods of time.

If silver continues to grind sideways near lows, speculators will get bored and cover and move on to greener pastures.  But the far-more-likely scenario is a resurgent gold upleg ignites a silver surge that forces the short traders to quickly buy to cover.  Silver is a strange metal, after long periods of listless slumber it just explodes higher on new investment demand.  These rallies slaughter speculators trapped on the short side.

So back at the dawn of this year I expected a major short squeeze was coming with silver so low and speculators’ shorts so high.  And it indeed soon started although it was short-circuited and amazingly actually reversed in February a month before gold started retreating.  But with speculators’ total silver-futures shorts now back up near last year’s extreme highs, the odds of an imminent silver short squeeze are very high again.

And ironically it may be silver-futures action that triggers it.  While most speculators are aggressively short, others have been stealth buying longs this year.  The ranks of this minority silver-bullish group will grow dramatically when gold and therefore silver inevitably start moving higher again.  As these long-side traders accelerate their buying, it will put tremendous pressure on the short-side ones to quickly buy to cover.

And their buying could be massive.  Merely to return to 2009-to-2012 normal-year averages of speculator silver-futures short positions, traders would have to buy to cover an astounding 27.7k contracts.  This equates to 138.4m ounces of silver, or the equivalent of over a sixth of total global mine production last year!  If this buying all happens in just a matter of weeks as short squeezes are fast, silver will certainly fly.

As a contrarian who likes to buy low when others are scared, it never ceases to amaze me when traders choose to be super-bullish and heavily long at major highs or super-bearish and heavily short at major lows.  To buy low and sell high, the polar-opposite outlook and bets are necessary.  So I remain wildly bullish on deeply-out-of-favor silver near these major lows.  It’s formed a strong base and is ready for a major upleg.

And it’s not only me and a minority of futures speculators that feel that way, a growing number of stock traders do too.  This next chart looks at SLV-share prices again in blue superimposed over this ETF’s total silver holdings in red.  These are super-valuable for investors to track, because they show whether the colossal pools of stock-market capital are flowing into or out of silver bullion via this flagship silver ETF.

SLV’s silver bullion held in trust for its shareholders has grown rather impressively this year.  As of early May its holdings were up 4.2% year-to-date while silver was only up 0.2%!  Stock traders are buying SLV shares faster than silver is being bought, forcing this ETF’s custodians to increase its holdings.  This silver stealth buying is even more remarkable given general-stock euphoria sapping alternative-investment demand.

Since SLV is a tracking ETF, it will fail its mission if its share price decouples from the underlying silver price.  So whenever stock traders buy SLV shares faster than silver itself is being bid higher, this ETF’s custodians have to equalize this differential buying pressure directly into silver.  So they issue new shares to sop up the excess demand, and use the proceeds to buy more silver bullion for their holdings.

And that’s exactly what has happened so far in 2014.  Despite the hyper-bearishness plaguing silver at such low prices, there has been major differential buying pressure on SLV shares.  Stock-market capital is stealthily flowing into silver, making the bet silver is due for a new upleg erupting from this past year’s strong technical basing.  And I certainly suspect this big SLV-share demand is coming from hedge funds.

For over 14 years now, I’ve been studying the financial markets, trading, and writing newsletters on all of it.  Over that time I’ve heard from countless investors and speculators.  And generally individual silver investors loathe SLV.  They understandably consider it and silver futures just “paper silver”, mere claims on silver rather than silver itself.  So the great majority of individuals, including me, prefer to own physical silver.

But professional money managers who merely want silver-price exposure love SLV.  It is quick, easy, and dirt-cheap to trade, and there are no large premiums or logistical hassles like when dealing with physical silver.  So usually when SLV’s holdings rise or fall significantly, it is professional fund capital moving in or out.  And if today’s relatively-small hedge-fund bets in SLV start winning, far more capital will start chasing it.

This silver stealth buying underway from the professional traders who traffic in silver futures and SLV is exceedingly interesting.  Big capital has been increasingly positioning on the long side of silver at a time when sentiment is atrociously bearish.  It is definitely a smart contrarian bet, but atypical before silver shows some more convincing signs of life.  But sentiment aside, silver’s technicals are very appealing.

For nearly a year now while silver (and gold) bearishness has remained extremely high, silver has ground sideways on balance.  Neither additional silver-futures selling nor SLV liquidations were able to push silver much below its strong support between $19 and $20 for long.  And if silver can’t be forced any lower after suffering its worst year in a third of a century, then any shift to buying should catapult it higher.

And nothing begets buying like buying, it feeds on itself.  As more silver-futures speculators add new long-side bets, and more stock traders buy SLV shares, silver’s price will recover.  And soon after gold starts rallying decisively and flashes that ultimate silver buy signal, the silver buying will accelerate in a big way.  This is going to put tremendous pressure on the futures speculators to cover their outsized silver shorts.

Merely to return to their normal-years average levels, these traders alone will have to rapidly buy the equivalent of 138m ounces of silver.  And the last time their total shorts were at these averages, the silver price was far higher near $31.  If silver makes a move back up to similar high-$20s or low-$30s levels today, it will attract in vast amounts of additional new buying.  Silver uplegs are spectacular and exciting.

And a fascinating buying catalyst just emerged that could help accelerate the silver stealth buying into a major new upleg.  Just this week, the company that administers the 117-year-old London Silver Fix said this anachronism would cease in mid-August!  As I’ve covered extensively in our newsletters, there’s widespread evidence of abnormal trading during those conference calls before the resulting prices are published.

This is the equivalent of insider trading, using privileged data not available to anyone beyond the gold and silver fixing calls to gain an unfair advantage.  So regulators in multiple countries have been putting serious pressure on the fixing banks, which are abandoning this process.  Since silver often fell during the daily London Silver Fix, its death may trigger some short covering among American futures speculators.

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While silver and SLV will surge as silver stealth buying erupts into major buying, the beaten-down stocks of the silver miners will soar.  These companies are trading today as if silver was just a fraction of its current price and will never rise again.  Once silver starts moving, capital will flood back into this radically-undervalued sector.  In December we published a fascinating 27-page report detailing our dozen fundamental-favorite silver companies.  Buy yours and get deployed while these stocks are still cheap!

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The bottom line is silver has actually enjoyed strong stealth buying this year.  Professional traders are adding to their long-side silver bets despite this metal’s price continuing to languish near major lows.  A minority of futures traders have been relentlessly buying long contracts, while stock traders are buying SLV shares fast enough to drive an impressive year-to-date holdings build.  They know silver is overdue to surge.

This hasn’t happened yet for two reasons.  Gold’s young upleg suffered a pullback and consolidation, and the majority of futures speculators have sold aggressively to accumulate near-record silver short positions.  But as gold recovers, silver sentiment will thaw and the shorts will be forced to rapidly cover to stave off catastrophic losses.  And the silver stealth buying will spread and erupt, catapulting silver higher.

Adam Hamilton, CPA

May 16, 2014

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