Silver has suffered a lackluster year so far, really lagging gold’s upleg. Sentiment is still reeling following silver’s crushing selloff from mid-April to mid-May. But that plunge was largely driven by extreme silver-futures selling by speculators, including a blistering spike in short selling. The resulting excessive shorts have left silver with excellent near-term potential for a short squeeze, which would catapult it rapidly higher.
Technically, silver ultimately acts like a leveraged play on gold. The yellow metal has long been silver’s dominant primary driver. Investors and speculators alike flock to silver when gold is rallying, forcing this tiny market to surge dramatically. But when gold sentiment is weak due to lackluster price action, silver demand from traders dries up. Thus silver drifts listlessly or grinds lower, compounding bearish psychology.
As of the middle of this week, silver was only up 8.9% year-to-date. That actually bested the beloved S&P 500 broad-market stock index, but it’s still considered pretty weak. That’s because gold has rallied 10.3% YTD. Silver’s gains and losses over any given span often about double gold’s, since the silver market is radically smaller. This is readily apparent in the latest world fundamental data for both metals.
Last month the Silver Institute published its World Silver Survey 2017, the definitive read on global silver supply-and-demand fundamentals in 2016. It reported total physical silver demand last year of 1027.8m ounces. At last year’s average silver price of $17.12, that was worth just $17.6b. That’s a rounding error in the financial markets, a mega-cap stock like Apple can gain or lose that much market cap in a single day!
Meanwhile according to the latest global gold fundamental data from the World Gold Council, last year’s gold demand ran 4315.0 metric tons. At 2016’s average gold price of $1250, that was worth $173.4b. So the global silver market is merely 1/10th the size of the world gold market per the newest available data! That makes capital flowing into and out of silver an order of magnitude more potent in moving its price.
Earlier this year when traders were growing excited about gold, silver was normally amplifying its upside. By early March, silver was up 15.6% YTD to gold’s 8.6%. But as gold enthusiasm faded in subsequent weeks, silver soon deflated. By mid-April its 16.2% YTD gains were only running 1.36x gold’s 11.9%. And that relative outperformance collapsed after silver plunged 12.6% on a mere 5.1% gold pullback into mid-May!
It’s very unusual to see silver disconnect so sharply from gold, so traders looked for explanations. One of the main rumors surrounded Asia’s largest commodities trader, the Noble Group. Its stock trading on the Singapore Exchange has literally imploded this year, as it faces a huge liquidity crunch from credit-rating agencies downgrading it on default fears. Rumors swirled that NG was a big forced seller of silver.
Many of NG’s commodities positions were apparently illiquid, unable to be sold to raise cash without triggering serious losses on those very trades. But silver of course is highly-liquid and readily-marketable worldwide. Over 17 trading days between mid-April and mid-May, silver fell for 16 and the only respite was a trivial 0.1% bounce. That extraordinary span of consistent selling often defying gold was rumored to be NG.
Whether the Noble Group was unloading huge silver positions to raise desperately-needed cash or not, American futures speculators were dumping in concert. Maybe the Noble rumors triggered their serious selling, maybe they would’ve sold anyway. Either way, silver was blitzed with a withering assault of silver-futures selling. Given silver’s tiny market size, this mass exodus of capital quickly brutalized silver prices.
Due to that order-of-magnitude market-size differential, capital flowing into and out of silver commands up to 10x the price impact of the same capital moving in gold! And this is in outright terms, assuming silver is fully-owned with no leverage. But silver-futures speculators wield great leverage, further amplifying the impact of their collective trading on silver’s price. So heavy silver-futures selling drives sharp losses.
Every silver-futures contract controls 5000 troy ounces of this white metal. At $17.25 per ounce, that is worth $86,250. But this week, the minimum maintenance margin required to trade each silver-futures contract is only $5000. This means futures speculators can choose to run leverage up to 17.3x on silver futures! That dwarfs the decades-old legal limit in the stock markets of 2x. 17x is extreme and hyper-risky.
So the capital futures speculators bet on silver’s near-term price action can have up to 17x the price impact of the same amount of investment in silver owned outright. When this enormous leverage is mixed with a tiny market, the result is naturally incredible volatility. At 17x leverage, speculators can’t afford to be wrong for long on silver’s price moves. A mere 5.9% adverse move against their bets results in 100% losses!
Every Friday afternoon, the Commodity Futures Trading Commission publishes its famous Commitments of Traders report that details what speculators are collectively doing in silver futures. Their buying and selling as a herd is the overwhelmingly-dominant driver of short-term silver price action. That doesn’t negate gold’s power over silver, as these silver-futures traders mostly look to gold’s fortunes for trading cues.
This chart illuminates why silver enjoys excellent potential for a major short squeeze catapulting its price rapidly higher. It shows speculators’ total silver-futures long contracts in green, and total short contracts in red. Silver along with some of its key moving averages are superimposed on top. The silver-futures selling since mid-April has been torrential, including extreme shorting. Those shorts have to soon be covered.
In futures trading, buying is buying and selling is selling. The upside price impact on silver of buying a new long contract or buying to cover an existing short contract is identical. Rising longs and falling shorts are equally bullish for silver. The opposite is also true. Selling an existing long contract or selling to open a new short contract is identical in silver-price impact. Falling longs and rising shorts are equally bearish.
Futures speculators’ collective price impact on silver is fueled by their total trading on both the long and short sides. Buying from either side pushes silver higher, selling from either side forces it lower. The key differences are the long side is much bigger, and long-side trading is voluntary. Once traders effectively borrow silver futures they don’t own to short sell them, they are legally obligated to soon buy them back.
Those debts must be repaid, so silver-futures contracts sold short are offset and closed by buying long contracts. This involuntary dynamic along with the extreme leverage inherent in silver futures is what creates short squeezes. Speculators short silver futures face potentially unlimited losses if silver rallies, so once it starts climbing they have to rapidly buy longs to close their shorts. This quickly becomes self-feeding.
Not that long ago in mid-April, silver was faring pretty well. It was trading just under $18.50, up 16.2% YTD. In the weekly CoT report right after that interim high, silver-futures speculators held 154.2k long contracts and 37.4k short ones. Those longs were actually really high, just off their highest levels seen in the 18.3 years since early 1999! That’s the limit of this dataset, but that was almost certainly an all-time record.
Futures speculators’ collective bets are a powerful contrarian indicator. Despite their sophistication to trade at such extreme leverage, these guys are always wrong as a herd at trend turning points. The record longs showed they were super-bullish on silver. That’s not necessarily an immediate risk alone, but if silver turns south that big selling overhang can really compound its downside. That happened in late 2016.
Days before gold’s own interim high in mid-April, and over a week before gold’s own selling intensified enough to suck in silver, silver started falling relentlessly. It looked like some large trader was trying to unload large amounts of silver-futures long contracts as quickly as it could without crushing the silver price. That would adversely impact its own exit, so that position was unwound over weeks instead of hours.
If the troubled Noble Group was indeed involved in silver’s unnatural selloff between mid-April and mid-May, it was in this major long liquidation. CoT reports are current to every Tuesday close, so we only get weekly Tuesday reads on them. From mid-April to mid-May, 29.5k silver-futures long contracts were dumped by speculators. That was nearly 1/5th of the total longs from that record high seen in mid-April.
Since silver futures are so hyper-leveraged, their speculators’ time horizon is measured in hours or days on the outside. No one running 17x can afford to be a long-term trader, the risks are too great. So there is no doubt short-side speculators immediately noticed that relentless liquidation of longs. Their ears are always to the ground, so they certainly heard these same numerous rumors of a Noble Group forced liquidation.
True or not, there was some big seller desperately trying to exit an enormous silver-futures long position. So the short sellers jumped on this bandwagon and started piling on. If the large seller was being forced to liquidate to raise cash, there would be more selling for the shorts to ride. Remember on the short side the profit incentive is reversed. Short sellers borrow to sell high, in the hopes of buying back low later to profit.
Speculators’ silver-futures shorts were on the low side into mid-April, just 37.4k contracts. But once they smelled blood in the water, a shorting feeding frenzy erupted. In just 4 weeks, silver-futures shorts exploded an astounding 34.5k contracts higher! That was nearly a double, a truly-extraordinary surge in such a short time. By mid-May, total spec shorts hit 71.8k contracts which is a super-high level historically.
It wasn’t just a 21.4-month high for speculators’ bearish bets on silver, which would itself be a very bullish contrarian indicator. Mid-May’s 71.8k wasn’t far under the all-time record high of 81.6k spec shorts seen back in early July 2015 when silver plunged to just over $15 per ounce. Such high short levels, driven by such fast shorting spikes, are very rare. And they are usually contrarian indicators signaling major bottomings.
These bearish speculators were way out over their skis with such epic shorts. If they were betting on that huge long liquidation, it appeared to cease in mid-May. If they were trying to leverage the simultaneous sharp gold pullback, that too ended within a day of that relentless long selling. So these short sellers had no choice but to start aggressively buying to cover to close out the extreme shorts they’d quickly amassed.
That likely largely-involuntary silver-futures buying to cover drove silver sharply higher, even without new long buying which hasn’t materialized yet. The latest CoT report before this essay was published, which is current to May 23rd, showed massive short covering already underway. Silver-futures speculators’ total shorts plunged 13.5k contracts last CoT week, or nearly 1/5th of their total shorts at that recent peak!
And indeed silver surged on that short covering, enjoying multiple big up days way out of proportion to gold’s own. But it still only rallied 1.5% in that CoT week seeing all the short covering, suggesting there is still selling out there retarding silver’s upside. Some rumors claim the Noble Group not only sold silver futures, but physical metal positions it owned. Perhaps that hasn’t finished, or other Asian traders are still selling.
At any rate, silver is set up for a big short squeeze. So far the shorts have been very lucky, they’ve been able to buy to cover without silver rallying too much. That’s largely because other speculators have not yet returned on the long side. But once gold rallies consistently and materially for a few trading days, they will come flooding back in to play the upside. Then the shorts will frantically cover to get out of harm’s way.
In the first quarter of 2017 before April’s strangeness, specs’ silver-futures shorts averaged just 32.0k contracts. Based on the latest CoT available, that means traders would have to buy to cover another 26.3k contracts to mean revert back down to normal short levels. That’s nearly twice as much as the short covering already seen last CoT week. In other words, 2/3rds of the total short covering is still coming!
That is mandatory near-term buying. These traders effectively borrowed silver futures they didn’t own to sell them, and they are legally obligated to soon buy them back to repay those debts. This has real potential to drive silver sharply higher in the coming weeks, especially if spec longs are also rising greatly ramping the pressure on shorts to cover fast. The most-likely catalyst to ignite this would be a gold surge.
Today’s situation in gold futures is actually much more bullish than even silver futures’ current one! On the gold side, longs are very low. That means they have vast room to buy back in and propel gold sharply higher. Big gold-futures buying could be triggered by anything that implies lower future Fed-rate-hike odds, including weak economic data or the FOMC itself.
Despite gold thriving in past Fed-rate-hike cycles, futures speculators remain irrationally terrified of higher rates. The day before the last Fed rate hike in mid-March, both gold and silver had slumped to major interim lows. The FOMC indeed hiked as expected, but gold and silver still soared that afternoon and over the subsequent weeks! Why? The FOMC’s outlook on future rate hikes wasn’t as hawkish as expected.
So even if the Fed hikes again in mid-June as universally forecast, that could yet again prove a very bullish catalyst for speculators to flood back into gold and silver futures. If the FOMC members’ famous dot plot, their predictions for future federal-funds-rate levels, moderates, gold and silver will likely again be bid sharply higher. That’s a huge risk for the silver shorts, who weren’t willing to make that gamble in mid-March.
The day before that last Fed rate hike, spec shorts slumped to just 29.3k contracts. Even without short covering, silver still surged 2.7% higher on rate-hike day due to long buying. I doubt today’s speculators heavily short silver will want to take the risk that the FOMC’s FFR projections due at its mid-June meeting won’t be hawkish. So odds are the short covering and potential short squeeze will come before June 14th.
There is nothing more bullish for silver in the near term than excessive silver-futures shorts. These are guaranteed near-future buying! And staying short heading into a likely rate hike after silver has surged after recent Fed rate hikes is like playing Russian roulette. So the pressure on these guys to cover soon is big and growing. Their short covering will likely push silver high enough to entice longs to return en masse too.
Don’t underestimate the silver upside when shorts are covering and longs are buying! Silver hit a major 6.4-year secular low in December 2015 two days before the Fed’s first rate hike in 9.5 years. Then over the next 7.6 months, silver rocketed 50.2% higher! That was driven by speculators buying like crazy, adding 55.6k silver-futures long contracts while covering 30.0k short ones. Similar short covering is likely soon.
Again to mean revert back to Q1’17 levels, speculators still need to buy to cover another 26.3k short contracts. That could happen any day with the next major FOMC meeting looming, one of the every-other ones that includes future rate projections. So investors and speculators alike should position for some silver upside, potentially big, in the coming weeks. The stars are aligning for silver buying returning in a major way.
The bottom line is silver is set up for an imminent potential short squeeze. A likely forced liquidation of a huge long position enticed speculators to flood into silver-futures shorts between mid-April and mid-May. That fueled a massive shorting spike, leaving shorts exceptionally high despite some covering buying since. These remaining shorts must soon be covered by buying offsetting longs, driving silver sharply higher.
Given the extreme leverage inherent in silver-futures trading, these speculators can’t mess around with the next FOMC meeting looming. Silver has surged sharply after all three previous Fed rate hikes in this latest cycle! So major buying to cover is actually highly likely before mid-June’s universally-expected next rate hike. This short covering will probably entice in long buying, amplifying silver’s near-term upside.
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