Silver on the Verge of Another Breakout

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Silver appears extremely bullish from a structural point of view, something that myself and others have been talking about the last 12-14 months. We first saw this in the vast reduction in the adjusted open interest (reference to spread positions) by about half followed by 2 monster rallies beginning in Sept 2010 and again in February 2011. From personal experience, gauging physical investment demand, paper (ETF) demand, shape of the futures curve and the Commitment of Traders report, silver will likely see a monster rally to at least the $40-$43 area before year end and possibly a breakout pushing the $50 level. In any case, Silver would be the one commodity I would want to own for the next 12-24 months.

From talking to various bullion dealers around the world as well as hearing stories from others, investors appear to have become savvier, loading up on silver following the 3 day orchestrated takedown from $40 to the sub $30 level. Of those I’ve been able to obtain details from, the demand for silver on the investment side outweighs that for gold, at least in dollar terms. This speaks volumes when you look at the amounts available for investment demand in both metals.

Getting back to my point, the recent structural change in the net commercial position coupled with the banks containing the largest net short positions (See Bank Participation Report) appear to have reached the conclusion that this game of knocking down silver at will is close to an end. The physical market has become so tight, it could easily cause these commercial banks to lose billions especially when one takes into account the size of this market.

silver cot net short positions
Click for larger image

Points worth noting:

  • An astounding reduction in the total net short position in excess of 26k contracts or 132m oz (approx. 20% of world inventories).
  • Perhaps the most telling is the reduction in the net short position of the largest 4 commercial traders (notably JP Morgan and HSBC) by 10.3k contracts or more than 51m contracts.
  • While the 5-8 largest only slightly reduced this position, it is not all that telling given the top 4 make up the bulk of this position.
  • The smaller 35 commercial traders in this case have increased a relatively flat position 5 weeks ago to over 18k contracts.

Conclusion

Selling appears to be exhausted on both the speculative side and the commercial side (commercials have tended to pile on short positions prior to a takedown and cover on the way down, which they have done over recent weeks). The commercial traders who essentially control price via the paper market are positioned in such a way that bodes well for silver. Continued backwardation, signaling a supply constraint remains and should intensify over the coming weeks and months. With mine and secondary market supply growing a few percent a year, investment demand is growing much faster and has been accelerating. In other words, demand is outstripping supply, which should lead to higher prices as dictated by the laws of supply and demand. While there is no certainty silver will head higher in the weeks ahead, it looks more likely than not, and this presents investors with a period of time to accumulate. If I we’re a bettin man I wouldn’t bet against a potential double to $60/oz in 6-12 months. With the monetary problems intensifying around the world, those who fail to take advantage of these attractive prices will surely be kicking themselves down the road.

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About Chris Marchese

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