Silver is volatile and works both ways. Am sure you know that by now. But I am still in silver stocks, only watered down. And I continue to believe that silver will do well and its rebound would be equally as sharp.
As I said yesterday, I believe it was BTD opportunity. SLV: Buy The Pullback In Silver
Sep. 25, 2020 3:26 AM ET
Summary
Silver fundamentals are setting up for a strong rally over the next year as both market volatility and relative performance to gold are bullish at this point.
The technical picture suggests that silver is likely going to continue trading higher.
SLV is protected from roll yield losses due to its physical holdings which is a benefit to shareholders.
As can be seen in the below chart, the iShares Silver Trust ETF (SLV) has taken a dip in line with a general pullback in the price of silver.
While this dip appears fairly strong (with price falling over 16% in a week), I believe this is actually a pullback setting up for a solid buying opportunity. I believe SLV’s underlying methodology as well as silver fundamentals are supportive of a trade to the upside at these levels. Silver Fundamentals
Over the past few months, we have seen quite a bit of volatility in the silver markets, with the outright price of silver seeing substantial upside. While these price changes have been turbulent, I actually believe there is an underlying fundamental story which this change is reflecting.
Earlier this year, we saw one of the fastest meltdowns in the history of equities markets with shares collapsing in the face of the spreading coronavirus. This collapse in shares led to the level of volatility in the markets hitting some of the highest levels ever reported.
What is noteworthy about meltdowns in markets is that they actually tend to be fairly correlated with future price appreciation in the value of silver.
This chart shows the average 1-year return in silver following a VIX reading of a certain level. This data spans the last 27 years of market information and is fairly comprehensive. What the data shows is very interesting: when the VIX hits elevated levels, it tends to signal further price rallies in store for silver.
To understand what this specific index is signaling now, here is a chart of the current level of the VIX.
As little as two weeks ago, we saw the VIX in the area of 35-40. If you look at the prior chart, then you can see that historically speaking, the VIX at these levels is actually normally a very strong buy signal. For example, over the last 27 years, when the VIX was in this territory, the price of silver rallied by an average of 32% over the next year.
While this relationship is certainly important and can be traded on its own, it makes sense to try and understand what is actually driving the price of silver in these circumstances. I believe the key driver is that during market volatility, investors tend to pull capital from equities and park their money into assets which are perceived as a store of value. What the data above shows is that in the case of silver, this tends to make for a very sound trade.
An additional metric which is suggestive of further price rallies in silver is the relative performance of gold and silver. In the precious metals space, there tends to be a perception that silver or gold are stores of value so during market turbulence, investors should park capital in one or both of these assets. However, there is an interesting pattern in the data which suggests that differences in performance between these two assets actually does a fairly good job at calling future changes in the price of silver.
This chart shows the performance of silver in the year following the gold minus silver 1-year return at any given point of time. This is over 50 years of data and gives a very interesting picture into the inner workings of the drivers of the return of silver.
At present, gold and silver are basically tied in terms of performance with silver outperforming gold by about 3% over the past year. However, within the last two weeks, gold was outperforming silver by around 20%. Historically speaking, when gold is outperforming silver by this amount, we tend to see the price of silver appreciate by 15% in the next year.
I believe the key relationship driving this data is that the momentum effect. Specifically, when investors see silver outperforming gold, this can serve as a buy signal for momentum trades, leading to additional capital flowing into the silver. I believe this relationship is clearly evident in the data and that we are getting a clear signal from the markets that now is the time to buy silver to capture these future returns.
While I personally prefer to focus on fundamental drivers of prices, the technical landscape in the price of silver is also suggesting that now is a good time to buy the commodity.
At present the market is in a prolonged correction against the primary trend with momentum remaining bearish since the middle of August. However, over the past 24 hours, silver has start to find support at around the $21/oz level with price testing a prior low and recovering somewhat.
I believe this is a textbook pullback in a larger trend and that in the coming days and weeks, silver will correct to the upside. I base this on the fact that silver has previously found support at these same levels (in the middle of July) and we are currently finding support here once again. Additionally, bearish momentum has likely peaked based on the fact that the current trend is fairly prolonged and the recent magnitude of bearish momentum is essentially at the same apex levels reached in early March which signaled a multi-month low.
I believe the charts are supportive of buying silver at this point as well as the previous studies noted. I believe that SLV is a strong ETF for trading this movement. About SLV
In the commodity ETP space, methodology matters… a lot. If you’ve read any of my articles before, I tend to put a good degree of emphasis on the underlying methodology of any specific instrument. The reason why I do this is that two instruments which track the same commodity but use different methodologies can see differences in performance of perhaps dozens of percentage points per year.
In the silver markets, the key question for investors regarding any given ETP is what exactly the fund holds. Investors should in general gravitate towards funds which hold the commodity rather than futures due to the issue of roll yield.
Roll yield is the return investors get from holding a futures contract as it converges towards the spot price of a commodity. In general, the futures prices for silver are in what is called “contango” or increase in value along the curve (as can be seen here). The reason why silver futures are in contango is that each futures price will be equal to the spot price compounded by the borrowing rate as well as any fees or returns earned from actually storing the commodity. If the futures price is different from this compounded rate, investors can earn a risk-free profit by borrowing capital to physically store or short silver and making or taking delivery on the futures contract (depending on if the price is above or below the compounded spot price). This is called arbitrage and it’s what keeps the silver market in a fairly steady level of contango.
At present, the math is showing that silver futures holders are losing about 2% per year in roll yield losses. This means that if you are holding futures instead of physical, you will see your returns in the ballpark of 2% less than those earned by those holding the actually commodity. This may seem slight, but when you add in the additional commissions and slippage associated with continuously trading in and out of futures contracts, the actual cost can be higher and it is material.
This is why I believe that SLV is a strong play at this point. SLV is a trust which is holding physical silver in vaults in London which means that it is not exposed to roll yield and therefore will outperform an investment in futures through time. Conclusion
Silver fundamentals are setting up for a strong rally over the next year as both market volatility and relative performance to gold are bullish at this point. The technical picture suggests that silver is likely going to continue trading higher. SLV is protected from roll yield losses due to its physical holdings which is a benefit to shareholders.
