Gold and Silver miners (Jr and Exploration)

[Edge83]

Silver Has Been Dead Money

Andrew Hecht

Summary

A wide trading range in 2017 narrows.

A highly speculative metal.

Silver is historically cheap compared to gold.

Investor and speculative interest dictates the path of least resistance for the price.

Silver's day will come, perhaps in 2018.

This idea was discussed in more depth with members of my private investing community, Hecht Commodity Report. Become a member today >>

Silver can be one of the wildest speculative trading sardines in the futures market. There are times when volatility explodes in the silver market and times when the metal just rests. Silver is a precious and an industrial metal. Many market participants believed the industrial value of silver died when photographic technology moved from requiring silver nitrate to digital applications. However, computers, cell phones, solar technology and other uses have more than replaced silver consumption and the metal is still an industrial commodity these days. When it comes to the investment angle for "gold's little brother" silver is always a metal that moves on sentiment and reacts to herd behavior that can take it to extraordinary heights and ugly lows, at times.

On my first day as a trader back in the mid-1980s, my boss taught me a critical lesson when it comes to silver and most markets that have a speculative element when it comes to price volatility. He said, "Fundamental and technical analysis is all well and good, but market prices go higher when there are more buyers than sellers, and they go lower when there are more sellers than buyers." The statement sounds like a simple truism, but when you think about it, the lesson is profound and one that is lost on many traders and investors as they dig deep into the weeds of a market. When it comes to silver, it is the behavior of the herd of market participants that determines the path of least resistance for the price of the precious metal.

A wide trading range in 2017 narrows

The trading range in silver has taken the precious metal from highs of $18.655 per ounce in April to lows of $15.15 per ounce in July.


Source: CQG

As the weekly chart highlight, the $3.505 range has narrowed over recent months, Since August the range has been from $16.345 to $18.16 almost half the width of the band for the year. Silver fell to its bottom for the year following a flash crash in early July that took the price to the lowest level since April 2016. Therefore, while it made a new low and traded below the December 2016 bottom at $15.70, it did not even approach the 2017 high at just over $21 per ounce. Silver has been a sleepy precious metal since August, and that is not the norm for the precious metal that tends to display the highest volatility.

A highly speculative metal

The weekly chart shows that historical volatility is at the 14.75% level, but the commodity typically trades at 20-30% when it comes to the metric that measures price variance. The narrowing trading range has caused many market participants to ignore silver as the midpoint of the trading band since August is at the $17.25 level. Silver has been trading either side of $17 since late September, and it has run into technical resistance and selling at the midpoint of the range. There have not been more buyers than sellers in the silver market and sellers have not dominated buyers, so the price is just sitting at a level that is not attracting much action these days. However, silver continues to be cheap when compared to its yellow cousin.

Silver is historically cheap compared to gold

In the world of commodities, the terms cheap or expensive are highly subjective. Meanwhile, I believe the best way to attribute such an attribute to a raw material's price is to compare it to another commodity that can be a substitute or has similar properties.

The silver-gold ratio dates back to around 3000 BC when the first Egyptian Pharaoh Menes states that one part gold equals two and one-half parts silver. When it comes to the precious metals positions as means of exchange in the world, gold is analogous to currency notes, while silver is the coinage or change. My grandfather often referred to the change jingling in his pocket as silver.


Source: CQG

As the quarterly chart of the price of gold divided by the price of silver illustrates, the range in the ratio over more than four decades has been from lows of 15.47:1 in 1979 to highs of 93.18:1 in 1990. The midpoint and average value over the period has been around the 55:1 level meaning that over the past forty years since futures contracts have been trading, it has taken an average of 55 ounces of silver to purchase an ounce of gold. When the ratio is below 55:1, silver is historically expensive compared to gold, and when it is above, silver is cheap. Silver has been trading above the midpoint level since 2012, and on November 16 it was at the 74.84:1 level. Therefore, on a comparative basis, either silver is currently cheap, gold expensive, or a bit of both at their current price levels.

Investor and speculative interest dictates the path of least resistance for the price

Throughout my career, I have been a big fan of silver because of the price variance that offers market participants the opportunity to make or lose lots of money. After all, price volatility may be an investor's nightmare, but it is a trader's paradise.

Sometimes there is a cloudy line between investors and speculators in the silver market. In the late 1970s, when the notorious Hunt Brothers made a small fortune from a large one as they attempted to corner the silver market, they could have argued their position was an investment in what they perceived an undervalued asset. However, the regulators disagreed and labeled the Hunts wild speculators manipulating the price of the metal.

In 1995, when I was part of a team of four traders that bought over$1 billion worth of silver as a proprietary position for Salomon Inc., we argued that at $5 per ounce, the price of the metal was cheap and we were investing the company's capital to provide a return for shareholders. The regulators were none too thrilled with our explanation which led to a liquidation of the long position of almost 250 million ounces. However, when Warren Buffet showed up long about half that amount of the speculative metal just two years later, regulators and the market viewed him as an investor. In all three cases, the price of silver moved higher during the period of buying and lower as liquidation and profit or loss taking occurred. It was the speculative interest that dictated the path of least resistance for silver then, and the same is true today.

At $17 per ounce, silver is almost one-third the price it was in 2011 at the recent high, but it is more than four times the price it was trading at in 2001. To some investors and speculators, it is cheap today, and for others, it is expensive. Action makes the silver market move, and that comes from the perception of significant market participants. Once silver gets going higher or lower, trend-following traders tend to hop on board to take advantage of volatility in one direction or the other. Many factors cause the price of the trading sardine to move, but with the price at $17 per ounce, it is likely that silver is waiting for the next significant buyer or seller to make a move.

Silver's day will come, perhaps in 2018

The world has changed dramatically since I was involved in buying and selling almost one-quarter of a billion ounces of silver metal. The position consisted of physical 1000 ounce bars held in London and Brooklyn, New York, and futures and options positions that were within Exchange limits, at the time. In hindsight, $5 or even $6 or $8 was very cheap indeed. However, some might deem the current price level as cheap given that the metal trader at a high of $49.82 per ounce in April 2011.

In the aftermath of the global financial crisis of 2008, central banks flooded the system with unprecedented amounts of liquidity to inhibit saving and encourage borrowing and spending. There continue to be significant amounts of capital flowing through the system after almost a decade of accommodative monetary policy. Even though central banks have begun tightening credit, short-term rates remain at historically low levels with the U.S. Fed Funds rate at 1% and perhaps 1.25% by the end of this year, and at negative 40 basis points in Europe.

The price for all of that liquidity is likely to be inflationary pressures on the world economy in years to come. Precious metals tend to thrive in inflationary environments, and as the most volatile metal in the sector, silver could offer a high-profile individual or group a vehicle to position for that event. In 1994 and 1995, when I participated in one of the biggest trades in the history of the silver market the silver-gold ratio was at the 76:1 level with silver at $5 and gold around $380 per ounce. The ratio was close to its current level, when Mr. Buffet decided to take on silver, the metric moved to 40:1 as silver traded at $7.40 and gold moved lower to $300 in January 1998. At the time he took profits, silver had become expensive compared to gold.

Silver has been dead money, but at the current level of the silver-gold ratio and with the potential of inflationary pressures in the years ahead, it may be only a matter of time until the price begins to move higher as buyers overwhelm sellers in the metal that is the ultimate trading sardine.

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Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: The author always has positions in commodities markets in futures, options, ETF/ETN products, and commodity equities. These long and short positions tend to change on an intraday basis.

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