something interesting from Saxobank-fwiw
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Weekly Market Update, 3rd of February, 2006
The bullish case for silver
There are many reasons to be bullish on silver despite the large advances it has made recently. First and foremost, the fundamentals remain quite extraordinary. Each year we produce less silver than we use and the difference (the so-called structural deficit) is covered by various stockpiles being dumped on the market. This is not news; it has been going on for at least 15 years and to a certain extent ever since the US government among others began to dump their strategic stockpile of silver on the market. This silver had been accumulated through hundreds of years through the silver-standard era.
Now, there is hardly any silver left in a deliverable form. The rumours in the market place indicate an extremely tight physical market and considerable time for delivery on larger contracts. At the same time, the various COT reports for the futures market show an extremely large short position. Actually the paper market (futures market) seems to be leveraged to dangerously high levels compared to almost any other metal or commodity in the world. Some market participants have seen this as a collusion in the silver market, because the limits on speculative positions was simply so high that they were effectively void and enabled the short side of the market to engineer a sell-off by simply dumping naked contracts on the market. These voices – regardless if they are right or wrong – have until now been countered by the claim that if they were right, the market would just take delivery of silver and squeeze the shorts.
Now, this is actually happening. Barclays Capital is trying to launch a Silver ETF, which – if approved by the US authorities – will take unknown but significant amounts of silver off the market. This is why silver has been rallying so strongly and without any serious drawdowns lately. While the ETF has not yet been approved, we expect it to be a big story in the market going forward. The chances of it being approved have increased markedly by the SEC allowing it to begin its 21 days comment period, which is a standard procedure for financial products in registration.
Who is buying now? Barclays are probably buying to avoid being forced to put large orders at the market at the eventual launch of the ETF. Silver traders are buying to front-run Barclays and silver users are buying in order to get their physical silver at good prices and/or while it is available at all.
There is one threat to the ETF, though. A non-profit organization called the Silver Users’ Association has announced that it will try to halt the launching of the silver ETF on the grounds that the silver market is simply too small and illiquid for such an entity. If we think about this for a moment, the association is actually implying that there isn’t enough silver for both the traditional users and investment demand for silver. We should make no mistake about this. If anyone knows the tightness and troubles in the physical market for silver, it should be the Silver Users’ Association and if they say there isn’t enough silver, we should buy it.
Therefore, we are engaging in a long-run bullish silver strategy based on selling covered calls on silver with strikes around 30-40 cents higher than market prices to benefit from the immense volatility in the silver market.
Positions:
We went long spot silver yesterday at $9.9415. At the same time we sold a February 16th call with a $10.25 strike at $0.13. We intend to hold the position to expiry.
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