The silver market is all about sentiment. Unlike many other commodities and even precious metals, the production cost for silver is secondary to almost all other factors that influence the price of the metal. While there is some primary production of silver around the world, the vast majority of output comes as a byproduct of copper, lead, zinc, and gold production. Therefore, the average cost of extracting an ounce of silver from the crust of the earth is an enigma.
Silver moves higher or lower when a herd of buyers or sellers move the price. Therefore, fundamental supply and demand analysis are often useless when it comes to projecting the path of least resistance for the price of silver. However, there is a silver lining, no pun intended when it comes to an understanding of the silver market. That lining comes from the technical road map that can influence the price and cause the herd to become buyers or sellers.
Silver is currently trading around the lowest level against gold in a quarter of a century. With gold at an elevated level compared to silver, the deviation from the historical norm over the past forty years could be telling us that at its current price, silver provides a compelling investment opportunity. If that is the case, this could be the perfect time to begin monitoring the Velocity Shares 3X Long Silver ETN product (USLV).
Silver fails at $16.20
The most recent lower low in the continuous silver futures contract came in mid-November at $13.86 per ounce. Silver came within 22.5 cents of its critical technical support level at $13.635 from December 2015. However, the price recovered and rose to a high at $16.20 in late January. After a correction that took silver to $15.195, the price made another attempt to move to the upside but failed at just one-half cent below the January high at $16.195 during the week of February 19 which sent the price for another peak below the $15 per ounce level last week.
Nearby silver futures recovered from the most recent low and were back above $15.40 on March 13, but the pattern of lower highs remains intact. While short-term technical resistance is now at the recent $16.20 high, the critical line in the sand on the upside that would end the pattern of lower highs stands at $17.35 per ounce, the June 2018 high.
A $15-$16 range could be healthy
After a long-term trend in a market, a period of price consolidation is often a healthy sign that builds cause for a move that ends the trading pattern. Silver has been in its bearish trend since it traded to a high at $21.095 per ounce in July 2016 in the aftermath of the Brexit referendum that caused both gold and silver prices to reach highs. Historically, silver is a far more volatile metal than gold and its moves on the upside and downside are much greater on a percentage basis when the price gets going. However, gold is beckoning silver high as the price action in gold has been far more constructive than in the silver futures market over the past months.
Gold says higher
As the weekly chart illustrates, gold fell to $1161.40 in mid-August 2018 on the back of a stronger dollar and the prospects for rising US interest rates. While gold fell to the lowest price since January 2017 last summer, silver waited until mid-November, and it declined to its bottom since early 2016.
Moreover, while silver moved within 22.5 cents of its level of critical support at the December 2015 low, gold remained over $115 above its support from the same month. At the same time, gold recently moved to a high at $1344 on the continuous futures contract on February 20 which was only 2.5% below its July 2016 peak at $1377.50 while silver made it to a high at $16.20 which was over 30% below its high from the same month at $21.095 per ounce. Gold continues to send a bullish signal to the silver market.
It is all about sentiment in the silver market- the technical roadmap
As the daily chart shows, some of the technical indicators can offer a guide to the path of least resistance for the price of silver. Open interest is the total number of open long and short positions in a futures market. In silver, when the metric falls below the 180,000-contract level, silver tends to run out of steam on the up or downside, and the price often reverses. When the metric rises above the 220,000-contract level, the same phenomenon tends to occur. The silver market seems to become oversaturated when open interest moves to the highs and runs out of interest on the lows which often triggers a price reversal. When it comes to price momentum and relative strength indicators, silver typically runs out of buying in overbought conditions and selling when the metrics display an oversold condition. Since silver can be a highly volatile commodity, historical volatile tends to rise when a move gets underway. A period where the metric that measures price variance remains stable at low levels often leads to a sudden move. A move that takes the volatility metric below the 10% level has often led to a rally in the silver futures market.
Past performance is never a guaranty of future performance, but the technical metrics in the silver market can provide a guide for market participants. Technical analysis examines the past behavior of market participants. In a market that moves higher or lower from sentiment, the technical metrics can take on a unique significance.
Buy this metal when it looks its worst and sell it when it looks best- USLV and DSLV
Silver is a market that attracts speculators and those looking for significant percentage moves. The most direct route for a trade in the silver market is via the futures and futures options on the COMEX division of the CME. For those who do not trade futures, the Velocity Shares 3X Long Silver ETN product (USLV) and its bearish counterpart (DSLV) provide leveraged exposure for market participants that can be useful when sentiment is preparing to shift according to technical indicators.
The fund summary for USLV states:
“The investment seeks to replicate, net of expenses, three times the S&P GSCI Silver index ER. The index comprises futures contracts on a single commodity. The fluctuations in the values of it are intended generally to correlate with changes in the price of silver in global markets.”
The fund summary for DSLV is similar as the product takes the opposite positions to create the triple leverage on the downside. Both USLV and DSLV are only appropriate for short-term forays into the silver market as the triple-leverage comes at a cost which is time decay. The value of these products deteriorates over time, and both are subject to periodic reverse splits which destroy the value. However, for short-term positions, they offer turbocharged results. Most recently May silver futures rose from $14.985 on March 7 to a high at $15.55 on March 13, a rally of 3.77%.
Over the same period, USLV rose from a low at $64.69 to a high at $71.56 or 10.6%, almost triple the move.
The chart of DSLV shows that over the same timeframe, the ETN moved from $24.50 to $31.09 per share or 26.9% higher, just over triple the move to the downside in the silver futures market.
USLV and DSLV have net assets of $230.79 and $27.77 million respectively. Each day an average of 110,448 shares of DSLV change hands while average daily volume in USLV is 199,319 shares. Market participants tend to favor bullish compared to bearish positions accounting for the higher assets and volume in the USLV compared to the DSLV products.
Silver remained in a bearish trading pattern as of March 14. However, the price action in gold could eventually light a bullish match under the price of its precious cousin and send the price higher for a test of $17.35 which would end the trend of lower highs. USLV and DSLV are short-term tools that can be very useful if the silver market is going to come back to life and trading ranges expand over the coming weeks and months.
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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.