SILVER PRICE PROSPECTS / MACLEOD FINANCE

Silver’s price prospects

Panicky lease rates and backwardations in silver are widely publicised. They are characteristic of a bear squeeze. Can it be resolved, and will the price then subside?

Alasdair Macleod

The silver chart below is enough to give investors vertigo, prompting them to think in terms of taking profits. 

But silver is no longer an investor’s market: it is turning from an industrial metal into a funk-hole for escapees from fiat credit.

For weeks we have been pointing out the bear squeeze conditions in both gold and silver, but it’s more acute in silver. 

It has now culminated in a well-advertised panic for physical metal in London, where vaults are desperately low on deliverable metal.

Normally, such an aggressive rise in values results in overbought conditions, and technical analysts point out that favoured measures such as relative strength indicators confirm that silver is wildly overbought. 

But a mechanical RSI is misleading. 

A more accurate market indicator is the level of open interest on Comex, which is the next chart:

Clearly, by this measure silver is far from overbought. 

And notably, it has remained neutral despite silver charging into new high ground. 

This is because the speculator categories, principally managed money representing hedge funds and momentum traders have not bought into it. 

But both the other reported and non-reportable categories have been taking delivery, with stand for deliveries this year so far totalling 11,732 tonnes — that’s 377.2 million ounces, the equivalent of 56% of silver mine output over the ten months of this year.

So, silver is not overbought and the momentum speculators are yet to buy. 

Given that silver is transitioning from industrial metal to an industrial metal with monetary characteristics, the chart which really matters is of the gold/silver ratio. 

This is next:

Note how after peaking at 103 ounces of silver for every ounce of gold last April, this number is in a full-on move lower, with its value being followed lower by both the short and long-term moving averages. 

It is this feature which confirms that silver is being repriced to reflect is historic monetary qualities.

Silver was the monetary standard for China until 1935, so perhaps its monetary qualities are more ingrained in the citizens’ minds than gold from a practical viewpoint. 

Furthermore, through the Shanghai Gold Exchange the Peoples Bank controls the silver market alongside gold, confirming its monetary status in the legislators’ minds.

In the West, silver’s relationship with gold was set by Sir Isaac Newton at 15.5:1 in 1717. 

While bimetallic standards had problems, the fact that silver remained a monetary standard for many nations until the 1870s meant that the gold/silver ratio remained at that approximate level until Germany adopted gold, replacing silver following the Franco-Prussian war when France paid reparations in gold to Germany. 

The other European nations then followed suit, and the silver price fell, i.e., the ratio rose to reflect its loss of monetary status. 

However, it remained in coinage well into the twentieth century.

Today, the fiat currency era which commenced following the suspension of the Bretton Woods Agreement appears to be coming to an end the way fiat currencies always do — through the accumulation of unsustainable debt eventually destroying faith in their value. 

For now, a small but growing minority of savers suspect that fiat currencies are in trouble. 

It is their buying which has led to the liquidity crisis now evident in western bullion and paper markets.

There are two dynamics at work here. 

The first is that as the gold/silver ratio declines, perhaps towards one third of current levels, gold itself is rising measured in fiat currencies whose decline valued in gold appears to be accelerating. 

See the chart below.

The second problem for markets is that with an increasing tendency for both industrial users and savers to hoard silver, it takes on the characteristics of a Giffin good. 

That is when rising prices only creates further demand instead of profit-taking, evident as retailers are currently running out of bar and coins. 

Therefore, supply becomes increasingly restricted as prices rise.

Conclusion

Despite the prospect of arbitrage reflected in a backwardation between London spot and Comex (currently 99 cents on the active December contract) liquidity shortages look like persisting. 

Furthermore, silver is dramatically underpriced for any monetary role, and being a Giffin good it has the potential to double or triple in short order.

There appears to be no ready resolution to the current squeeze on the paper market.