The silver dilemma: five great reasons to buy – and two good reasons to sell

Today, we consider gold’s erratic little sister – the bi-polar metal that is silver.

There is no other metal on God’s earth that has so much potential to make its buyers millions. And there is no other metal that has so consistently failed to deliver.

Its proponents point to supply shortages and increased usage. Its detractors point to charts showing bear markets that go on for years.

If I could fast forward three years into the future, and I saw that silver was $200 an ounce, it wouldn’t surprise me.

But then if it was $5 an ounce, that wouldn’t surprise me either.

To reflect the numerous contradictions that accompany this metal, we give you five reasons you should buy it now – and two reasons you should sell it.

Five good reasons to buy silver

Let’s start with some reasons to buy.

1. China’s supplies of silver are drying up

On the Shanghai futures exchanges, physical metal – rather than paper derivatives – is traded. As a result, many declare that the action there is a truer reflection of what is going on in the real world.

Since March 2013, silver inventory has fallen by more than 90%. At the high, there was 1,143 tonnes of stock. Last week, that had fallen to just 103 tonnes. In July and August alone, there has been a 56% drop. That is some drawdown.

At this rate, China – a significant producer of silver, but also a consumer – will become a net buyer before the end of 2014, putting upward pressure on the price.

The exchange only came into being in 2012. Since then, there has been a correlation between the silver price and the exchange’s holdings. In other words, buying and selling on the exchange may be driving the price. As there is very little metal left to sell, selling pressure could dry up.

2. The time of year

A boring one, I know, but we are coming into what is traditionally a strong time of year for precious metals. After the summer months, when the price tends to stagnate and fall, September usually sees gains for silver.

In fact, with average gains of more than 2% over the last 20 years, September is the second best month of the year for silver. The best month is November, with average gains of 5%.

3. The ticking time bomb

Silver has the largest concentration of short positions of any commodity (in other words, some people have placed big bets on the price falling – see the chart below from Nick Laird at Sharelynx). To cover those short positions (in other words, buying back enough metal to close down the shorts) would require more days of production than any other commodity.

Concentration of silver traders chart © Sharelynx

This is a time bomb that has been ticking for years – but there is a huge potential run on physical metal that is waiting to happen that could send the price a lot higher. Perhaps the Shanghai situation will spark it.

4. Silver’s increasing usage

Aside from its monetary and investment uses, silver is finding more and more practical, industrial applications. The more electrical, computer and mobile phone use grows (and nothing will stop that), the more silver consumption increases. New discoveries are being made all the time about its ability to combat infection, fungi, bacteria, bad smells even – so demand is increasing from medicine, biotech and clothing.

But perhaps the most exciting source of growing demand is solar power. Demand for silver on photovoltaic cells has gone from one million ounces in 2000 to 50 million ounces last year. That is about 5% of global supply. As solar power usage grows – and it will (think high oil prices, nuclear problems and all the rest of it) – silver demand will increase.

5. Global silver supply could fall

About 80% of silver’s billion-ounce annual demand comes from mining, the rest from scrap. Pure silver producers are struggling to make money at current prices, and investment in exploration has disappeared. Meanwhile, a great deal of silver is produced as a byproduct of lead and zinc mining. This is another area where investment has disappeared. Shortages could lie ahead.

All very exciting I’m sure you agree. But before you pile in, let’s just balance that out with the bearish case.

1. There are too many longs and not enough shorts

Holdings in SLV, the largest of the silver exchange-traded funds (ETF) are, according to the Atlas Pulse newsletter, not far off all-time highs. That is despite the miserable action that has been seen in silver over the last three years (it was $50 an ounce three years ago, as opposed to $19 today).

In short, the silver bulls have not been washed out – if this was the end of the bear market, they should have been. Atlas Pulse has combined the ETF data and data from Comex (the US futures exchange) in the chart below.

“What’s striking”, he says, “is how the silver market currently has an all-time high net long position, whilst the silver price is on the edge of a long-term support level that dates back several years”.

The silver line shows the silver price, while the red line shows the ‘net length’.

Silver price with net COT and ETF flows chart

That is a bearish situation. It means there are potentially a lot more sellers than there are now buyers, which will put downward pressure on the market.

Of course, if you ignore ETF holdings, the short-long position looks rather different. It is the ETF holdings that are the story here.

2. I don’t like the price action

One of my mantras, and something I’ve repeated here many times, probably too many times, is that the more something tests a level, the less likely that level is to hold. It doesn’t make any difference whether the direction is upwards or downwards.

In this case, silver is retesting that key support just below $19 too many times for my liking. I’ve illustrated it in the chart below. Will that amber band hold this time around?

Silver price chart

This re-test is coming off the back of a long downward trend. The short- and long-term moving averages are all pointing lower. If that amber band doesn’t hold, silver could easily fall to $15.

This is an important re-test. If it holds, I’ll change my point of view here. If you are long silver, I would have a stop not far below the recent lows.

So there we have it, some of the key factors to consider when evaluating your decision whether to buy or sell silver. For all I’ve said, here’s some full disclosure: I own silver.

But not as much as I used to.

PS My colleague,  former MoneyWeek writer David Stevenson, is very bullish on the outlook
for silver. He believes silver could be about to start a record climb. I can’t see it myself – but David is convinced. Click here (capital at risk) to read about the three irresistible forces David believes could push the price of silver through the roof. 

Category: Market updates

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