Playing Catch-up?
Fundamentals
After seemingly playing second fiddle to their more popular precious metals cousin Gold, Silver futures are starting to attract a bullish following, with the lead month July contract trading at its highest levels of the year. Among the reasons given for the renewed investor interest in Silver are concerns over the debt issues in Europe, which have caused traders to flee the Euro currency and in favor of alternative assets such as precious metals. Gold has been the biggest beneficiary of this "flight from currencies", as prices are once again approaching all-time highs in U.S. Dollars. Some of this demand for precious metals, especially from smaller investors and traders is now moving into Silver due to its much lower cost per ounce than Gold, as well as the belief by some investors that Silver prices will need to "play catch-up " to that of Gold. Silver prices are still trading well below their all-time highs that occurred in early 1980, during the infamous "silver short-squeeze". In addition, Silver's value as an industrial metal is also lending support, as there are certainly signs in the U.S. of an economic recovery, with the employment picture starting to turn slowly for the better. Finally, an improving economic picture combined with continued "accommodative" economic policies by the European, Japanese and U.S. Central Banks has many analysts fearing a rise in inflation. This is especially true given the European Central Bank's (ECB) announcement that they will purchase European bonds. This has led to concerns that the ECB is embarking on a policy of "quantitative easing", despite denials from ECB officials. The most recent Commitment of Traders report shows both large and small speculators are holding a net-long position in Silver of 57,756 contracts as of May 4th. Although this seems like a relatively large net-long position, it is well off the over 97,000 combined net-long position seen back in 2004. Given that the net-long speculative positions in both Platinum and Palladium are at or near record levels, and that Gold is starting to approach the record, it does appear that the net-long position in Silver may have some room to go before the speculative position moves to extreme levels.
Trading Ideas
Some traders who believe that the bullish run in Silver prices still has some legs, but who do not want to take the potential risk of holding a futures position outright, may wish to explore the purchase of bull call spreads in Silver futures options. An example of this trade would be buying the July Silver 20 dollar calls and selling the July silver 23 dollar calls. With July Silver trading at 19.61 as of this writing, this spread could be purchased for about 0.62, or $3,100 per spread. The premium paid would be the maximum risk on the trade, with a potential profit of $15,000 minus the premium paid if July Silver is trading above 23.00 at option expiration in late June.
Technicals
Looking at a daily continuation chart for Silver going back to 1970, we really notice the price that occurred back in 1979 and 1980. Even though we are still in the midst of a bullish run, we have not yet approached the highs seen back in 2008, when the commodity bull market was at its peak. During that time, front-month Silver futures did not trade above 21.00 and, in fact, formed a double-top formation, which triggered a price correction down to the 16.00 level. Silver prices have not been above 21.00 since late in 1980, and if we are able to move above this major resistance level, the possibility for increased buying by trend-following systems traders has the potential to spark a sharp run-up to the 25.00 area. Support is seen near the recent lows just above the 17.00 area.
Mike Zarembski, Senior Commodity Analyst
