Trading in silver has been extremely volatile, with the metal currently hugging the 100-day moving average at around $35/ounce. With such a steep selloff but still bullish fundamentals, the question of when to get back in on the long side is looming large in many commodity investors’ minds. We believe the time may be nearing for a number of reasons.
The following chart shows the price of silver on top with the aggregate open interest on silver futures on bottom.
[Click all to enlarge]
The aggregate open interest on silver futures is an interesting metric because it tracks the general interest level in the market, as well as shows the type of buying and selling occurring. For example, if open interest takes a big dive as price declines, this means that longs are liquidating their positions. On the contrary side, if open interest increases as price declines, this could mean that short sellers are driving the price down.
As can be seen, the notable valleys in open interest for silver over the past year coincide well with major bottoms. The first occurred in July 2010, almost exactly as silver began its historic run and broke $20/ounce. The next major bottom in open interest occurred during the January precious metals selloff. The last bottom in open interest is currently occurring, with open interest down 21% since the peak of silver’s run. Of course with open interest still at 120,000 contracts, it could always go lower, but it does appear that a bottom may be forming.
Such a finding would seem to be supported by the Managed Money net long position. Managed Money net longs on silver are in the 32nd percentile of readings going back to 2007. Such a low net long position would seem to indicate that sentiment has taken a bearish turn, and could see renewed strength with only a small recommitment of Managed Money longs.
The below chart shows the price of silver with the blue dashed line connecting the August 2010 low with the January 2011 low.
The long-term uptrend in the price of silver has not been broken. Rather than a “bubble bursting” scenario, this indicates a reversion to mean, as silver had obviously gotten way ahead of itself. The bullish fundamentals driving the precious metals rally are still in place, and are only going to become louder as time goes on. However, volatility in silver is probably here to stay, as the market has received an outsized amount of attention compared to its size, and will most likely be in the spotlight for some time to come.
Trade Recommendation
As silver appears to be bottoming, we recommend a bullish position in silver in a number of ways. The most aggressive position would be to purchase silver futures in the $30-32/ounce range. While the recent volatility may be over, we suspect that we may see a retest of the $30 level before this correction runs its course. However, in case the worst is already behind us, a more conservative stance taken simultaneously could also be profitable.
We would also recommend selling the September 30 put for 1.672. Such a position would be profitable as long as silver is above 28.328 on August 25, 2011. We view the $30/ounce mark as a hard floor on silver prices going forward due to the ongoing bullish fundamentals for precious metals, as well as the presence of the 200-day moving average around the $30 mark. While selling this put option would not be as profitable in a silver rally as an outright long position, it does offer a significant downside margin before incurring losses.
Disclosure: I am long SLW.
Additional disclosure: Long silver futures
No comments:
Post a Comment