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Author Topic: What is Going on with Silver? (Jan 24, 2011)  (Read 924 times)
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Capitalist Pig
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« on: 2011 Jan 24, 08:20:48 pm »

A little while ago, I posted a chart and commentary saying that silver had broken a key support trendline.

Before we go to the charts, let's examine the fundamental drivers of silver (and any other commodity) prices.  Essentially, there are 4 factors: supply, demand, hope, and fear.

In terms of supply, numbers are only available with a time-lag. But we can be fairly sure that supply hasn't changed that dramatically over the last few months.

Demand, however, is way up. There are reports every other day of this distributor or that one running out of silver bars, rounds, and coins. In addition, the futures contracts are in backwardation. As you can read in this previous post, that usually means that there is heavy demand to leave paper assets and get into physical assets.

Hope and fear are in plentiful abundance as well. Retail silver buyers simultaneously hope and fear that the continuous increase in the dollars from the Fed and the banking system will cause prices to shoot to the moon.

Let's look at the action in the charts.  Previously, I posted this one:

Now, a couple weeks later we have this:

As you can see, the first level of support has been breached, and things are looking like they are headed down.

So, have any of those fundamental drivers changed over the last month? In a word, no.

Then what is to explain this drop in the price of silver? Well, from what I can tell, there are 3 issues. One is that the exchange where most of the silver contracts are traded, the COMEX, has raised the margin requirements on silver (and gold and a few others). When margin requirements are raised, then the institutional traders have to come up with more money per contract. For a given amount of money, that means you can buy fewer contracts. This means less buying in the paper markets. The second factor is the backwardation I mentioned. This pattern usually means traders are dropping paper in favor of the real asset. This makes sense if the trader believes that the paper market doesn't reflect reality in some way. The third factor is that the CFTC has grandfathered in JP Morgan (JPM) as exepmt from position limits. You may recall that there was a lot of hoopla over JPM having naked short positions in the silver market. Essentially, this boils down to the fact that JPM was selling into the market without having the assets to back it up. More selling, lower price. The CFTC has creating position size limits that puts a cap on how much any one trader/institution can have - except for JPM.

Put these 3 things together: JPM can sell with impugnity, more money is required to enter a position, and traders are dropping paper in favor of metal. What do you get? You get the beginning of a decoupling of spot paper markets and hard asset markets. It means that the markets are beginning to believe that the paper silver market is being manipulated and does not reflect the true supply and demand.

The take away action is that these few months of low silver prices will be a buying opportunity for hard metal. Eventually, when paper silver is trading for $25/ounce, but you can't actually buy any for less than $35/ounce (pulled these numbers out of the air, btw), the paper markets will respond and close the gap. But until then, you can take advantage of the arbitrage opportunity!

Happy trading!

* 2011 01 24 - Silver.jpg (46.31 KB, 900x401 - viewed 262 times.)
« Last Edit: 2011 Jan 24, 10:10:56 pm by tamo42 » Logged

Neal McSpadden
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