A few months ago, we pointed out that gold had formed a bullish pattern over the previous year known as the cup and handle. Scarcely a month after we published our article, gold had broken out of a multi-year resistance line to land in the $1400 range. While these technical formations do not always guarantee upside price movements, they have been shown to be quite accurate much of the time in various markets, including stocks.
Silver has been forming a similar cup and handle bullish pattern. But the silver pattern does not just cover the previous year. No, silver has been forming this pattern for the last 39 years. While short term technical patterns are often quite handy in predicting relatively modest price movements, these long term technical patterns are another matter. When a pattern forms over this period of time, it is telling the market that a methodical drumbeat of base support has been building for nearly two generations of traders. Or in other words, silver may be telling the market that it is about to begin a major bull market that will likely last for years.
To determine if the technical pattern is likely predicting a future rise in silver prices, we need to examine what is going on in the market for it using some fundamental analysis. Silver is a major input to many markets, including medical, photography, jewelry, solar, and a myriad of other technologies. The reality is that silver cannot be perfectly substituted by any amalgamation of other metals in today’s technology-dependent market. A good view of silver usage is provided in the following artifact which I created earlier this year:
Source: Silver’s Luster Outshine’s All
The amount of industrial use has caused many industry analysts to believe that immediately available, above-ground stockpiles have been waning, and a potential silver shortage could cause prices to rise sharply. Silver demand has outstripped silver supply for quite some time, according to reports from the Silver Institute.
Source: Silver Institute
Some of this demand is to meet investment purposes, but the majority is for jewelry and various forms of industrial use. We can view the existing, above-ground silver inventories using the following chart.
Source: Gold Charts R Us
It may seem as though the world would potentially have no problem supplying enough physical silver to the industrial market, given that almost a billion ounces are held by various parties. But getting that silver free is another matter.
Much of silver is in the hands of traders on COMEX to support the futures market. To release that silver, the record amount of open interest in the market for silver needs to be unwound and participants agree to settle their futures positions. In addition, funds like SLV hold silver to support shares issued to third parties. To release those stockpiles, those shares will need to be sold first.
Given that many parties are holding positions in funds and in futures to receive or hedge price exposure in silver means that it is highly unlikely all of those reserves will be released at the same time. That is, unless the silver market price picture changes substantially causing current positions to massively unwind. Let’s examine what that would look like.
Silver would be likely to rise first to encourage fund longs to sell, because the price of silver on the market today is trading below the costs of mining by the primary silver miners. Would longs sell en masse now when silver is trading at a cycle low? Unlikely! Those fund holdings are not likely to change much until silver rises first. The following chart shows silver mining cost still about $1 above the current price of $15.57 at time of this writing.
Source: Money Metals
Silver’s price is not likely to fall substantially enough to unwind the huge amount of short futures positions currently held. Unwinding the shorts would of course cause the price of silver to rise substantially in the process.
Given the industrial demand for silver rising, along with prices still below primary miner production costs, I do not see a strong case that silver will be falling substantially from its current price. Over the last few years, silver has fallen off recent highs resulting from the financial crisis. But fundamental silver market factors seem to back the current technical formation telling us that silver will rise substantially from current levels. Silver needs higher prices to bring the market into equilibrium, and free existing above-ground stores from the clutches of investors and hedgers. As well, higher prices will be needed to secure future production from the miners whose costs have overtaken the current market price, on average.
Silver shortages, as defined by less above-ground silver demanded by industry than can be immediately liquidated into the market, would be the first catalyst to cause silver price to continue it’s recent rise. Second, and perhaps much more importantly, silver needs a signal from gold that investment demand has returned. Gold’s recent break-out seems to have provided at least an early signal to the silver investors. How much gold rises in the near future likely determines how much additional investment demand for silver comes into the market.
So if you want to know where silver will trade, follow the general direction of the gold price until silver decides it wants to break out on its own.