There is probably no more frustrating market to trade than silver. The poor man’s gold has a nasty habit of breaking all the rules. It refuses to rally when all indicators seem to point upward, runs protective stops on both the upside and downside, and then reverses mightily, crushing traditional technical traders in the process. Silver is mean. Silver is cruel. Silver is cheap.
Stuck in a seemingly endless sideways pattern since 2014, silver has been oscillating between support at roughly $14.00 per ounce and resistance at $21.00 per ounce. The last two years have been frustrating for the bulls; we expect the coming months to be equally frustrating for the bears. Despite being unloved and extremely oversold, we would not rule out the market taking one final run at the stops under eight-year lows at $13.63. This would clean out the last of the stalwart bulls and set up an extraordinary buying opportunity should it occur.
Data Source: Reuters
Silver is Extremely Cheap Versus Gold
Silver is not only cheap on a historical basis, it is also inexpensive when compared with its richer cousin, gold. Gold is roughly 15 times rarer than silver. Back when both were considered money, this ratio didn’t stray far. It took 15 to 20 ounces of silver to buy one ounce of gold. This relationship ended when President Nixon pulled the US out of the Bretton Woods Agreement, severing gold’s connection to the US dollar. Since then, it has taken anywhere from 27 to 98 ounces of silver to buy one ounce of gold.
Silver is more volatile than its richer cousin, rising far faster in bull markets and declining much more in bear markets. Because of this, the gold / silver ratio tends to be inversely correlated to the over-trend in precious metals. It peaks at the bottom of precious metal bear markets and bottoms at the peak of bull markets.
Date Source: FutureSource
Today’s ratio of 84.78 ounces of silver to buy 1 ounce of gold is the highest since early 1991. Then silver traded as low as $3.50 per ounce and the gold/silver ratio soared as high as 97.80. Not only is silver extremely over-extended to the downside on an absolute basis, it is over-extended vis-à-vis its historical relationship to gold. While cheapness is never a sole reason to buy anything, we believe silver is due for a bounce for other reasons too. Let’s look at some of the factors that make silver so cheap.
Why Silver Is So Cheap
It starts with higher interest rates in the US. Higher rates increase the opportunity cost of holding physical silver and gold which earn no interest. Higher interest rates in the US also help increase the strength of the US dollar. Capital will chase the highest returns and, for now at least, American interest rates are among the highest in the developed word. Investors need dollars to buy US Treasury debt.
A stronger American currency means it takes fewer dollars to buy a fixed amount of silver. Silver may have declined versus the dollar – but it has soared in Turkish lira, Russian rubles, Iranian rials and Argentine pesos as those currencies have collapsed due to financial mismanagement, US sanctions, or a combination of both. Add in an attractive bull market in American stocks, and it’s easy to see why the poor man’s gold gets no respect. However, many of the factors behind silver’s malaise are showing signs of change. Let’s start with the US dollar.
Data Source: Reuters
You wouldn’t know it by reading the financial press, but the US dollar has gone virtually nowhere since negating its uptrend at the start of 2017. The Federal Reserve has raised interest rates numerous times since then while Europe has kept theirs at a negative yield. One would have guessed that the increasing American interest rate advantage would have sent the mighty greenback rocketing higher. But that hasn’t happened. The big, bad buck has actually weakened again a basket of the world’s major currencies.
What is holding it back? Is it the Trump Administration’s stated preference for a lower dollar? The political uncertainty arising from the same administration? Is it the recent announcement by Mario Draghi and the European Central Bank that the ECB will taper their bond-buying Quantitative (QE) operations? Or is it something else altogether?
The Federal Reserve has signaled it would raise rates to 2.5 percent in 2018, 3.0 percent in 2019, and 3.5 percent in 2020. This represents a massive and widening premium to Europe’s currently negative risk-free rates of return. The US dollar should be soaring in this environment, but it isn’t. Something is not right. So why not just sell the dollar? Because we believe silver is far cheaper than the dollar is expensive.
Tariffs = Slower Economy & Faster Inflation
Then there’s inflation. Don’t look now, but inflation is showing signs of returning. Core inflation has hit the Fed’s 2% target and is poised to climb higher due to a tight labor market and its inflationary effects. Chartists will recognize the bullish “reverse head and shoulders” formation developing in the chart of core inflation (below).
Because they are essentially a tax on production, tariffs increase the prices consumers pay for goods. More expensive Chinese imports enable domestic producers to charge more. Prices go up for everyone. Cheap imported goods have enabled lower-wage workers to make a living. Expensive goods mean these same workers will either not buy as much – slowing the economy – or demand higher wages, fueling even more inflation. A whole generation of Americans has never experienced full-fledged price inflation. Neither has silver – at least since the 1990s. Silver could get interesting in a hurry if inflation continues to climb.
Are rising prices “just what the doctor ordered” as far as the Fed is concerned? Or should Jerome Powell and Company be “more careful about what they wish for?” It is still too early to tell. Meanwhile, RMB Group trading customers may want to dip into the bargain bin and pick up a little silver on the cheap. Our target is a move back to the top of silver’s “never-ending trading range” sometime next year. Keep some powder dry and get ready to add to your position should silver get “nasty” and run the sell stops below $13.63.
What to Do Now
RMB Group trading customers may want to consider buying COMEX December 2019 silver $18.00 / $21.00 bull call spreads for $900 or less. We are looking for the December 2019 silver futures to test the top end of silver’s 6-year trading range prior to option expiration on November 25, 2019. Your maximum risk is $900 plus transaction costs. Your spread has the potential to be worth as much as $15,000 should silver hit our $21 objective on or prior to option expiration.
Some patience may be required as spreads are currently trading higher than our suggested entry level. Contact your personal RMB Group broker for the latest pricing and a full explanation of this strategy. He or she can also help you create similar strategies in line with your risk tolerance needs.
Please be advised that you need a futures account to trade the recommendations in this report. The RMB Group has been helping its clientele trade futures and options since 1984 and are very familiar with all kinds of option strategies. Call us toll-free at 800-345-7026 or 312-373-4970 (direct) to for more information and/or to open a trading account. You can also visit our website at www.rmbgroup.com.
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The RMB Group
222 South Riverside Plaza, Suite 1200, Chicago, IL 60606
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