Speculative silver holdings down to core low – time to buy or sell?

Speculative holdings of silver have fallen dramatically, opening the path for a rally- but if ever there was a candidate for Caveat Emptor, it is this metal.

LONDON - 

The latest figures from the Commodity Futures Trading Commission show that the net speculative long position on COMEX stood, at the end of August, at just 4,196 tonnes. Silver was trading, at that point, at between $11.80 and $12.00. This net speculative position is at its lowest level since the end of April 2003, when silver was about to embark on its four-year bull run. So does this mean that prices are poised to move higher?

On the plus side, there is evidence that silver demand is picking up in India, which has, on average over the past six years, accounted for 12% of global fabrication, while Japanese investors are again showing some interest and dealers are also reporting increased uptake in China and the rest of East Asia. The fact that the gold:silver ratio has moved out in recent weeks to levels not seen since the middle of last year, when gold was at $640 and silver at $10.50, has not gone unnoticed and this has helped to encourage silver purchases in India, which, generally speaking is the major marketplace that takes notice of the ratio (the other being COMEX). There are also signs of industrial buying interest in the market once more, although the price at which buyers are prepared to look for the metal has now dropped towards $12, having been as high as $13 earlier this year.

On the negative side, there is little inclination on the part of these consumers, at the moment at any rate, to pay any price for the metal and the fact that so much supply is price-inelastic also plays an important part.

Primary silver mine production (as opposed to supply as a by-product or co-product from lead-zinc, copper or gold mines) amounted to just 25% of total silver mine production in 2006, at a cash cost of just $2.51/ounce (all figures from GFMS Ltd).

When industrial scrap supply and government sales are added into the equation, primary silver mine supply, the only source to which an accurate production cost can be ascribed, amounted to just 18% of total silver supplies into the market last year. If there is a clearing price for silver, therefore, it lies in the hands of the consumer rather than any price-driven threat to primary supply.

It is important to remember, also, that COMEX is a centrally cleared Exchange and by definition for every short there must be a long. The "commercial" users of the Exchange are, therefore, as "short" as the speculators are "long". This largely reflects commercial consumers hedging their price risk, or managing inventory. The current level of physical metal held in COMEX warehouses stands at 4,105 tonnes, an increase of 650 tonnes since the start of the year.

The recent tumble in prices stemmed primarily from investor and speculator liquidation followed by fresh short sales, some of them technically induced, and consumers were happy to stand back and let the market be offered down before coming in to absorb the sales. As a result the price fell, during the commodities sell-off in the middle of August, by 14% in the space of two trading days.

This brings us back to the position of the speculators and a necessary word of warning.. The net speculative long on COMEX comprises outright longs of 8,340 tonnes, partially offset by shorts of 4,144 tonnes. The outright long is at its lowest since mid-October last year (silver trading at $11.55, and the short is at its highest since April 2006 (silver trading at $12.17, much the same as at current levels. In the two weeks following that date in April, silver spiked up to $14.90.

This was a rally induced by strength in the commodities overall and a run on gold's part to $715, and was driven by short covering. In theory, therefore, silver is capable of doing the same thing again.

It is also, however, equally capable of repeating the correction, which was violent, with prices falling to $12.15 in just one week. At present, while there is some retail support among private investors, professional speculators are nervous of the market and investors, if the iShares Exchange Traded Fund is anything to go by, are equally cautious; ETF holdings have declined slightly at the start of September and stand at 4,297 tonnes, an increase of just 528 tonnes in the year to date and compared with annual global industrial demand of approximately 28,500 tonnes.

In a period in which commodities as an asset class have been volatile, silver has traded in a 21% range since the start of August and a range of 36% over the past twelve months. Compare 4% and 29% respectively for platinum, and 3% and 23% for gold.

Lade Caroline Lamb once said of Lord Byron that he was "mad, bad and dangerous to know". She might equally have been thinking of silver.

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