Silver - is there a chance for rebound?

Summary:

• Plans from the beginning of the year point for output increase in the next year

• High production forecasts could be connected to higher price expectations

• Demand for silver from ETFs rises, demand from high tech to be crucial in the future

• Extremely low positioning on silver, strong US dollar

• Silver to gold price ratio on the lowest levels in several years

So far 2018 is not so good for precious metals. Prices of gold, silver or platinum were significantly higher at the beginning of the year. Among reasons one can name expectations of further interest rate increases in the US, stronger USD or continuously rising stock prices on Wall Street.

So what made silver prices drop even 15% YTD while gold traded just 8% at its worst this year? Spare for the investment preferences and somewhat different demand structure it is worth to look at the supply side. Deficit has been present on the silver market for couple of years what in theory should lead to higher prices.

Despite several years of deficit silver prices fail to move higher on the back of lacklustre investment demand. Source: Silver Institute

Silver in comparison to other precious metals could be hurt by increased expectations of output during this and next year. The last year saw the lowest deficit in many years but the expected rise in production was negative for silver. Nevertheless, if the investment demand does not rebound while the demand coming from photovoltaics remains subdued one cannot count on any brisk rise in prices.

Both primary and secondary silver production rises. Source: Bloomberg

It should be noted that silver production costs are in majority of cases really low. It results from the fact that silver is mostly extracted as a side product when mining other metals. Because of that silver is often produced at cost.

Cost of producing one ounce of silver ranges from 10 to 12 USD per ounce. However, some companies report a “negative” cost of silver production. Source: Bloomberg

Nevertheless, it should be mentioned that significant rise in expected production is mostly connected to primary production. According to price estimates of silver producing companies we can assume that production plans may change. Miners expected prices of 17 to 19 USD during this and the next year while they are slightly above 14 USD per ounce at press time. There is a possibility that new investment projects will not be worth conducting under such low prices.

Primary silver producers expected much higher prices. Source: Bloomberg

Silver does not look as the best trading idea right now but it should be noted that investors’ sentiment is negative what can be viewed as contrarian signal. Net speculative positioning is at its lowest level in history but ETFs increased their holdings quite significantly in comparison to previous year.

While the amount of long positions remained quite stable the amounts of shorts increased significantly as of late. Source: Bloomberg

Silver ETF holdings were constantly rising since the end of 2017. Interestingly, there is a negative correlation between silver prices and silver ETF holdings. Source: Bloomberg

It should also be noted that ratio of silver prices to gold prices is at very low levels. Ratio reached extreme low level that was seen just a few times in the previous years what suggests that a rebound of silver prices in relation to gold prices may be looming.

Ratio of silver prices to gold prices (inverted gold/silver ratio axis on the chart above) broke to the extreme levels. Moreover, industrial metals index suggests that silver should be more expensive against gold. Source: Bloomberg

Even before the latest Fed meeting we experienced significant divergence between gold and silver price movements in the short term. Interestingly, silver price did not react to latest slump on the gold market. Nevertheless, gold price increases should be followed by silver. In our opinion there is a chance for the weakening of the US dollar in the short term what should support silver prices with a possibility of further extension of this trend. We see potential in long position on silver at market price with a stop loss at 13.60 (below local lows) and the first target at 15.20. Local lows from 2017 and 2018 at 15.650 could serve as the second target. Source: xStation5