3 Key Takeaways
- The Silver market is significantly larger but possibly more vulnerable than GameStop
- Physical delivery in gold/silver increased dramatically after the COVID Lockdowns
- No one has any idea where prices are headed, but the recent activity may be bad for silver
What is Happening?
As everyone knows, a massive short squeeze in GameStop began unfolding recently that has been the topic of conversation everywhere. Last Wednesday, the same group on Reddit started a similar thread on the Silver market that has sent prices higher. Although many of the posts have now been deleted, a separate Reddit group has branched off to keep the momentum going. I imagine many articles will be covering the story, but as someone who has followed the gold and silver market for years, I wanted to offer some perspective.
I am incredibly bullish on precious metals in general. With the government spending like crazy, and the Fed printing money very aggressively, I think the fundamentals are fantastic. I have written a previous article on the US Debt problem and even built a full dashboard to track the debt and gold/silver market dynamics. I have been even more bullish on Silver over Gold because of its use as an industrial metal, especially for things like solar panels. With the Biden administration pushing for more green energy, the fundamentals look even better.
What does the data show?
Every night I scrape data from the Comex to track the Gold and Silver market. Without getting too technical, the Comex is where Gold and Silver futures trade and settle. A futures contract allows you to lock in a price for a specific commodity. When the contract nears expiration, the holder has the option to settle in cash or take physical delivery of the commodity.
For anyone paying attention last year, this is how the oil market blew up and went negative. Oil is very hard to store and when all the ports filled up, no one had anywhere to put all the oil. People were being forced to take delivery. To avoid taking delivery, people payed to get rid of their oil contracts, sending prices negative.
For years, people have been predicting that the opposite could happen in gold and silver. Essentially that more investors will stop rolling futures contract and will actually take physical delivery of the gold and silver. Being much easier to store, taking physical delivery is not as big an issue. More importantly, this would then require the seller of the contract to deliver physical metal.
As someone personally invested in precious metals, combined with my nerdy interest in data, I decided to start pulling the data myself. The Comex publishes data every night that shows how many contracts are open (known as open interest) and how many contracts are standing for delivery. By capturing this data and looking at long trends a picture has emerged.
During March of 2020 when the financial markets went crazy because of COVID lockdowns, so did the metals market. The spot price of metals disconnected from the futures price because no one could get physical metal from vaults in London to New York. I personally think this woke people up to the risk of not having physical metals. When you have a contract there is counterparty risk if the other side cannot deliver the commodity. Thus, since last year, the amount of deliveries on the Comex has sky rocketed. For Gold and Silver the dollar amount delivered went from $8.9B/$2.75B in 2019 to $45b/$6Bin 2020! Essentially up 5 fold and 2 fold. From 2017 and 2018 levels the move is even greater.
Figure 1: Gold and Silver notional Delivery
This means that instead of rolling contracts, more people are standing for delivery. Has this stressed supply? It is no secret that the futures market for precious metals is larger than the physical market. Based on Comex data, there are about 2.5 paper ounces per ounce of eligible physical gold (52m paper vs 19m eligible), and 3.3 for Silver (850M paper vs 248M eligible). For Gold this means that if everyone requested delivery, only 2 in 5 people could get physical and the rest would be settled in cash.
Compared to other derivative products, this is actually not a large leverage ratio, especially when you consider that a small percentage of people actually request delivery each month. Even based on the large 2020 delivery numbers, the Comex has about a year of metal supply. As can be seen in the chart below, they responded very quickly to the sudden increase in delivery requests over the past year.
Figure 2: Registered and Eligible Gold Stock on Comex
Two important things to note. First, most gold/silver bugs argue that the Comex has not been audited for years and these numbers are not reliable. They make the case that most of this metal has been leased out and is in the hands of other people who may not return the metal when called. As delivery requests increase, the Comex will need to source the metal from the market rather than their own vaults. I personally trust the data. Second, assuming the data from Comex is reliable, this big accumulation at the Comex took physical supply out of the market. There is only so much metal to go around, so this could pressure the market if delivery rates continue as they have been regardless.
With so much delivery occurring, why have prices not been rising? Well first, they have, silver was up better than 47% last year and gold was up almost 25%. But those price moves do not justify the MASSIVE increase in physical demand that occurred in 2020. The second piece of the puzzle is that more players have been going short. They don’t have the physical, but by flooding the market with paper supply (contracts), you can still contain the price. In this case, “they” appears to be the big bullion banks who might have to deliver all this metal. They currently sit about $9B short based on the latest COTS data (pink and green bars below). Most would argue that the banks have all that metal and are short as a hedge, but others would argue they do not have the metal causing them to buy in the market if demand increases.
Figure 3: Net Short and Long positions
Okay, taking a step back, so physical demand has been through the roof, but prices have only moved up some because of the paper market. That means the physical market is thinner than it was a year ago. Last week, when the Reddit post hit, at first people piled into SLV (an ETF that tracks the price of Silver). The prospectus indicates they own all the physical but many claim they lease it out and don’t have it on site. Again, I don’t like conspiracies so I believe they own it, but maybe that theory will be tested. The price of Silver moved up some last week, but nothing major for average Silver price moves.
Over the weekend, the Reddit group changed the focus to the physical market and bid up EVERY ounce of silver they could find on different sites like JM Bullion. Supply was decimated and everyone started trying to hedge their position when markets opened on 1/31/2021 at 6PM. Simple supply and demand states the prices will rise, and thus Silver was up better than 7%. Certainly nothing compared to GameStop rising +1,000%, but we are talking about a trillion dollar market!
With everything going on, I almost missed the most interesting chart. February is typically a very small month for Silver delivery, with bigger contracts in March, May, July, September, and December. Gold is a decent sized month. Below is the way contracts roll as it nears expiration. This happens in every month going back in history. Contracts start high, drift lower, and then plummet right before as the contracts cash settle instead of stand for delivery. Again, this trend has changed as the charts above show.
Figure 4: February Gold contracts rolling towards expiration
The Silver market for this February, had the opposite happen. Contracts started creeping up at least a week before the Reddit post. I have never seen this happen. It is very important to note that this is still a small month relatively speaking. Big delivery months for Silver are around 10,000 contracts and Feb might net 2,000. The Reddit post occurred about 2 days before 0 which caused the final spike up. The spike down after 0 are all the contracts that have now stood for delivery, more will come as the month continues.
Figure 5: February Siver contracts rolling towards expiration
As of now, the March data looks fairly normal. It has almost 135k contracts open (about $17 Billion notional). I will be watching this closely as it becomes time to roll because more people could stand for delivery due to depleted bullion supplies thanks to the Reddit community. If this happens, this could put more pressure on physical supplies and drive prices.
The bottom line
Physical metals have been delivered at a historic rate for at least 12 months. This is not a conspiracy, this is data published by the Comex that they make freely available. A conspiracy would be to speculate on who it is and why: China/Russia, Hedge Funds, the bullion banks trying to cover their short? Honestly, I don’t really care and I try to avoid speculation. I focus on the data. If deliveries continue at the same rate they have been, the physical market will get thinner.
Leading up to the Reddit post, someone was quietly accumulating Silver contracts for February, diverging from history. All of these contracts are standing for delivery. Who/why? Again, I don’t know. Maybe someone saw what happened in GameStop and thought they could use the WallStreetBets crowd to their advantage. Regardless, of who it is, it seems to be working. Considering the size of contracts being opened, it does not look like a large player with a notional value only totaling $130M.
I don’t have any advice to offer. It’s entirely possible the futures traders get this market under control and force the price back down. The Comex could also increase margin requirements forcing long contracts to liquidate, putting pressure on prices. This happened in the famous Hunt Brother Silver squeeze in the 1980s. Furthermore, the hot money coming from Reddit can leave in a moment, this could crash the price of Silver and actually hurt the technical picture. This possibly means Silver finishes the year lower because of the mania, despite great fundamentals.
All that being said, in my honest opinion, this is the start and we are in the very early innings. I track all this data because I believe that physical supply is being removed slowly. Eventually more people will want to turn their paper into physical metal and eliminate the counterparty risk. This could snowball as people try to source physical metal. I think there is a compelling case for owning precious metals in this environment that the Reddit crowd is supporting. If they have staying power, I would imagine that at some point the gold market could see similar pressure. If this were to happen, it could create a short squeeze as counterparties are forced to deliver more physical metal. It only comes out of the ground so fast.
With all that being said, this is NOT GameStop (Silver won’t go to $0 or be up 1,000%). Forgetting the fact that commodities and stocks are dramatically different, you are talking about a few billion dollar small cap stock versus the Silver and Gold market which run in the trillions of dollars. A few gun slinger Wall Street bros are not going to roil this market. Also, no one really cares if a few Hedge Funds go out of business because of a short squeeze on GameStop. If precious metals start going up, countries and central banks around the world will be watching very closely. I think there are players that have been strongly accumulating metals for the past year, and this Reddit article is a distraction from the bigger picture. Most likely these people do not want prices to skyrocket, hence the slow accumulation.
I wrote this because I am sure stories will be published in the coming days and weeks and I wanted to provide a slightly different perspective from someone who literally tracks this data every single day. This may seem like something small that started last week. The data shows it could be bigger than that as someone has been stockpiling metal for at least a year. Maybe the markets normalize in the next week or two, or even drop sharply if the Reddit crowd gets distracted with something else. I have absolutely no idea and no one else does, but I will be watching very closely! I hope you found this helpful.
Note: This is absolutely NOT financial advice. I do have positions in both gold and silver as well as the miners
Disclosure: The content herein is my own opinion and should not be considered financial
advice or recommendations. I am not receiving compensation for any materials produced.
I have no business relationship with any companies mentioned.