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Silver is a troubled metal. Stuck in a wide trading range since hitting $30.35 per ounce four years ago, silver is miles away from its all-time high of over $49 per ounce set by the futures market back in 2011. By contrast, gold futures traded to an all-time high of $2,152 per ounce as late as December 2023. Gold is within striking distance of this price as we write this. Has silver lost its luster? If not, why is it so far behind?
Reuters
Silver has a split personality: it is both an industrial and a precious metal. Silver trades like an industrial metal most of the time, driven more by commercial supply and demand factors than investment interest. Its reaction to Covid is a case in point. It acted like an industrial metal and declined sharply due to fears of an economic slowdown, then turned on a dime, becoming a precious metal in its hot pursuit of gold. The Fed’s rapid reduction in interest rates, meant to offset the economy-killing effects of Covid, didn’t hurt either.
Known colloquially as “the poor man’s gold,” silver benefits from its lower cost. Traders and speculators priced out of the gold market flock to silver in precious metal bull markets, driving up volatility and price. The silver market is not as liquid as the gold market, making sudden increases in investment demand responsible for outsized effects. Because of this, silver has a history of outperforming in precious metal bull markets and underperforming in bear markets.
Silver shines when the focus on it shifts to speculation and it becomes a financial metal. As the chart above illustrates, this can happen overnight, often spurred by breakout of its yellow cousin, gold. Silver’s split personality helps to explain its current 4-year trading range, where it is alternately rising and falling based on which identity the market prefers to focus on. We believe silver’s recent period of underperformance vis-a-vis gold may be ending soon. This is due to a number of factors, starting with interest rates.
High Interest Rates Hurt Silver More than Gold
Holding physical silver has a built-in opportunity cost. Silver pays no interest. So the amount of interest a holder can make in risk-free investments like CDs or government securities is lost opportunity. These opportunity costs climb as interest rates rise. An investor holding $100,000 in silver forgoes approximately $5,500 he or she could make by purchasing a 12-month FDIC-backed CD currently yielding 5.5%. (Source: Bankrate: Guiding you through life’s financial journey) This doesn’t include other actual costs of owning physical silver like shipping, storage, dealer markup and insurance.
The same holds true for gold. However, there are extremely liquid proxies to physical gold, such as ETFs and mining stocks. Some gold stocks even pay dividends. Alternatives exist for silver too, but like the metal itself, are not as liquid. Gold is cheaper to ship and store than an equivalent dollar value of silver due to its sharply higher price per ounce. Gold nearly always trades like a financial metal. It is also the beneficiary of central bank demand. This discourages individual investors from making big investments in silver, especially when high interest rates impose a large opportunity cost upfront.
Currently at 3.4%, inflation is down sharply from its high of 9%, putting Jerome Powell and Company on a glide path towards their 2% target. Some analysts are predicting inflation will drop to 2% by the end of the year. February’s Fed meeting may have disappointed those who expected rate cuts as soon as March, but it did confirm the next move will likely be a cut. We believe silver will be far more attractive once the market perceives the Fed is serious about reducing interest rates – and begins reducing them.
Gold, War, and a Potentially Contested US Election
Why look at silver if gold is the metal making new highs? Because silver has a long history of catching up and outperforming gold in bona fide bull markets. For this to happen, the yellow metal needs to make a sustained move above its December high of $2,152 per ounce. There is also a very real possibility that one or both of wars in Ukraine and Gaza spin out of control and become regional. Houthi attacks on shipping have already re-routed cargo the long way around Africa. A major escalation in either conflict could ignite a global flight-to-safety push that would likely benefit gold, silver and US Government debt like T-notes and bonds. The latter would cause longer term interest rates to drop, ultimately lowering the opportunity cost of holding metals in the process.
America’s presidential election in early November is also a potential wildcard. The country is sharply divided and extremely mistrustful of the other side. The election is close. A narrow victory by either candidate runs the risk of being rejected by the opposition as illegitimate. Protests, massive demonstrations and even violence are possible. It hurts us to even imagine this possibility, but the potential is real given the current environment. We expect gold and silver to do well as flight-to-safety alternatives if there is trouble this fall.
2024 Price Target is $30 Per Ounce
Our 2024 price target for silver is the top of its 4-year trading range at $30 per ounce. An extended breakout above this range could set the stage for a run to $40 per ounce. We’ll address that should a breakout occur. Multiple closes below $17.50 per ounce will negate our bullish outlook.
Reuters/Datastream
Use COMEX Call Options to “Rent” Silver for Pennies-on-the Dollar
This strategy is designed to give our customers upside exposure to silver for a lower cost and risk than purchasing the metal outright – while freeing up capital to generate a return elsewhere. Our strategy also insulates holders from the type of volatility that forced many bulls out of the post-Covid silver market where prices fell hard before taking off in pursuit of gold. (See chart on Page 1.)
We’ll use 5,000-ounce COMEX silver options to create our “pennies on the dollar” strategy. Each option covers 5,000 ounces of silver, making each $1.00 per ounce move worth $5,000 and each 1-cent per ounce move worth $50. Buyers of silver call options pay money, known as a “premium,” for the right but not the obligation to be long silver futures at a specific price for a specific period.
Call option buyers do not buy the market; they merely buy the right but not the obligation to be long that market. The key phrase is “but not the obligation.” Should silver decline or fail to rally before the option expires, the option buyer will simply not exercise the right to buy the futures contract. All a silver call option buyer risks is the premium paid, plus any transaction costs.
Silver call option sellers receive money in exchange for the obligation to sell silver futures at a specific price for a certain timeframe. Notice how this definition is the exact opposite of call option buyers. Think of it this way: if you are an employer, you pay money to your employees. This gives you the right to tell them what to do. As an employee, you receive money from your employer, obligating you to do what your employer tells you. Options work the same way.
Combine Long and Short Positions to Reduce Risk
We can lower the cost and risk of our bullish position by combining long silver options with short silver options. Our upside target for silver is $30.00 per ounce. We want to position ourselves to capitalize on a breakout over silver’s key resistance level of $26.43 per ounce without a lot of undue risk.
One way we can do this is by purchasing December 2024 Comex Silver call options with a strike price of $27.00 per ounce, while simultaneously selling an equal number of December 2024 Comex silver call options with a strike price of $30.00 per ounce. This “bull call spread” pairs the right to buy 5,000 ounces of silver at $27 per ounce with the obligation to sell 5,000 ounces of silver at $30 per ounce.
This spread costs $1,750 on the close of February 6, 2024 when spot silver was trading for $22.40 per ounce. Compare this to the roughly $112,500 it would have cost to buy 5,000 ounces of silver outright. December 2024 COMEX silver options expire on November 25, 2024. This gives us time for the trade to work, keeping us long through the American election. Should silver fail to trade above $27.00 per ounce on this date, we will lose the entire amount we paid for this spread plus any transaction cost, but no more.
Selling the $30.00 call obligates us to sell silver at $30.00 per ounce, so we cannot participate in any rally above this level. This means the most our bull call spread will be worth is the $3.00 per ounce difference between the two strike prices. Multiply this times the 5,000-ounce contract size, and you get $15,000 – not a bad outcome given our $1,750 (plus transaction cost) risk.
Take Advantage of High Rates and Create Your Own “Silver-Backed” CD
Yields on T-bills and CDs have soared. This makes it possible for silver buyers to lower risk by creating their own “silver-backed” CD. Combine the bull spread strategy above with the purchase of a one-year CD and use the interest to fully offset the cost of your bull spreads.
Comex 5000 oz. spot silver futures are trading for $22.40 per ounce as we write this, making each contract worth $112,500. Instead of buying 5,000 ounces of silver bullion or a futures contract, you could purchase a 12-month, FDIC-insured CD. (A quick search of www.bankrate.com lists numerous 4 and 5-star, FDIC-insured CDs with an APYs of 5.50% or higher.)
Subtract the $1,750 cost of our bull call spread from the $112,500 cost of 5,000 ounces of silver and use the $110,750 difference to buy a CD yielding 5.50%. Simple interest on your CD works out to roughly $6,090. This more than covers the $1,750 cost of a bull call spread. You get both the benefits of today’s higher rates and upside exposure to the silver market.
This material has been prepared by a sales or trading employee or agent of R.J. O’Brien & Associates (“RJO”)/RMB Group and is, or is in the nature of, a solicitation. This material is not a research report prepared by a Research Department. By accepting this communication, you agree that you are an experienced user of the futures markets, capable of making independent trading decisions, and agree that you are not, and will not, rely solely on this communication in making trading decisions.
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