Short Squeeze in Silver

Last week the price of silver broke its 30-year top. The white bullion market is tight, and the short squeeze in the futures market is exerting a constant upward pressure on the price. If current trends persist, the all-time high of $49.45/ounce will be reached in the near future.

Silver is performing exceptionally, outstripping a vast array of commodities and stocks. Even unrest in the Middle East has not stopped the price increasing, whereas during similar circumstances in the past, silver would have taken some serious blows.

As far as silver is concerned, we are living in exceptional times. Supply shortages have existed since the Fifties, but this deficit was traditionally eliminated with the (once strategic) reserves of central banks and other financial institutions, who wanted to get rid of their silver due to its lack of monetary use. Consequently, bank supplies have fallen rapidly. Today, the shortage on the silver market is mainly supplemented by recycling used silver, aka 'scrap'.

Nick Laird of ShareLynx, who supplied the chart below, gave the following explanation in a recent MoneyWeek interview: "Since 1950, the demand for silver increased up to 925,000 tonnes, while the production only amounted to 570,000 tonnes. This equals a silver production deficit of 16 years!"

Continuous increases in demand for silver means producers can barely keep track with demand, particularly now from the investment community. Recently, Eric Sprott of Sprott Asset Management reported exceptional delays on deliveries of physical ingots, and national mints are pointing at shortages, in part owing to the gigantic increase in demand for coins. The US Mint recorded selling 4.6 million Silver Eagles in January 2011 - a one-month record - while the website King World News recently reported shortages at the Royal Canadian Mint, producers of the popular Maple Leaf.

Futures markets are becoming increasingly important in the commodity pricing and silver is no exception; indeed, trends in silver futures are largely responsible for the price rise over the past few months. This is due to the gigantic short positions retained by some major (American) banks. The four largest traders are short an impressive 104 days of global silver production on the COMEX. The eight largest traders are short for almost 140 days of silver production. Herewith, silver is the highest in advance sold metal within the entire commodities complex.

The largest short position is held by JP Morgan. JPM's short position was vastly increased by its acquisition of the bankrupt Bear Stearns in 2008, which prior to bankruptcy held an impressive commodity-trading desk.

Because of the negative press surrounding several banks trading on their own accounts, JP Morgan decided to shut down its proprietary trading department at the end of August 2010. JPM's "prop desk" was one of the largest active short players on the silver futures market. It is no accident that the price has risen dramatically since then.

In technical terms this is called a short squeeze, whereby the upward price spiral - caused by the settlement (or resale) of short contracts - ensures that more and more shorts have to cover: the snowball effect. Nobody can tell when a short squeeze will end. It is a phenomenon that usually originates from a small inducement and could end as suddenly as it began. They can last just a couple of days, or a couple of months or even years.

Given the still gigantic short positions on the silver futures market, this short squeeze could persist for some time. Increasing price volatility as the squeeze continues is likely. But the all-time high of just under $50 /ounce could, if the current pace of appreciation persists, be broken this year.

Nico Pantelis is a contributing author for GoldMoney.com and an independent certified investment adviser.

Copyright Gold Money (c) 2011. All rights reserved.

About the Author
Nico Pantelis

Nico Pantelis is a contributing author for GoldMoney.com and an independent certified investment adviser.

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