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Traders’ Positioning Shows Preference for Silver vs Gold Price

Action in the metals market is heating up. Gold prices have broken down to fresh lows for the year over the last week while silver prices have remained well supported.

Silver did break to new yearly lows alongside gold but the white metal promptly reversed the breakdown, while the yellow metal sits near its lows. Gold and silver typically trade in tandem, to a large extent, and so the break in correlation is worthy of some attention. 

Traders are now questioning whether a fuller recovery in silver prices is possible over the remainder of the year, or if this is just a short-lived correction before the downtrend continues. Next, we consider the factors driving price action in silver currently and how they look set to develop going forward. 

Factors Affecting Silver Prices

  • Gold/silver ratio 
  • Institutional positioning 
  • US Dollar 

Gold/Silver Ratio Favours Silver Rally 

The first factor we can investigate is the shift in the ratio between gold and silver. The gold/silver ratio is a well-regarded market tool which looks at the relationship between gold and silver. The ratio tells traders how many ounces of silver it takes to purchase an ounce of gold. 

We can use the ratio to predict movements in the silver market. The key is to look for when the ratio moves to extremes either in the 80:1 – 100:1 range or the 1:1 – 20:1 range. When the ratio is at extremes, this is when a reversal is most likely to occur, although the ratio can remain at extremes for extended periods.

Looking at the ratio currently, the current reading is around 86, with the index reversing from highs at the end of August around the 96 mark. This current dynamic is bullish for silver as it shows that silver prices are rising against gold. So, if the ratio continues to weaken, this supports the view that silver prices will continue to rise in the near future. 

COT Report Shows Silver Longs Increasing 

The next factor we can consider is the movement in institutional positioning in the silver market. The CFTC COT report (which tracks institutional positioning adjustments) shows that non-commercial players have been building silver longs recently with the net position close to turning positive. 

Following a move down to lows around -13k contracts at the start of the year, silver positioning is now back up around -4K contracts suggesting a flip to net-bullish could be coming in the coming weeks. If this position continues to grow, we can expect silver prices to be supported. 

US Dollar Impact 

The final key element for the silver marker is the US Dollar. Silver prices typically fall as the Dollar strengthens due to each Dollar allowing for a larger purchase of silver. Similarly, when the Dollar weakens it takes a larger currency amount to purchase an ounce of silver. The rally in the US Dollar this year has been the largest headwind for silver prices.

Surging inflation in the US has seen the Federal Reserve having to raise rates aggressively this year in order to combat rising prices. With each rate hike this year the Fed has maintained its hawkish outlook while voicing its concern over inflation expectations. The impact of this has been that the bullish USD view has been reinforced steadily. 

Hawkish Fed Outlook 

At its latest rate meeting this week, the Fed hiked rates once again by a further 75bps and issued fresh guidance. Fed chairman Powell voiced his concern over inflation which the fed forecasts say is likely to stay at elevated levels for longer than expected. With this in mind, the central bank projects the need to continue pushing ahead with rate hikes next year. While the Fed noted that some of the issues in the supply chain had corrected themselves, there was little evidence that inflation is likely to reduce meaningfully in the near term. 

Upside Risks for Silver

However, the bar for a downside shock in USD is now very low. Given that USD long positioning has been so built up this year and with the Fed’s outlook on inflation and rates clearly outlined, any shift in this narrative will likely reflect in a rapid covering of USD longs, allowing for silver prices to recover quickly. With this in mind, the better risk: reward appears to be to the long side in silver instead of chasing any further downside. 

Silver Weekly Chart

 

 

Price has been moving lower within a bearish channel following the reversal from the year’s initial highs. Recently, the price has stalled at the 18.16 support level, potentially setting up for a double bottom. The market is currently testing the bear channel top. If bulls can break the channel, the key area to watch will be the 20.69 level with a break of this region confirming a bullish shift and putting the focus on 22.52 in the longer term. 

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