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Silver – on the turn, or more of the same?

Samson Li  Senior Precious Metals Analyst

Samson Li  Senior Precious Metals Analyst

Did 2016 mark a turning point for silver prices?

After recording three consecutive years of decline and a cumulative loss of 53.9 percent over the 2013-2015 period, silver prices finally broke out to the upside in 2016, rising 17.5 percent during the year.

With the reversal of the downtrend also comes a lot of questions: Was the silver rally last year for real or was it just a dead cat bounce? Did 2016 mark a turning point for silver prices?

Looking at the cycle

In order to answer these questions, one needs first to understand that unlike other investments, hard commodities in general are very cyclical, and commodity cycles can usually last for years. For example, silver was in a bull market during the 70s, rising from $1.31/oz in 1971 to peak with the London “fix” (as it was then termed) of $49.45/oz on January 18, 1980. Thereafter, silver prices began to slide, and did not reach the bottom until 1993 at $3.50/oz. It then remained largely range bound between $4 and $6/oz for 10 years. It took until 2004 before silver prices finally broke out again, peaking on April 28, 2011 with a fix of $48.45/oz.

Annual silver price directions from 1972-2016

Clearly, silver price trends tend to be long. For example during the bull market from 1972 to early 1980, there was only one down year, while during the 1980 -1993 bear market, 11 years of annual decline were recorded, and of those that recorded annual price increases, none lasted for more than a year. After some mixed signals during the span of 1994-2001, the silver bull returned across 2002-2011, with only two down years (again not consecutive). If this past relationship holds, we think 2017 will actually be an important year to determine whether 2016 was a true rally.

From a technical standpoint, if silver prices record a positive year in 2017, then it may be safe to call the return of the bull market. Likewise, if silver suffers a down year in 2017, then 2016 may be nothing more than just a dead cat bounce, with silver prices broadly directionless, similar to the 1994-2001 period.

Other explanations for a strong silver year

From a fundamental standpoint, it is much easier to find explanations on why 2016 marked a turning point for silver:

Relationship with gold

Historically, while the gold:silver ratio (how many ounces of silver can be purchased with one ounce of gold) varies to a large degree, the correlation between these two metals has always been high, as silver is largely viewed as ‘gold’s poor cousin’. While recording a higher return in percentage terms compared to gold in 2016, silver’s rally was actually aided by gold’s strength throughout the year. With silver’s innately higher volatility than that of gold, this is to be expected as silver typically outperforms gold in a bull market and underperforms in a bear. This is almost self-fulfilling as experienced traders taking a view on gold will often gear up by the addition of silver to that trade. The global meltdown in the equities market at the beginning of 2016, weaker than expected Q1 2016 economic data for the United States, and the event of Brexit, forced global capital into safe haven assets, thus offering strong support for silver prices in the first seven months of 2016. In the final quarter expectations of a possible rate hike surged along with Donald Trump’s victory in the U.S. presidential election rekindling market optimism and bringing with it meaningful corrections in both gold and silver.

Relationship with the dollar

As commodity prices are usually dollar-denominated, it is easy to understand that a weaker dollar means a higher price for commodities, and vice versa, assuming all else equal. In addition, as gold is money, it is often competing against the dollar, and so, therefore, does silver. Indeed, the bear market for gold and silver from 2013-2015 took place at a time when the dollar started to rebound, as the market anticipated the interest rate cycle in the United States. However, an interesting thing to note is that, despite interest rates in the United States remaining in an uptrend in 2017 (the futures market is currently discounting a 95.8 percent probability that the Fed will raise interest rates in June), the dollar has softened notably, with the dollar index breaking down below the 100 level. Technically this is quite dollar-bearish, and if this signals that the dollar peaked in 2016 and that 2017 is the beginning of another medium-to-long term down cycle, silver should benefit.

Investor sentiment

Investor sentiment is sometimes a useful indicator to indicate tops and bottoms. According to the CFTC reports, managed net positions of silver on COMEX were net short from June to August in 2015. This is rare and indicated an extreme pessimistic sentiment of the market towards silver during that time; almost by definition this was potentially signaling the formation of a long-term bottom, given that sentiment frequently swings, and in silver’s case, these swings can be extreme.

Silver in 2017

Geopolitical concerns and a weakening dollar have contributed to a 6.6 percent gain in silver prices in the first five months of 2017. Managed net positions of silver peaked at 15,372 tonnes equivalent in mid-April this year (compared to 6,080 net tonnes at end-2016), and bottomed at 2,846 tonnes in mid-May. Net positions began to rebound in the following weeks, mostly due to dollar weakness. For the rest of 2017, the directions of both gold and the dollar will continue to dictate silver’s future trends, and investor sentiment will be a useful barometer to determine how undersold/overbought silver becomes throughout the year. We forecast that silver prices to rise to an annual average of $18.70/oz this year, compared to an average of $17.14/oz in 2016.

Learn more

To learn more about the silver market, click here to download a copy of the World Silver Survey (WSS) 2017 from the GFMS team at Thomson Reuters.

For more information and Answers On the precious metals market, check out our features on how the gold market has changed over the past half century, and whether gold jewelry is for adornment or investment.

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