Thursday, 4 February 2021
By now, many readers would have come across the “Silver Short Squeeze” trend on social media getting around at the moment as silver took a wild ride from $33 AUD an ounce to $40, before pulling back to $35 all within a few days.
Some participants of the Reddit group Wall Street Bets (mentioned in last week’s update) turned their eye towards the silver market as a few posts went viral about the potential to squeeze silver short positions into covering. Well at least that was the narrative pushed by some members.
Sure enough, that was enough to get the whole world scrambling to buy anything silver related. Silver miners shot up, ETFs saw inflows, and physical bullion dealers saw a massive spike in bullion orders over the weekend. Large bullion dealers in the US offering weekend trading were caught out and had to hedge their positions on the Monday morning open, which sent silver spot spiking higher. A complete mania which lasted a few days before the market stopped and had a breather, only to see prices pull back over 10% from the highs. Here domestically at Guardian Gold we saw a big spike in online account openings and silver volumes, and Perth Mint have had to pause silver cast bar orders to catch up with demand. This was clearly a global event that had a much larger reach than most expected.
So, is there any merit to the ‘silver short squeeze’ story? And how long could one expect this spike in demand to last?
Firstly, lets break down the idea of a short squeeze. A short squeeze can occur when an asset class has a very high level of short interest, with traders, institutions or hedge funds selling an asset they’ve borrowed with the intention of buying it back later at a lower price and making a profit. A squeeze can occur if too many traders are all on the one side of the ship, betting on the price moving lower, but they get caught out when the price rises unexpectedly, and the loss on their trade starts building. Your loss from a short position is technically unlimited, so traders would usually have stop-losses where they eventually throw the towel in and are forced to buy back the asset at a higher price, to minimize their losses. What we saw recently in Game Stock shares is that short interest reached a ridiculous level of 148% of shares available. So, this was ripe for a short squeeze scenario if enough people got together and bought shares and call options all at the same time. Those caught short saw their losses building and building and they eventually have to give up and buy the stock back to close the position and take a loss. This leads to more buy orders on the bid as a rush for the exit occurs, and the share price sky rockets as a result.
But when it comes to trying to create a squeeze in the silver market, this is a totally different ballgame. The Reddit crew have courage to attempt it, but there are a few reasons as to why this would likely fail. But wait for the kicker in all of this, as there is some merit to the idea of a ‘physical squeeze’.
First, when it comes to physical commodities there are two main reasons why an institution or traders may hold a short position. One is to speculate on the price moving lower, but the other (which most may not have thought about) is to hedge physical inventory. For example, when a refinery buys actual physical silver from a mine, in order to hedge their price risk (between the time of taking it in, refining it, and on-selling it) the refinery will enter a short position to the same number of ounces using a paper derivative or futures contract etc. Likewise, when bullion banks are seen to be carrying a large silver short position, it doesn’t necessarily mean they are speculating on lower prices, there could be long physical position to match, and they are simply hedging their exposure. So not all, but a large number of short positions listed by ‘commercials’ are to hedge an equal long position of physical metal. So these positions can’t be ‘squeezed’ out if the spot price moves higher. They take a loss on the paper ‘short’ position but have a profit on the physical ‘long’ to match. Down in one hand and up in the other. They don’t care what the spot price does and they are simply hedging risk, so you can’t squeeze them out of their position.
This is accurately noted by Goldman Sachs analyst Jeffrey Currie in a recent Bloomberg article as follows:
‘WHILE SOME (SILVER) SHORTS ARE SPECULATIVE AND REQUIRE COVERING BEFORE EXPIRY, MOST ARE DRIVEN BY INDUSTRIAL PRODUCERS HEDGING THEIR FORWARD EARNINGS. WHEN COMMODITY SHORT POSITIONS ARE BROADLY BACKED BY REAL PHYSICAL STOCK, THERE WILL BE NO SUBSEQUENT BUYING AND NO SHORT SQUEEZE.’
Secondly, in order to create a short squeeze scenario, you would need to pick a point in time when the market is significantly net-short by those that are speculating on price. For this you would need to look at large speculator positions and pick a time where the market is heavily net-short and buy into that market in significant volume in the hope that you would stop some of them out. But this has not been a market that was heavily net short. In fact, speculative positioning by managed money has been net-long the market in recent times, as investors and traders have actually been quite bullish on silver for most of 2020, with the price rising 24% in USD terms.
Thirdly, as I noted to Bloomberg news earlier in the week, there is a big difference in the dollar volume requirements of forcing a short squeeze in an individual stock VS squeezing the entire silver market, which is much larger in comparison to the relatively small companies the Reddit group have had recent success in.
So the silver ‘short squeeze’ narrative has some flaws to it. But there is another squeeze that silver investors should rather be focused on, and that is the potential for a ‘physical’ squeeze. Short positions in silver didn’t close their positions this week as many didn’t need to, as described above. But what we did see come out of the coordinated buying all at once, was physical bullion inventories drying up in under a week. This is the real story that should have circulated and the silver short squeeze movement should have focused attention on the ‘physical squeeze’ that can happen if everyone actually takes delivery.
There are many silver products out there, including ones that aren’t regulated as much as others. So the true physical backing of silver ‘paper’, ETF’s or ‘pool allocated/unallocated’ products is somewhat difficult to know for certain. If everyone demands to take delivery, you could see supply drying up very quickly. A general rule of thumb is if it is not 100% allocated physical metal, either stored in a safety deposit box or in your backyard, you might not truly own it, or there might not be the physical backing that you think there is. Luckily all we do at Guardian Gold is 100% physical allocated bullion and nothing else.
If we continue to see a significant increase in demand for physical metals, either from investors or from industrial demand, quite quickly you can hear news around a squeeze on physical supplies. This in itself can be more bullish than any short squeeze attempt. When news breaks of silver supply drying up, this often sparks more investors and speculators to enter the market, and the cycle can feed into itself similar to what we saw in 2011. Palladium in recent years experienced big deficits in supply combining with increasing industrial demand and we saw what happened there.
If you’re going to list on a Reddit forum the top five bullish fundamentals for silver moving forward, a short squeeze is not one of them. But one major silver lining in all of this (pun intended) is that the more exposure silver receives as an investment class the better. There are legitimate long term tail winds for the metal in the coming years that all investors should know about.
Despite Goldman Sachs calling out the silver short squeeze attempt as “unattainable”, they still remain very bullish on the metal, and have a price target of $33 USD per ounce, on the back of increased industrial demand and a huge renewable energy spend under the Biden administration (boosting silver demand for solar PV).
Despite us calling out the silver short squeeze thesis, we also expect silver to outperform gold in 2021 on both increasing investment and industrial demand. Central Bank policy will continue to support inflation hedges such as gold and silver, with silver having the potential to experience a ‘physical squeeze’ as industrial demand continues to rise. There was and is a legitimate reason for silver to become a popular investment class, but the Reddit narrative was slightly misguided, or perhaps misunderstood.
Guardian Gold Sydney
If you have any feedback or questions about this report, you can contact John Feeney direct at firstname.lastname@example.org or on Twitter @JohnFeeney10
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