Investment thesis

Welcome to Orchid’s Silver weekly report, in which we wish to deliver my regular thoughts on the silver market through the Aberdeen Standard Physical Silver Shares ETF (SIVR).

SIVR has rebounded by a little bit more than 4% since our last publication, in line with our expectations. Although the Fed has not yet guided the market toward more aggressive easing, the noticeable deterioration in the manufacturing and service sectors as well as the slowdown in job creations have prompted the market to lift its subjective probability of a rate cut at the forthcoming FOMC meeting on October 30 to 80%.

Source: Nordea

Given the deterioration in domestic economic data, we think that the Fed will offer a more aggressive policy response, having enough evidence that the global economic slowdown wave starts being felt at home. In this context, we think that the market is right to shrug off the hawkish tone of the minutes of the September 17-18 FOMC meeting, released earlier this week (link).

Investor appetite for safety should therefore remain strong in Q4, benefiting silver prices and the performance of SIVR.

We forecast a trading range of $15.50-$19.50 per share for SIVR in the course of October.

Source: Trading View, Orchid Research

About SIVR

SIVR is an ETF product using a physically backed methodology. This means that SIVR holds physical silver bars in HSBC vaults.

The physically-backed methodology prevents investors from getting punished by the contango structure of the Comex silver forward curve (forward>spot), contrary to a futures contract-based methodology.

For long-term investors, SIVR seems better than its competitor SLV, principally because its expense ratio is lower (0.30% for SIVR vs. 0.50% for SLV), which is key to make profit over the long term.

Speculative positioning

Source: CFTC, Orchid Research

The net spec length decreased on the margin in the week to October 1, having reached a plateau since August.

Over the past month, the net spec length has dropped by 1,914 tonnes or 6%.

Still, it remains up 7,415 tonnes or 22% in the year to date.

Currently at 23% of OI, we believe that the net spec length remains light judging by historical standards, as the chart below illustrates

Implications for SIVR: Since there is plenty of room before silver’s spec positioning becomes stretched on the long side, the upside potential for silver spot prices is great, in our view. This therefore bodes well for the performance of SIVR.

Investment positioning

Source: Orchid Research

ETF investors bought 61 tonnes of silver in the week to October 4, marking a second straight week of net inflows.

We think that silver ETF inflows were elicited by the surge in risk-off mood, evident in the decline in global risky asset prices, driven by economic weakness and lingering uncertainty surrounding the US-China trade dispute.

While silver ETF buying has already surged massively so far this year, we believe that ETF inflows will continue because the current macro picture calls for caution; ergo, we expect investors to continue to lift their risk-unfriendly positions to hedge their portfolios against tail risks.

Implications for SIVR: The acute increase in investment demand for silver has pushed silver spot prices strongly higher this year, which is therefore positive for SIVR investors.

Gold to Silver ratio

Like taking a trip to Paris, showing a chart of the gold to silver ratio is always a good idea, in our view.

Source: Trading View, Orchid Research

The ratio has declined steeply since it reached a high of 93.46 on July 1, reflecting the outperformance of silver vs gold prices. Currently trading at 84.7, however, it is still firmly above its average of 60 over the past 20 years, and significantly below its average of 47 in the 20th century.

We believe that the outperformance of silver prices will continue further in Q4, which is consistent with the current spec positioning differential between silver (light) and gold (heavy), which suggests that there is plenty of dry powder among the speculative community to deploy on the long side in the silver futures market while the room for further speculative buying is limited in the gold futures markets, as we wrote recently (link).

Implications for SIVR: Our expectations for a lower gold to silver ratio are supportive of silver spot prices, and thus SIVR.

Our closing thoughts

We expect the rebound in SIVR since the start of October to continue in the rest of Q4, underpinned by a more aggressive policy easing response from the Fed in the wake of the latest raft of domestic economic weakness. While the Fed has been reluctant to deliver more aggressive rate cuts in the global slow global growth environment, the tangible deterioration in domestic economic conditions should convince the US central bank to ease more swiftly its policy stance.

By pushing the dollar and US real rates lower, the monetary demand for silver should increase strongly, tightening the supply/demand balance of the silver market (especially considering its relatively inelastic supply profile), and pushing silver spot prices and SIVR accordingly higher.

Our October high forecast is at $19.00 per share, representing an upside potential of 15% over a 1-month horizon.

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Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: Our research has not been prepared in accordance with the legal requirements designed to promote the independence of investment research. Therefore, this material cannot be considered as investment research, a research recommendation, nor a personal recommendation or advice, for regulatory purposes.

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