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SLV Bullish Divergence

Adam Hamilton
May 24, 2013

Silver has suffered horrendously in 2013's opening months, plunging dramatically to miserable lows. This exceptional weakness has naturally kindled extreme bearishness. Predictions abound for silver to continue selling off indefinitely. But amidst this severe carnage, the silver bullion held by the flagship silver ETF has remained flat. This is an extraordinary bullish divergence in the face of rotten sentiment.

Silver is almost certainly the most volatile of the world's more-popular markets. When silver starts moving, it often moves fast. Fortunes are won and lost in a matter of months, a very exciting or terrifying prospect depending on which side of the trade you are on. The key to silver's price action has always been gold. Silver follows gold, usually dramatically leveraging the yellow metal's fortunes. Silver is a gold play.

Over the past decade I've sometimes teased silver's hardcore enthusiasts, calling the white metal "gold's little lapdog". While flippant, technically this is absolutely true. Silver's current secular bull was born near $4 way back in November 2001, a whopping 11.5 years ago. Ever since, its daily price action has had a correlation r-square with gold of an astounding 92.7%! That is just off-the-charts high statistically.

Over the entire 2,895 trading days of silver's secular bull, nearly 93% of all its daily price action is directly statistically explainable by gold's own! Gold's fortunes are the only thing that matter for trading silver, its commanding driver. Silver is so exciting because it leverages gold's moves. When gold rallies, silver amplifies its gains. When gold falls, silver magnifies its losses. Gold paves the way for silver to move.

So silver's miserable year is a direct consequence of gold's miserable year. The only reason the white metal has plummeted 26.4% year-to-date is the yellow metal has plunged 18.3%. Silver simply can't buck such a hurricane-force gold headwind. The speculators who fuel silver's big price moves are not willing to buy when gold is weak. Falling gold crushes silver psychology, leaving those traders quick to sell.

Gold's terrible year has also almost exclusively been the product of a single driver. As the US stock markets continued to levitate without respite, they sparked increasing euphoria that sucked in all available capital like a black hole. American traders were so excited about general stocks that they sold everything else to buy in. And gold was one of the biggest casualties of this massive capital rotation.

Gold's mass exodus centered around American stock traders owning its flagship ETF, GLD. They rushed to sell their GLD shares to move that capital into the melting-up general stocks. This placed tremendous differential selling pressure on GLD, forcing its custodians to liquidate much gold bullion to keep their ETF tracking the gold price. The magnitude of this GLD holdings drawdown was radically beyond precedent.

Every day that stock traders sold GLD shares faster than gold itself was being sold, this ETF's price threatened to decouple from gold to the downside. Its custodians had to soak up this share supply by buying all those excess shares offered. They raised the necessary cash to buy back GLD shares by selling some of GLD's physical gold bullion held in trust for its shareholders. This marginal gold supply trashed prices.

Of 2013's 98 trading days, GLD suffered differential selling pressure and resulting holdings draws on a whopping 66 of them! Such a sustained rotation out of GLD has never been seen before. The result was this ETF liquidating 24.5% of its total gold-bullion holdings so far in 2013! A quarter! That equates to a staggering 330.8 metric tons of gold flooding into the markets in just 4.7 months. No wonder gold crumbled.

This was the biggest and longest GLD holdings correction by far in this ETF's entire 8.5-year history. And it had nothing at all to do with fundamentals, it was driven solely by greed and fear. American stock investors first succumbed to their fear to sell gold low, and then were seduced by their greed to buy general stocks high. The result was the first-ever GLD mass exodus which slaughtered gold and silver.

Now with gold loathed and silver down a seemingly-catastrophic 26.4% year-to-date, you'd think that the American stock traders who own the flagship SLV silver ETF would be panicking for the exits too. But as I've been pointing out to our newsletter subscribers in recent months, rather remarkably they haven't. While GLD's holdings are down 24.5% so far this year, SLV's are merely down by 0.6%. That is dead flat!

This is an amazing bullish divergence with major implications for the entire precious-metals market. Before I dig into them, check out these charts. This first one looks at SLV's holdings, silver, GLD's holdings, and gold over the past couple years. To make all this diverse data perfectly comparable, each series is indexed off its respective record high set at 100. SLV's recent divergence is truly remarkable.

For most of the past couple years, the holdings of GLD and SLV naturally tracked each other closely. Gold drives silver, and usually silver's fortunes drive American stock-investor interest in holding SLV shares. So generally as gold and silver rallied and retreated, GLD's and SLV's holdings waxed and waned in concert. There have only been two material exceptions to this perfectly logical relationship.

Back in early 2011 silver started to regain favor dramatically, which led to a flood of capital deluging into this relatively small market. So silver's price skyrocketed to hyper-overbought levels that soon collapsed as I had been warning our subscribers well in advance. SLV's holdings surged to their highest levels ever as silver grew popular, and then plunged dramatically as silver subsequently nearly crashed.

Since this was a rare instance when the silver speculative fervor somewhat disconnected from gold, neither the yellow metal nor GLD's holdings retreated with silver and SLV's holdings. After that anomaly stabilized though, GLD and SLV tracked closely on the holdings front until late last year. Though it's hard to believe today, GLD's holdings reached their all-time high of 1353.3 tonnes in December 2012!

But that was about when the stock markets started rallying aggressively without any material selloffs to rebalance sentiment. Upside momentum surged on the fiscal-cliff tax deal and grew further on Q4 earnings that weren't the disaster expected. Eventually it started to take on a life of its own, investors rushing to buy stocks simply because other traders were doing it. They raised cash by dumping GLD.

So GLD's holdings started sliding rather precipitously, plunging during February's gold capitulation and April's full-blown gold panic. The huge gold supply thrust into the markets by GLD's forced liquidations further weighed on gold, igniting a vicious circle. The more stock investors dumped GLD, the more gold (and therefore silver) fell, and the more additional investors were scared into liquidating their own shares.

Since the melting-up stock markets were and are so euphoria-riddled, the fleeing GLD capital hasn't returned yet. The result is the biggest and fastest GLD drawdown ever by far seen in this chart. Having a quarter of the world's dominant gold ETF's holdings, several hundred tonnes, cast into the markets in such a short time has been a huge headwind for gold. It was too much for physical buying to overcome.

Just look at that staggering holdings plunge! The world has never seen anything like this, which is really evident if you check out a longer-term chart in a recent GLD essay I wrote. Though there have been many sizable differential selling days forcing GLD to liquidate some bullion to soak up excess GLD share supply, the biggest draws center around February's gold capitulation and April's futures-driven gold panic.

Each of those sharp gold selloffs had very specific causes which I explained in depth in essays on them. Gold's capitulation was driven by fears the Fed would prematurely exit its massive and highly-inflationary QE3 debt monetization. Incidentally the Fed's unprecedented torrent of paper-money creation in its quantitative-easing campaigns has been wildly bullish for gold and silver, which makes 2013's selling very odd.

The later gold panic was spawned by leveraged futures traders getting annihilated by margin calls and forced liquidations. They could run leverage up to an insanely-risky 29-to-1 in gold futures, so a mere 3.5% gold swoon would wipe out long traders entirely. Gold sold off far enough, partially driven by GLD selling pressure, to trigger a big mass of futures stops just below a major multi-year gold support line.

But these big anomalous gold selling events certainly don't tell the whole story of the GLD exodus. Even though gold bounced decisively after both its February capitulation and April panic, American stock traders kept on aggressively dumping their GLD holdings. During the panic and the week after it, GLD sold 76.7 tonnes of gold. But in the month since, it has been forced to dump an additional 84.6 tonnes!

Stock investors have been fleeing GLD because they believe the general stock markets are now a better place to invest capital than gold. As the stock markets continued to relentlessly levitate without any material selloffs to rebalance sentiment, euphoria slowly set in. This entranced foolish stock investors into believing nothing could drive a general-stock selloff, that the stock markets would power up indefinitely.

So they sold gold low in order to buy general stocks high. Selling low and buying high is the recipe for financial ruin, and the very-overbought, fundamentally expensive, and euphoric stock markets are way overdue to reverse dramatically. The moment the headline stock indexes fall far enough for traders to believe their uptrend has decisively reversed, the capital rotation out of gold and into general stocks will also reverse.

Gold's weakness in 2013 and the extreme antipathy towards holding GLD shares is a direct consequence of unsustainable stock-market euphoria! It hasn't happened before in this secular gold bull because we haven't seen truly euphoric stock markets since 1999 before this gold bull was born. When the stock markets inevitably roll over, the selling pressure on GLD is going to vanish overnight.

Provocatively it is probably almost finished anyway. GLD's holdings are currently at 1020.1 tonnes, down dramatically from their early-December record high of 1353.3. The first time GLD's holdings ever hit 1020 tonnes was back in February 2009 when gold was trading near $975 and silver around $14.25. So effectively all the remaining long-term GLD holders are still sitting on very large unrealized profits.

You have to realize how crazy-anomalous 2013 has been. Melting-up stock markets breeding euphoria are very rare, only seen at the ends of major bull markets. Stock euphoria diverting capital away from all other asset classes is equally as rare. But if you'd told me how 2013 would play out in the stock markets, GLD, and gold, but said SLV would ignore the carnage, I would have thought that was utterly impossible.

Nevertheless, it happened. The American stock traders owning SLV have generally not dumped their shares faster than silver itself has sold off, necessitating relatively minimal silver-bullion sales. Seeing SLV's holdings merely down 6.6% over a short span where silver has plunged 29.2% is mind-blowing. SLV's investors are apparently not suffering from the same mass delusion plaguing GLD's investors.

Part of this is due to a huge SLV holdings buffer. Out of the blue on January 16th, some fund put in a massive buy order for SLV. It was an unremarkable day in silver and gold, although the white metal had been trending higher nicely in 2013 at that point. I suspect it had to be a hedge fund, as SLV's holdings soared by 18.4m ounces that day! This represented an exceedingly-rare 5.6% single-day SLV build.

After SLV's first couple months of existence in spring 2006 when its holdings soared dramatically from very low levels, there have only been two other days in SLV's history that saw 5%+ builds. And one was nearly totally unwound the very next day. So to see such huge differential SLV buying pressure, and then to see SLV's holdings soon regain those levels despite sharp silver weakness, was truly amazing.

Unfortunately I haven't had time since the Q1 hedge-fund 13F holdings reports to the SEC were released last week to comb through them to see if I can identify this January buyer, so if you have found the right 13F please send me a link. But someone was making a huge bet on silver early in 2013. And this gave SLV's holdings a big boost and created a large buffer that SLV differential selling still has only just eaten through.

But even if that extraordinary SLV buy hadn't happened, SLV's holdings have still only fallen a small fraction of silver's plunge. That can only mean one of three things. Either SLV's investors are strong hands who aren't hypnotized by the fleeting general-stock euphoria, the market for SLV is too small to bother liquidating for cash to shift into general stocks, or SLV's investors believe gold is going to reverse.

I suspect the latter. Very few investors, only the hardest core of the contrarians, have been able to resist the sirens' call of melting-up general stocks. And silver itself has a long history of being influenced by the general-stock fortunes as well, since the sentiment over there universally affects the attractiveness of risky speculative bets like silver. And the truly strong hands in silver own physical, not SLV shares.

SLV is much smaller than GLD, but there is still serious capital in it. As this year dawned, GLD's and SLV's holdings were worth on the order of $72.6b and $9.8b. At less than 1/7th the size of GLD, there was a lot less capital in SLV that could be repurposed into chasing general stocks. But nearly $10b still wasn't trivial. As of this week these numbers have shrunk to $44.8b and $7.2b, or just under 1/6th.

With silver down so sharply you'd think SLV's shareholders would capitulate and flee like GLD's. But they haven't. This implies that they somehow don't believe gold's sharp selloff in 2013 is righteous, that it is going to reverse sharply. I couldn't agree more of course. The world's central banks are pumping out new paper currency at breathtaking rates, laying a huge foundation of pure inflation that is super-bullish for gold.

If this had been a normal gold selloff that was fundamentally justified in any way, capital certainly would have fled SLV as well. Its holdings nearly always move parallel to GLD's since gold is silver's primary driver. So SLV's bullish divergence is a powerful signal that gold's selloff was a sentiment-driven anomaly that should soon reverse dramatically. It is another clue that fleeting general-stock euphoria was what hurt gold.

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The bottom line is SLV's silver-bullion holdings have held strong this year despite silver plunging, a very bullish divergence. They usually closely track the silver price, gold price, and GLD's holdings, all of which have fallen dramatically in 2013. This suggests American stock traders owning SLV don't believe 2013's gold plunge is righteous, highlighting a hidden bullish faction ready to flood back into silver.

All it will take to reverse gold and silver is for the euphoric stock markets to decisively roll over. That will quickly end the capital rotation out of GLD shares into general stocks, arresting the flood of supply crushing gold prices this year. Without GLD's huge liquidations, exploding physical demand globally sparked by such low prices will retake the driver's seat and gold and silver should start flying higher.


May 24, 2013
Adam Hamilton, CPA

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