Like many physical commodity markets, silver futures are still on the decline from their 2011 highs near $50 per/oz. This market had begun to find a base through mid 2014 when the Fed's announcement to end Quantitative Easing sparked several commodity rallies. Clearly, this was premature in the market as silver, along with most of the other markets quickly found that its spark failed to catch and once again resumed its downward trend. The primary characteristic of this downward trend in silver futures has been the commercial traders' consistent selling on rallies. This has been especially notable as these rallies have neared the downward sloping trend line that has capped them.
Commercial traders are typically negative feedback traders. This means that they have a predetermined value area that they expect the market to trade in. Commodity producers do their best to hedge their production above the value area while end line commodity users try to purchase their inputs below the value area. The farther away from value the market gets, the more commercial traders show up attempting to pad their bottom line.
The interesting point regarding the silver market is that commercial traders are behaving more like trend traders in the sense that it is clear that they are selling with the trend and adding to their position as the market moves in their anticipated direction. Thus, their net short position is growing even as the market makes new lows.
The accompanying chart shows the actual contract months back to 2012. The commercial traders sold both of the rallies in 2012. More importantly, they sold more contracts on the second rally of 2012 which coincided with lower prices than the first one. The scary thing for silver futures is that this pattern is repeating itself with greater frequency and magnitude. The most recent round of selling in February pushed the commercial traders' net short position to its most extreme level since October of 2010.
This type of behavior is fairly rare among the commercial traders. What we're seeing here is a predictable ramp up in buying as the market slowly builds a base. The base draws in the early speculators. Early longs and weak shorts battle for control as buy stops get hit. Finally, as the market nears the major trend, the commercial traders come in and dump everything.
This should easily lead to a test of the December low at $14.15 per/oz. Then, maybe by the fourth quarter, we'll see a lasting change in sentiment. As for now, the odds still favor selling rallies and putting the power of the commercial traders behind new short positions.
