Kay Van-Petersen
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Article / 05 July 2016 at 10:00 GMT

Chinese day traders love silver — as long it behaves

Head of Commodity Strategy / Saxo Bank
  • Silver surged to a two-year high Monday before the rally hit a wall above $21/oz
  • Precious metal was up nearly 50% year-to-date at its intraday peak
  • Surge occurred in Asian session as commodity trading venues in China proliferate
  • Silver's rise mirrors a similar surge in steel rebar and iron ore futures in April
  • Silver unlikely to repeat the extent of the April correction for steel and iron futures


When Chinese buyers start moving in one direction, it can create distortions. Photo: iStock

By Ole Hansen

The biggest two-day surge in silver since 2011 has raised a few questions about the sustainability of the current rally and what is driving it.

Macro economic developments which have been highlighted on several occasions during the past few months continue to attract demand for precious metals from retail, real money and hedge funds. 

Speculative positions held by hedge funds in both gold and silver have reached record levels while demand for exchange-traded products especially those in gold have continued to rise on an almost daily basis. 

The 13% bottom-to-top rally from Friday to Monday in silver could represent a short-term top in the market, not least considering the 44% year-to-date rally seen already. During the rally in Asia Monday, several major stop levels got hit on Comex silver which could indicate that many short positions have now been flushed out.

Silver looking to consolidate the post-Brexit strong gains. Key area of support between $19.14 and $18.67.
Spot silver with retracement
 Source: SaxoTraderGO

It was not a coincidence that the Monday surge occured during Asian trading hours. When it comes to commodity trading, the Asian session was often in the past a period of tranquility with limited market action. 

The emergence of commodity trading venues in China has, however, changed the balance in the market. Back in April, a sudden rise in demand for steel rebar and iron ore futures from Chinese day traders triggered a major surge in daily volumes.

As markets got increasingly disorderly, the regulators stepped in and raise the amount of colleteral required to trade and hold a position. This led to a collapse in activity and the price of iron ore and steel rebar collapsed by 25% and 33% respectively before recovering. 

Iron ore and steel rebar
The movements in silver during the past couple of days resembles what happened to iron ore and steel rebar. The below chart shows the price development of silver traded on the Shanghai Futures Exchange. Following the Brexit vote traders around the world, not least in China, have increasingly cast their eyes on silver.

During the past week, volumes have spiked to levels last seen during the April frenzy. What happened Monday was that silver fairly quickly went limit up at the 6% daily cap in response to the strong COMEX close on Friday. This helped trigger a spill over surge on Comex silver which went through several major stop levels before retracing after hitting a two-year high above $21.

The fact that the traded volume goes up while the open interest goes down is a clear indication that day traders have taken over for now. As long this continues, we are likely to see bigger daily price swings with the Asian session seeing most of this. 

Yesterday the Asian session yielded a 7.4% trading range while the remainder of the day it was only 4% (the US holiday did reduce activity during their session). Today the Asian session saw a 4.5% trading range while the European session so far has seen less than half of that. 

SHF Silver

Source: Bloomberg

Do these observations lead to a warning that silver could be in for a collapse similar to that in iron ore and steel rebar? No is probably the shortest answer. Silver is a much more globally traded commodity than some of the other futures currently available for trading in China.

A major move in SHF silver may attract the opposite interest from investors using other silver instruments from COMEX silver futures to spot and exchange-traded products. 

The latest surge has triggered a great deal of attention and with both XAGUSD and XAUXAG reaching and temporarily breaching their technical extension levels, further upside now hinges on the support from a continued rally in gold. 

The XAUXAG ratio completed the extension of the March to April move yesterday when the ratio temporarily hit a low around 64.2. With the ten-year average at 60, silver is no longer as cheap as it was back in March when it hit 84.

On that basis, continued demand for precious metals should see silver continue to outperform but at a much slower pace with the relative value increasingly coming back into line with longer-term averages. 

XAUXAG ratio
 Source: SaxoTraderGO

— Edited by Martin O'Rourke

Ole Hansen is head of commodities strategy at Saxo Bank


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