Silver experienced another amazing week, advancing from 42.155 to 45.175 on the week (and up another $1.5 in Asian trading at the time of this writing).  Even more impressive than the gain in silver has been the volume behind the advance.  The below chart shows the price of silver, with the aggregate volume on silver futures contracts below the chart.

As can be seen, volume on silver futures has exploded with the recent price gains in silver, a very bullish technical sign.  Usually, when volume on a security increases with a significant move in price, the conviction behind the move is thought to be strong because of how many people are participating.  Conversely, when market participants view a large move in a security with falling volume, it is a sign of an imminent reversal.

The average volume on silver futures has increased from 73k contracts on April 1^st to 117k contracts as of April 21^st.  This is an absolutely huge increase.  The average volume on silver futures has increased 59.7% in the same time span that silver itself has increased 22.22%.  The amazing increase in breadth behind this move is truly striking, and indicates the strong likelihood of further gains.  However, even more amazing is the lack of participation of Managed Money (hedge funds, commodity funds, pension funds, etc.) in silver’s recent strength.

This Week’s Commitment of Traders Report

The below chart shows silver’s price in gray and Managed Money net longs in green.

As can be seen, Managed Money has cut its net long position by 13.34% in the same time span that silver itself has rallied 22%.  This indicates that silver is actually rallying in spite of futures speculators, not because of them.

In fact, Managed Money short positions in silver are actually quite high.  The below chart shows total Managed Money shorts since January 2009.

It appears that the number of traders trying to “call a top” in the silver market is growing very quickly.  As can be seen, the number of Managed Money short contracts has more than doubled since the end of March.  This type of action is exactly what a silver bull wants to see, silver prices climbing in the face of greatly increased short selling pressure.  As these short sellers are forced to cover, the price of silver will only go higher.

The lack of participation by Managed Money continues to perplex us, as we believed Managed Money would come around and join the uptrend much sooner.  However, as we have stated recently, the buying pressure of physical and ETF buyers of silver has greatly outweighed any skittishness on the part of Managed Money.

The below chart shows price and volume on the SLV.

As can be seen, volume on the SLV has increased greatly in the past 2 weeks as silver has started to soar yet again.  Even with the SLV almost 22% above its 50 day moving average, the breadth of the silver rally has been astounding.

As we mentioned last week, the increase in silver holdings by physical buyers and the ETFs is a massively bullish development for the silver market.  So-called “retail” participants favor the SLV and silver coins to silver futures because of their relative ease and familiarity.  In most financial markets, increased participation of retail investors is a death signal to a large rally, as small mom and pop investors are the last to get in.  However, in silver’s case, the hoarding of silver by physical and ETF buyers takes the metal out of world supply, further constricting supply tightness for investment demand, and thereby boosting prices.  As more and more silver comes out of supply, the amount left for industrial demand and absolutely booming investment demand is decreased, and a physical shortage commences.

The other reason to be bullish about greater retail participation in silver is that retail investors are by and large not leveraged.  Although it is possible to buy the SLV on margin, the leverage afforded even the most daring margin investor is nothing compared to the futures market.  The physical silver market obviously has no ability to leverage, as silver dealers accept only cash for coins/bullion.  Since the greatest participants in the silver market currently (physical and ETF holders) are implementing their position with very little to no leverage, they will not be forced to liquidate even if prices correct severely.  This type of staying power should prove supportive if and when silver pulls back.

While Managed Money has stood mostly on the sidelines, if and when Managed Money decides to increase net longs, look out.  Silver may increase by another $10-20/oz in a matter of weeks or even days.

This post is from a series of featured articles pulled from a newsletter we are helping launch, The RealFinance Commodity Analyst.  These posts will be a few days delayed and only include a small portion of the newsletter, if you would like to have the entire content delivered over the weekend, see here to sign up: http://realfinancenewsletter.com

As usual, precious metals markets have received plenty of attention recently.  While many market prognosticators are calling for an end to the gold “bubble,” we believe that we are still in the early stages of the bull market in gold due to overwhelmingly bullish fundamentals.

The following chart shows the price of gold  in yellow against the size of the Fed’s balance sheet in red since the year 2000.  The chart has been normalized for percentage.

The reason why the Fed’s balance sheet is an important metric to track against the price of gold is because as the Fed’s balance sheet grows, the likelihood of the US government monetizing its debt (aka printing dollars to pay back debt) increases.  Throughout the history of time, any government that has been as indebted as the US currently is has had to finance the debt by printing money, at least in part.  Obviously, creating money out of thin air to pay back debts is a highly inflationary and currency debasing activity.  The gold market is reacting to the increased likelihood of such an event before its actual occurrence.

As can be seen, the price of gold has risen 375% since 2000, while the Fed’s balance sheet has increased 354% in size.  When viewing the price of gold in this context, it is very difficult to claim that gold is in any sort of bubble.  As investors lose confidence in the government’s ability to make interest and principal payments on our debt, they increasingly turn to gold as a store of value.  While gold has no industrial or commercial use outside of jewelry, it has been a store of wealth for thousands of years, and today’s environment is no different.  While it may be “irrational” to own gold under the premise that it does not pay any yield and it does not have industrial demand to support its price, gold’s status as an alternative to paper currency is so unquestioned that central banks hold massive amounts of it, and emerging market central banks are buying more.

To further illustrate gold’s relationship to government debt levels, the following chart shows gold in yellow and total US public debt outstanding in white.

As can be seen, while gold may appear to be rising parabolically, so is US public debt.  This incredible increase in public debt means that inflation is becoming more and more likely.

An argument I have also been hearing frequently as of late is that gold is “overvalued.”  My question is compared to what?  While stocks have some very loose boundaries as to valuation (i.e. there are usually far fewer willing buyers of a stock at a 100 P/E than a 10 P/E), gold has no such ceiling.  Furthermore, when a commodity such as crude oil rises too much, consumers use less; this phenomenon is known as demand destruction.  However, since all of the demand for gold is comprised of investment demand, demand for gold will not decrease solely because it has gone up in price.  In fact, it may actually increase at some point as momentum gains behind the price of gold and investors late to the party pile in.

In this manner, precious metals (and commodities as an asset class on some level) are a momentum trade.  As long as governments remain fiscally irresponsible and over-indebted, precious metals will continue to rise in price.  As there is no way to know exactly how inflationary these steps will be, and when inflation will peak, putting a price target on gold and silver is an exercise in futility.  The only aspect of precious metals prices an analyst can place a reasonable probability on is direction, not price.

Viewing the same argument from the reverse angle, if an investor expected a recession or deflation in the near future, the sale of gold would be a highly favorable strategy.  However, with the renowned willingness of central bankers around the world (most notably Ben Bernanke) to print money at the slightest hint of deflation, our view remains that the risk is to the side of inflation and not deflation.