Stock Market

This weekend, as the #silversqueeze hashtag made its way across the internet, silver prices forebodingly edged past the $30 mark – the highest it’s been since the beginning of 2013. With a physical metal shortage on the horizon, Redditors and Wall Street pros alike are starting to ask themselves: can another $SLV short squeeze happen?

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They’re right to wonder – it’s not the first time a group of investors has successfully cornered the market. An infamous case in 1980 saw prices rise from $1.50 per ounce to $49.45 before the U.S. government stepped in. And despite legislative changes, short squeezes in futures still happen more than you think.

So, whether Reddit sends silver to $300 or not isn’t whether they can. It’s whether they will.

SLV Futures: Will a Short Squeeze Happen?

The inherent mismatch between futures contracts and physical deliveries has often confused new traders. Futures contracts exist entirely on paper. So, for example, a hedge fund can double their financial holdings of silver without needing the world’s supply of silver to double along with it. That makes it possible, in practice, to buy more of something than physically exists.

Commodity investors have long known these perils. That’s why there’s such a delicate dance during “roll periods” when expiring futures contracts get traded in for new ones. And while most professional traders willingly roll their contracts forward, even minor supply/demand bumps (or an uncooperative group of market players) can send prices gyrating. In April 2020, for instance, oil contracts sank to negative -$37 on oversupply of expiring futures contracts relative to physical oil.

Today, silver contracts look headed in the opposite direction. And it’s not being done by professional traders.

SLV Futures to the Moon

It’s rare, but enough money in the right places can usually send most futures contracts to the moon. That’s because Wall Street tends to trade more in futures than whatever exists in real life. Today, there are almost 150,000 silver contracts outstanding for March 2021 delivery alone, representing more than 23 metric tons of silver. That’s about the equivalent of the entire U.S. silver reserve.

Ordinarily, the owners of these futures contracts will sell the March delivery futures at some point and buy May ones, representing a “roll forward.” (Investors usually want exposure to silver, not delivery of the actual metal itself.) But these aren’t ordinary times. With enough retail investors buying up silver coins and bullion, it’s possible to cause a supply/demand imbalance as March contracts come due. And if enough traders demand physical delivery of a metal that’s suddenly impossible to buy, there’s very little to stop the silver March contract from going to $300 or higher.

Pushback from Wall Street and r/wallstreetbets

“There is no silver short squeeze happening. NONE. NEVER,” proclaimed a posting on the now infamous r/wallstreetbets forum of Reddit. As silver embarked on its run, GameStop (NYSE:GME) fans have joined Wall Street pros in pushing back on the notion that silver could embark on a historic squeeze. (Presumably, the newfound attention on silver was distracting Reddit users from buying GameStop). In a sense, they have a point. Unless you can buy futures contracts directly, it’s harder to influence Wall Street’s dealings.

There are some stand-ins to futures – buying silver from dealers reduces the available supply for the March/May roll period. And buying exchange-traded funds like the iShares Silver Trust (NYSEARCA:SLV), which is 100% backed by silver, will eventually send ETF sponsors to the spot market to buy more.

But the most powerful way to create a short squeeze in silver futures is to buy the futures contract itself – something out of reach for most regular investors.

Silver Futures: Waiting for a Short Squeeze.

Commodity contracts are generally not an amateur day-trader’s game. At $30/ounce, a full March contract of 5,000 troy ounces would cost $30 x 5,000 = $150,000 to buy. Even a micro contract of 1,000 troy ounces still costs $30,000. But that’s also what makes silver so volatile. Because contracts are so expensive, professional traders usually use leverage to buy these options – $14,000 maintenance margin per contract, with adjustments for volatility.

That means even small changes in silver’s outlook could send professional traders panicking. With GameStop’s surge not even in the rearview mirror, hedge funds and traders have nervously watched for the next short squeeze. In other words, anyone short silver contracts are likely turning into net buyers.

Could regular investors send silver to $300 themselves? It’s not likely, given the restricted access to buying futures contracts directly. But cause enough traders to believe you can (via raiding the silver spot market), and the traders could well do it for you. Neither my colleagues nor I at believe that intentional market manipulation is ethically or legally warranted. But in today’s social-media-driven world, it’s certainly possible.

On the date of publication, Tom Yeung did not have (either directly or indirectly) any positions in the securities mentioned in this article.

Tom Yeung, CFA, is a registered investment advisor on a mission to bring simplicity to the world of investing.