Silver Squeeze? Who Cares… Buy This Instead

Published by Matt Warder on February 2, 2021

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If you faded the Reddit/WallStreetBets narrative and “diamond hands”-ed your puts, you are making some bank today.

Despite huge reversals in high short interest stocks — shares of GameStop Corp. (NYSE: GME) are currently trading 75% below last week’s high — the story continues to take hold of the markets.

Source: Bloomberg

For a time yesterday, that narrative even slipped over into the silver market, with prices hitting the $30 mark for the first time since 2013.

Source: Bloomberg

Later in the day, the narrative on the WSB forum itself shifted. Users began to deny that they were behind the move in gold’s little brother.

Instead of a populist version of the Hunt Brothers trying to corner the silver market back in 1980, what we wound up with was the best opportunity to short silver in a decade.

For educational purposes, I took it.

Source: Fidelity, My Tendies

I watched action in silver for most of the day, and when it became clear that the rally wouldn’t hold — after lunch, when it failed to move up on volume — I pounced.

I’m in the process of covering now, having been handed a nice little 20% gain.

Source: Bloomberg

I took on the trade to show how important volatility is when making decisions on when to enter and exit trades.

I’ve talked about this topic a few times before, so some of this may sound familiar.

When volatility increases, it doesn’t always mean that a stock price is specifically going up or down… It just means that something is about to happen.

If you look at the 30-day volatility of silver in particular, you can see what I’m talking about.

Source: Bloomberg

Volatility broke out in a big way during the initial stages of last year’s COVID crash — prices plummeted as volatility rose and took off when volatility fell. But in July, the opposite happened.

Similarly, if you looked for an inflection point in volatility there, you could have sold at the peak.

Which, you know, is generally what you want to do as a trader… buy low, sell high.

So when volatility breaks with recent trends and heads in a different direction, it’s time to pay attention.

I interpret these inflections like this.

First, as volatility increases, the range of possible outcomes — both to the up- and downside — widens.

When the range of possible outcomes widens, so does the standard deviation.

And if I were to plot the 2^nd standard deviations of silver’s price above and below the norm over time, you’d get something that looks like the red and green lines in the chart below.

Source: Bloomberg

So for me, this process was pretty simple.

Silver’s volatility increased slightly last week (circled above), which alerted me that prices were about to break out in one direction or the other.

I waited for clear directionality… In this case, it was up.

Then, I just waited for the move to exceed two standard deviations in that direction, and I took the other side of the bet.

And now that the silver price is back in the middle of those volatility bands, I’m out.

One thing to notice is that both volatility and price are beginning to trend upward, like they did last July.

Source: Bloomberg

This is a significant change from the last three months, so it is probably something I want to buy soon.

But given where volatility is right now, I would prefer to wait until silver prices are in the mid-$24 range — which would be two standard deviations below where they are currently.

Source: Bloomberg

That corresponds with roughly a $45 price for our old friend Proshares Ultra Silver (NYSEArca: AGQ), and I’m going to set a limit order to pick up a ¼ position somewhere down around that level.

Source: Bloomberg

One commodity that is getting pretty close to hitting that lower volatility bound, however, is copper.

Source: Bloomberg

I’m not sure if you noticed, but the United States is about to get a boatload of stimulus in the form of infrastructure spending here pretty soon.

More infrastructure means more copper demand.

More copper demand means higher prices… The math is pretty easy here.

There are a few effective ways to play a move in copper prices.

You could buy shares of the Global X Copper Miners ETF (NYSEArca: COPX), or the largest copper-focused mining company, Freeport McMoran Inc. (NYSE: FCX).

But I prefer a little optionality here, and so I’m looking at the highest-grade copper project in the world, Kamoa-Kakula.

This operation, controlled by legendary resource investor Robert Friedland’s Ivanhoe Mines Ltd (OTC: IVPAF) rose nearly 4 times as much as the underlying copper price last year.

And just as one last check, its volatility has started to level off.