SILVER

CURRENCY AND COMMODITY TRADING

The Bullion Twins

let us get straight to work and discuss Silver. Precious metals such as Gold, Silver, and Platinum are collectively referred to as ‘Bullion’. There is a common perception that the market price of gold and silver makes similar moves. If this is true, then it gives raise to many trading opportunities such a ‘pair trading’. We will discuss pair trading in detail, perhaps in a different module altogether. However, let us go ahead and investigate if Gold and Silver move in tandem. I did run a correlation check on Gold and Silver using 30 minutes intraday data for the last 3 months (note this is over a 1000 data points) and here are the results –

The correlation on an intraday basis is 0.7, which is quite remarkable. I’m guessing the correlation on end of day basis would be even better. So what does this mean? Well, the correlation suggests that the two metals make similar moves on an intraday basis. If you recall, we discussed the concept of correlation in detail in the USD INR chapter. I’d suggest you read up section 5.3 of chapter 5 if you haven’t already done so.

If the intraday correlation is as tight as 0.7, then we can think about exploring trading ideas of going long on gold and short on silver or vice versa. This will be a kind of hedged strategy as you are long and short (on similar assets) at the same time. The idea here is just to let you know that building such a trading strategy is a possibility, please don’t jump in and set up a trade just with this information. J

There are lots of other things to take care of when you initiate such trades; more on pair trading at a later point. Meanwhile, have a look at the intraday graph of both gold and silver; I’ve normalized it to start at 100 so that the graphs are more comparable –

If you were to just look at the graph and take a call on how closely the two metals move, then chances are you would disregarded any sort of correlation between them J, but the actual numbers paints a completely different picture!

Anyway, as I mentioned earlier, I’ve used intraday data here to develop both the correlation and the graph. Longer term data will portray more meaningful information. In fact, I dug up the correlation data between silver and gold from a recent survey by Thomson Reuters, and here is what they suggest –

he correlations are broken down on a quarterly basis (clearly a longer term approach here) and as you can see the correlation between Gold and Silver is on average is about 0.8, which is why traders prefer to call this pair the ‘Bullion Twins’.

The tight EOD correlation implies that traders and investors consider both gold and silver as safe havens in times of economic crisis. This further implies that any global geo political tensions tend to drive the price of not just gold, but silver as well.

Also, please do note the correlation of Silver with Oil, it is quite erratic and gives a sense on unreliability here.

The Silver Basics

Silver has applications in industrial fabrication, photography, fashion, electrical, and electronics industries. Hence, there is always a demand for silver. In fact the recent survey from ‘‘The Silver Institute’ in the United States suggests that the global silver demand stands at 1170.5 million ounces. Historically, the demand for silver has grown at roughly 2.5% year on year. Out of the total global demand, bulk of it comes from industrial fabrication and manufacturing. This directly suggests that the price of silver is kind of influenced by growth of manufacturing and industrial economies such as China and, to some extent, India.

On the supply side, global mining production along with scarp and sovereign sales stands at 1040.6 million ounces, clearly indicating that silver as a commodity is under slight deficit. The supply has not really improved over the years; in fact the data suggests that the growth in supply has just been about 1.4%.

Here is the table which gives you the complete demand supply scenario in silver –

You can read the complete survey report.

Given how the supply and demand scenario plays out, there is a lot of scope to trade silver as a commodity. This leads us back to the most important question – who decides the rate of silver? Well, silver rates are fixed the same way as that of gold, in London, by a pool of participating banks. To know how gold/silver rates are fixed, I’d recommend you read this.

 The Silver contracts

There are four variants of silver contracts that are available for you to trade on MCX. They differ mainly in terms of contract value, and therefore the margin required. These contracts are as follows –

Contracts	Price Quote	Lot Size	Tick Size	P&L/tick	Expiry	Delivery Units
Silver	1 kilogram	30 kgs	Rs.1/tick	Rs.30/tick	5th day of expiry month	30 kgs
Silver Mini	1 kilogram	5 kgs	Rs.1/tick	Rs.5/tick	Last day of expiry month	30 kgs
Silver Micro	1 kilogram	1 kg	Rs.1/tick	Rs.1/tick	Last day of expiry month	30 kgs
Silver 1000	1 kilogram	1 kg	Rs.1/tick	Rs.1/tick	Last day of expiry month	1 kg

Of all the four contracts, the ‘Silver’ 30 kg contract and ‘Silver Mini’ are most actively traded on MCX, we shall  discuss both these contracts detail. Let us begin with the main Silver contract.

The price quotation for the Silver contract is 1 kilogram. This means when you check the price of Silver on MCX or on your trading terminal, the price that you see is for 1 kg of silver. This price includes the import duties, taxes, and all the other applicable duties