In yet another precious metals downgrade this year, Bank of America Merrill Lynch has sliced its 2013 outlook for silver in what could be a warning sign for investors that view the precious metal as a leading indicator for gold.
BIG MOVES
While markets seem to have focused on the sharp fall-off in gold prices since September last year, the drop in silver prices has been proportionally greater. Gold bullion prices are 17.5 percent lower year-to-date and silver is down 26.4 percent.
In its latest commodities report, Bank of America forecast silver prices will average $24.35 per ounce in 2013 — 25.5 percent lower than its previous prediction of $32.70. “We believe the fundamental backdrop for silver has weakened,” the bank’s analysts, led by metals strategist Michael Widmer, said in a report on Tuesday.
Many analysts say silver had been struck a dual blow by deceleration in world industrial activity, coupled with a gradual recovery in the global economy which has seen investors move away from the traditional safe-haven metals. Perhaps most importantly, investors no longer seem to be purchasing precious metals as a hedge against an upswing in inflation. In its latest report, Bank of America cut its 2013 outlook for gold by 12 percent to $1,478 per ounce, its second downgrade this year. Several of the major banks have also cut their outlooks for gold, including Goldman Sachs, BNP Paribas, Credit Suisse, Societe Generale and Citi.
LOOKING AHEAD
I see two possible scenarios for both silver and gold as we enter into summer. As such, I am proposing the following gap trade. If recent lows hold, especially for gold, a near term technical bottom may form which could spark a rally back up and through the 1500 level. A gold-led rally could possibly take silver 200 to 300 points higher, above Bank of America’s average price of 24.35, possibly up and through 25 an ounce, in my opinion.
Traders shouldn’t discount a rally, especially if we see a measurable stock correction combined with the fact that central banks keep offering record amounts of liquidity to battle deflation. The second scenario is that recent lows in gold don’t hold and prices dip well below 1300 an ounce and fall to the low 1200’s or even high 1100’s. This could take silver well below $20 an ounce possibly to the $18 an ounce. The point is, as we enter into summer I am looking for a sizable move in price and have put on a trading strategy to attempt to catch such a move either way.
THE TRADE
I am proposing buying the August Silver 26.00 call and selling the August Silver 27.00 call for a purchase price of 6 cents, or in cash value $300.00. The risk on the trade is the price paid for the spread plus all commissions and fees. The max profit on the trade is $5,000.00, if both strikes finish in the money at expiration, minus the price paid for the spread and all commissions and fees. For protection to the downside, I am proposing buying the August Silver 18.00 put and selling the August Silver 17.00 put for 6 cents, or a $300.00 risk. The risk for the put spread is the price paid for the spread plus all commissions and fees. The maximum you could collect is $5,000.00 as well, if both strikes finish in the money at the time of option expiration, minus the price paid for the spread and all commissions and fees.
For both trades, the total cost is $600.00 plus all commissions and fees. What we don’t want to see is sideways action for the next 5 to 6 weeks in Silver, where neither the call spread or put spread gain meaningful value. I believe that given the volatility we have seen so far, we will see a meaningful correction or another leg lower in the precious metals. This trade potentially covers either one of the aforementioned scenarios.
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Contact Lusk here for other trade recommendations or to be added to his free precious metals report.
RISK DISCLOSURE: THERE IS A SUBSTANTIAL RISK OF LOSS IN FUTURES AND OPTIONS TRADING. PAST PERFORMANCE IS NOT NECESSARILY INDICATIVE OF FUTURE RESULTS. THIS REPORT IS A SOLICITATION FOR ENTERING A DERIVATIVES TRANSACTION AND ALL TRANSACTIONS INCLUDE A SUBSTANTIAL RISK OF LOSS. THE USE OF A STOP-LOSS ORDER MAY NOT NECESSARILY LIMIT YOUR LOSS TO THE INTENDED AMOUNT. CURRENT EVENTS, MARKET ANNOUNCEMENTS AND SEASONAL FACTORS ARE TYPICALLY BUILT INTO FUTURES PRICES. A MOVEMENT IN THE CASH MARKET WOULD NOT NECESSARILY MOVE IN TANDEM WITH THE RELATED FUTURES AND OPTIONS CONTRACTS.
