April 25 (Bloomberg) -- Options investors are bargain hunting after a two-month slump in precious metals prices.
While silver has wiped out almost all of a 15 percent gain through the first two months of the year, the cost of bullish contracts on an exchange-traded fund tracking the commodity has climbed to a three-year high relative to bearish ones. Traders are betting prices will rise with gold amid quickening inflation, a return of overseas demand and as the conflict in Ukraine continues.
Both silver and gold had their worst performances in more than 30 years in 2013, falling 36 percent and 28 percent, respectively. Investors lost faith in precious metals as a store of value amid an improving U.S. economic outlook and the prospect of the Federal Reserve cutting back on its monthly bond purchases.
“Silver is a precious metal, but it’s also an industrial metal and it’s taken a real punch in the face in the past few months,” Mark Sebastian, director of trading and investments at Swan Wealth Advisors Inc., said by phone from Chicago. His firm manages $1.3 billion. “You’re probably seeing some pressure on puts and a bid on calls because the metal’s cheap. None of the precious metals are having the best years right now.”
Silver rallied to a 2014 high of $22.215 an ounce in New York in February, before tumbling to reach a low of $18.95 yesterday. Gold has dropped 7.3 percent from a six-month high reached March 17, partly as investors assessed the pace of further cuts to the Fed’s monetary stimulus. The central bank reduced its bond purchases in March for a third time and indicated it will continue to pare the program.
The price of silver will rebound as demand for gold rises, said Philippe Capelle, a fund manager at Standard Life Investments Inc. in Montreal. China became the largest gold user last year as the steepest price drop since 1981 spurred demand for bars, coins and jewelry, according to estimates by the World Gold Council. In addition, the results of India’s election due in May are expected to bring a loosening in tariff rules introduced last year that led to a drop in official imports and a surge in cross-border smuggling in the country.
“Silver is gold on steroids,” Capelle said in an April 21 phone interview. His firm manages about C$33.2 billion ($30.1 billion) in assets. “If you think gold goes up, then silver will go up more. It’s what happens historically. I like the risk-reward on the silver price.”
Gold is considered an inflationary hedge, and the Commodity Research Bureau Food Index shows prices rising. The gauge, which tracks pricing on foodstuffs including lard, butter, corn and sugar, has surged 22 percent from a three-year low touched in December.
The U.S. consumer price index climbed on an annual basis by 1.5 percent in March, from a 1.1 percent gain in February that was the smallest in four months.
Investors have been trying to gauge the Fed’s intentions on interest rates since the central bank said in March that it will look at a “wide range of information” when considering the first increase since 2006. Chair Janet Yellen also said at the time that the rate might start to be raised “around six months” after the Fed ends its bond-purchase program.
“If interest rates were starting to move higher because of inflationary pressures or fears, that wouldn’t be bad for prices,” said Matt Skipp, chief investment officer at Sw8 Asset Management Inc. in Toronto April 21. His firm manages about C$36 million.
Geopolitical turmoil may also support precious metals as investors seek a haven. Aaron Izenstark, the co-founder of Iron Financial LLC, said the market views the tension between Russia and Ukraine as largely contained, so any escalation toward armed conflict would be seen as a significant shock.
“That would be a game-changer,” Izenstark said in a phone interview from Northbrook, Illinois. His firm manages about $2.2 billion. “Right now, things seem like they are contained, but if the world starts getting involved and it flares up again, you could see precious metals rally in a significant way.”
President Vladimir Putin warned Ukraine against continuing its anti-separatist offensive yesterday after government troops killed five rebels and prompted Russia’s military to begin new drills on the two nations’ border. President Barack Obama said the U.S. and its allies have prepared additional sanctions against Russia, with an agreement to disarm rebels signed last week in Geneva on the brink of collapse.
Contracts betting on a 10 percent rise in shares of Blackrock Inc.’s iShares Silver Trust ETF cost 0.50 point less than ones betting on a 10 percent drop in the next six months, according to data compiled by Bloomberg. Calls were 0.03 point less than puts April 10, the smallest gap since January 2011.
The Chicago Board Options Exchange Silver ETF Volatility Index, which measures options prices on the fund, slipped 1.5 percent to 24.61, the lowest since April 4, at 12:28 p.m. in New York. The CBOE Volatility Index, the gauge of Standard & Poor’s 500 Index derivatives costs known as the VIX, jumped 6.5 percent to 14.19.
The bullish bets made on silver are not indicative of investor optimism for a silver rally, said Wes Mills, chief investment officer at Scotia Private Client Group. He said silver is a “poor man’s gold” and the precious metals rally is largely exhausted for the year.
“You have a market that’s oversold and it bounces back,” Mills said. “The market will give some of that back if there isn’t sustainable demand. And some of it could be nothing more than short-covering.”
Traders have exchanged about 2.9 calls for every put that has changed hands this year, data compiled by Bloomberg show. That’s the highest annual put-to-call ratio on the fund since 2009.
All of the 10 most-owned options on the ETF were bullish. Calls expiring in January with a $30 strike price, 59 percent above the current shares, had the highest open interest, followed by $40 calls expiring in the same month.
“The market thinks silver should be higher,” said Michael Purves, chief global strategist at Weeden & Co. in Greenwich, Connecticut. “The options market is telling you there’s a decent floor at $19 here. And if you are short silver right now, you are heavily exposed to a short squeeze as well.”
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