January 2021 was a month when the world collectively turned its attention to GameStop and AMC Entertainment. The investment consensus was that these companies – a physical game store and a theatre company - faced fundamental threats to their business models.
Due to this, short interest in AMC reached 53% by the end of 2020, and an astounding 140% for GameStop. The high short interest made these stocks the perfect short-squeeze candidates. However, it was not institutional capital that took the contrarian position.
What started as chatter on Reddit’s forums translated into a strong market rally. Retail traders, who had so far passively witnessed mammoth institutional investors enjoy the ability to move stock prices, decided to collectively act as a whale.
This feat could be achieved due to the surge in retail traders since 2018. This segment of the market grew significantly in 2020, taking the share of retail investors from between 15% to 18% to more than 30% of overall market activity, according to Credit Suisse.
Backed by retail trading, the rally in GameStop and AMC resulted in the bears absorbing losses of an estimated $20 billion. Even now, the sentiment for the stock is positive, as can be seen on the Acuity Trading Dashboard.
Soon after the rally, the short interest in these stocks fizzled out, and retail traders began their lookout for a new asset. It appeared for the briefest moment that the new target could be a commodity, rather than a stock.
Silver Begins to Shine Brighter
The thesis seemed simple, at least on Reddit posts. Paper silver is one of the most heavily shorted commodities. Some investors online advocated a potential squeeze engineered by acquiring physical silver, stifling the supply, and driving up prices. The favoured method was the iShares Silver Trust (SLV), the largest traded silver fund, which backs shares issued with the purchasing of physical silver.
SLV rose to its highest since 2013, with inflows of about $1 billion on on January 29. Spot silver on London’s OTC market, the largest in the world, jumped 11% to $30 an ounce on February 1.
How the Narrative Differed
Unlike in the case of GameStop and AMC, silver did have strong reasons to rally. Over the years, demand for the white metal has risen steadily for industrial purposes. Despite this, silver has been relatively undervalued, especially compared to gold. Given the use of silver in industries like electronics and solar panels, demand for the yellow metal is expected to grow as the global economy rebounds this year. Global demand for silver is expected to grow to 1.025 billion ounces in 2021, the highest in eight years, according to the Silver Institute, a nonprofit international association of members from the silver industry.
However, the silver squeeze did not fail because the narrative was different. It failed because the narrative was incomplete. There is good reason for bullion banks, often the biggest shorters of paper silver, to take these short positions. These banks are not looking to profit off silver’s price. Instead, they acquire physical silver for their clients and hedge these acquisitions by shorting paper silver, thus locking in future revenues. These are not naked positions, like in the case of GameStop and AMC. These are backed by physical reserves. Silver is also shorted by gold and lead miners, for whom silver is a byproduct of their primary mining activities.
In addition, most hedge funds and money managers had increased their net long positions in silver through 2020 as inflation and volatility hedges. The metal gained 47% last year.
A further significant difference from the stock of one company is silver’s considerably larger supply. It has a market cap of $1.46 trillion and has maintained a large supply surplus in most years. It requires substantially larger capital to persistently move price levels than retail investors could summon.
For these reasons, the rise in silver prices was not a clear breakout. Spot prices retreated more than 8% below the $30 per ounce high almost immediately on February 1 to $27 per ounce. The rally was over before it truly began.
The sentiment for silver is more balanced, as can be seen on the Acuity Trading Dashboard.
Power of Retail Traders a Cause for Worry?
The strong rally and subsequent downturn in GameStop and AMC raised questions in the stock market. However, we believe this was something that the global markets should have experienced a long time ago. And, it’s not a bad thing. The value of a successful squeeze is more than just the payout. Squeezes can serve to stave off excessive bear speculation, as was initially the case for AMC and GameStop. Excessive speculative shorts can form a self-fulfilling prophecy. Short sales can severely dampen market rallies, form overall price depressions, and prompt large holders to sell their positions, further reducing the price. A squeeze is, therefore, the sign of a healthy market, helping it shrug off excess speculation by a few large investors.
Even the failed squeeze in silver has added two possibilities to the narrative. It is possible that speculation in the silver market is at healthy levels and that a large portion of the shorts is hedging rather than speculative behaviour. There is also a possibility that the market capitalisation is too large for retail investors to maintain the squeeze or test the patience of downside speculators. The short might have failed, but it is a strong signal for market integrity in silver – prices reflect more organic demand than bear speculation.