Silver is scraping major support again, after a rough couple months where speculators left it for dead. But today's brutal lows and extreme universal bearishness are the perfect breeding ground for silver's next big rally. Investors are very underexposed, while speculators have big short positions that will have to be covered. So as gold reverses decisively and paves the way, capital is going to flood back into silver.

Silver's great allure today when it is down and out is hard for most to understand. That's because most traders mistakenly make linear assumptions in a nonlinear world. They expect today's market conditions to persist indefinitely. But that's not the way markets work, they are forever cyclical. The best times to buy low before later selling high are when assets are universally despised and trading at super-low prices.

And once silver inevitably reverts back to bull mode, the gains to be won by brave contrarians are vast. Between November 2001 and April 2011 in its last secular bull, silver skyrocketed 1105% higher! Over that same 9.4-year span, the benchmark S&P 500 stock index merely gained 20%. Ever since, silver has been trapped in a brutal bear that saw it collapse over 68% at worst. So it's obviously deeply out of favor.

As a small market, silver prices are utterly dominated by investment and speculative capital flows. When traders return, their buying catapults silver higher. These characteristic sharp gains attract in even more traders, and their aggressive buying becomes self-feeding. The spark that ignites these wildly-lucrative silver surges is the price of gold. Gold prices drive silver prices, since traders look to it for their silver-trading cues.

And gold itself is due for an imminent major new upleg. As the euphoric overvalued and overextended US stock markets inevitably roll over, alternative investments that move counter to stocks will return to favor. And this coming gold buying will really be amplified by the overdue correction in the parabolic US dollar. Once gold's rallying convinces traders it's righteous and sustainable, they are going to rush into silver.

While there is always a fraction of contrarian investors eager to buy physical silver bullion, that is just a secondary driver of silver prices since that process unfolds slowly. Silver price action is largely fueled by inflows and outflows from two great pools of capital, the American stock markets and American futures markets. And one of the main reasons silver looks so bullish today is because both have great room to buy.

Stock-market capital flows into and out of physical silver bullion via the flagship iShares Silver Trust silver ETF, which trades under the symbol SLV. Its mission is to track the price of silver, and that is only possible if differential buying and selling pressure on SLV shares can be quickly equalized into the underlying metal itself. SLV effectively acts as a conduit between stock-market capital and silver bullion.

When stock traders buy SLV shares faster than silver itself is being bought, this ETF's price threatens to decouple to the upside. To prevent it from failing to mirror the metal, SLV's custodians have to shunt this excess demand into silver itself. So they issue enough new SLV shares to meet demand and keep SLV's price in line with silver's, and then they plow all this new cash raised directly into physical silver bullion.

Conversely when stock traders dump SLV shares faster than silver is getting sold, SLV's price will soon break to the downside. This differential selling has to be funneled into silver itself. SLV's custodians do this by buying back enough SLV shares to sop up their excess supply. They raise the funds necessary to do this by selling some of SLV's silver bullion held in trust for its shareholders. This ETF is merely a passage.

SLV's custodians have always been very transparent about these capital flows by publishing SLV's total silver holdings every day. When they rise, stock-market capital is flowing into physical silver bullion. When they fall, stock traders are exiting silver. And not surprisingly today given the dire silver sentiment out there, SLV's holdings reveal that American stock traders are quite underexposed to this white metal.

Here SLV's price, which perfectly mirrors silver's, is superimposed over its silver-bullion holdings. Note that despite silver's sharp downtrend of the past few years, SLV's holdings have actually been growing on balance! That implies contrarian stock traders have been wisely increasing their capital allocated to silver while it languishes near deep lows. I call this stealth buying, and it is a very bullish omen for silver.

While investors and speculators give lip service to buying low, the great majority are loath to practice what they preach. They buy and sell only when it makes them feel good, and that's when they are in step with popular consensus. That usually leads to buying high in euphoric markets when prices are topping, then later selling low in despairing markets when prices are bottoming. Obviously that's a fools' game.

And after silver prices plummeted 35.6% in 2013 before dropping another 19.7% last year, there sure aren't any psychological incentives to buy this white metal. Buying low always feels terrible, since it can only happen at a time when conventional wisdom argues that particular asset is doomed to keep spiraling lower indefinitely. Yet despite those extreme fear headwinds, stock traders still upped their SLV allocations!

And right now they happen to be relatively low, as evidenced by SLV's holdings drifting just under the major support of their strong multi-year uptrend. This week, SLV held 327m ounces of physical silver in trust for its shareholders. That same uptrend's resistance is now way up around 352m, and climbing with each passing day. These low SLV-holdings levels leave lots of room for stock capital to slosh back into silver.

Just to drive SLV's holdings back up to their uptrend's resistance, stock traders would have to purchase enough SLV shares to force this ETF's custodians to add about 25m ounces. That's not trivial by any means. According to the venerable Silver Institute, the world's leading authority on silver supply-and-demand fundamentals, global silver investment demand ran 247m ounces in 2013 (the latest data available).

So as American stock traders start pouring back into silver as gold powers higher again, their easy 25m ounces of buying adds on the order of 10% additional global investment demand. And that process of SLV's holdings surging from support to resistance can happen quite fast. This isn't academic. In less than 8 weeks between early August and late September 2014, SLV's holdings soared by 28m ounces!

But during that last big SLV-holdings build from uptrend support to resistance, which was 8.8%, silver's price still dropped 13.8%. So if SLV differential buying from stock traders is so bullish for silver going forward here, why didn't silver rally during the last big influx of stock-market capital? The answer is the dominant primary driver of silver prices, the silver-futures trading action by American futures speculators.

While stock traders bought silver aggressively via SLV shares in the late summer of 2014, futures traders sold it at extraordinary rates. Such an odd divergence where two major silver-trading constituencies totally disagreed on silver's price direction was very rare. And the futures traders' selling happened to be great enough to far overpower stock traders' buying. But this anomalous scenario is very unlikely to repeat.

This next chart looks at the silver-futures contracts held by American speculators. The red line is their total short contracts, or bearish downside bets on the silver price. The green line is their total longs, the bullish upside bets. The higher the shorts and lower the longs, the more bearish speculators happen to be on silver. And these traders' silver-futures selling late last summer mushroomed to record proportions.

Unlike SLV's holdings which are reported daily by their private custodians, speculators' total positions in silver futures are only published once a week by the US government. This is in the CFTC's famous Commitments of Traders reports. And during that same early-August to late-September span where SLV's holdings surged, American speculators shorted an astounding 37.0k silver-futures contracts!

Any futures short sale effectively adds silver supply to the marketplace. Traders effectively borrow silver they don't own, sell it immediately, and then hope to buy it back later at lower prices to repay their debt. And with each silver-futures contract controlling 5000 ounces of silver, that 37k-contract shorting binge flooded the market with an epic 185m ounces of silver in just 8 weeks! That sure explains everything.

The only reason silver dropped 13.8% over that last big build in SLV's holdings was that the 28m ounces of silver American stock traders bought was overwhelmingly dwarfed by the 185m ounces of silver that American futures speculators sold! That extreme short selling catapulted speculators' total shorts to a mind-boggling 69.9k contracts. That was their highest level since at least 1999, and most likely ever.

But futures shorting is the best kind of selling any market can face, because these highly-leveraged positions must soon be unwound. And then all that selling reverses into new buying. While shorts have to be legally covered to pay back those debts, the markets would force those repurchases anyway. This week a single 5000-ounce silver futures contract only requires traders to keep $7700 in their account.

But even at dirt-cheap $16 silver prices, that mere $7700 controls silver worth $80,000. That equates to 10.4x leverage, far beyond the decades-old legal limit in the stock markets of 2x. So if the silver-futures short sellers are only wrong by about 10%, if silver rallies that much, they will face total losses on their capital risked if operating at the minimum margin. Practically, traders exit those shorts well before total losses.

So even a small rally by silver's standards, a few percent, forces the leveraged futures shorts to run for the exits. They can only close those short contracts by buying offsetting long ones, which drives up the silver price. And this short-covering process quickly becomes self-feeding, with higher silver prices forcing more speculators to cover which pushes silver even higher. Short covering is powerfully bullish.

After every big shorting spike of the past couple years, speculators soon bought to cover enough of their contracts to quickly hammer their total shorts back down near support around 27k contracts. As of the latest CoT week ending Tuesday March 10th, American speculators' total silver-futures shorts were way up at a whopping 46.5k! These levels would have been extreme by all standards but the past couple years'.

As we saw again this week on that Federal Reserve meeting, when gold surges futures speculators are forced to cover their silver shorts which drives big gains. And as gold starts moving decisively higher soon as the wildly-overcrowded long trades in the US stock markets and US dollar roll over, the silver-futures speculators short will rush to buy. And once short covering starts, it reinforces itself and unfolds rapidly.

Note above that all past short-covering episodes in recent years happened very quickly. We are talking about a matter of weeks, a couple months on the outside. And these short-covering frenzies all stopped near that 27k-contract major support line. There's no reason not to expect similar frantic short covering this next time gold rallies decisively to spark big silver buying. That would put tremendous pressure on shorts.

Even though American speculators' futures shorts aren't near last year's epic record extremes, they would still have to buy to cover 19.5k contracts to cut their downside silver exposure back to support. And that equates to a staggering 98m ounces of silver! That is nearly 4/10ths of 2013's total worldwide silver investment demand coming from just one group of traders in a couple months or less, incredibly bullish!

As the late great legendary pitchman Billy Mays said, but wait there's more. There's a whole other group of American speculators who are long silver futures. And like stock traders, these contrarians have been stealth buying cheap silver for the past couple years. This is evidenced by the green uptrend of silver-futures speculators' total long contracts. And today that happens to be down near support as well.

When their opposing traders rush to cover their shorts, there's no doubt the long-side speculators will flood in as well to both chase silver's gains and squeeze the fleeing shorts. And if their buying is merely big enough to push speculators' total silver-futures longs to resistance of their uptrend channel, we are talking about another 7k contracts of short-term buying. That's another 35m ounces of silver from that group alone!

Just adding up these three ready sources of big silver buying illustrates this metal's big near-term upside potential. American stock traders could buy 25m ounces just to push SLV's holdings back up to their multi-year uptrend's resistance line. American futures speculators could buy another 100m or so just to cover enough shorts to force their total downside bets back to major support. That's 125m ounces.

And on top of that is the 35m ounces of buying from long-side speculators to bounce their bullish bets back up to their multi-year uptrend's resistance as well. This equals 160m ounces of potential silver buying that is very likely to unfold within a couple months once silver starts running! These 3 groups of American traders alone could buy the equivalent of 2/3rds of 2013's world investment demand in weeks!

And these near-term silver-buying projections are pretty conservative. Over centuries silver has rightly earned a reputation as an exceedingly-volatile asset. While it often slumbers for long periods of time, when it finally awakens it tends to just rocket higher. The bigger and faster silver's next upleg, the more buying there will be from American stock traders and futures speculators alike. It could easily break out of trends.

And obviously American stock traders deploying in silver via SLV and American futures speculators are just a portion of the traders worldwide interested in silver. The buying from the other silent majority during silver's next major upleg should easily exceed these particular American traders'. Silver is truly poised to surge, and its upside potential is vast coming out of such extreme lows. So what's the likely catalyst?

Gold, silver is always about gold. Once again gold is likely to soon surge dramatically as the euphoric US stock markets and parabolic US dollar inevitably roll over. And contrary to the popular myth, rate hikes are no threat to gold. During the Fed's last rate-hike cycle between June 2004 to June 2006, it more than quintupled its Federal Funds Rate from 1.00% to 5.25%. Gold soared 50% higher in that exact span!

Gold, and therefore silver, thrive when conventional asset classes like stocks and bonds are weak. And rate hikes hammer them. While gold climbed 50% in that last rate-hike cycle, silver soared by 80%! So don't make the common mistake of fearing Fed rate hikes, as the investment capital just floods into gold and silver in those environments. The entire 1970s precious-metals mega-bull was in rising and super-high rates.

Investors and speculators can certainly play silver's coming rally in physical bullion itself or SLV shares. But just like silver will leverage gold's coming gains, silver stocks will really amplify silver's gains. With silver prices so low, this entire sector has been abandoned and left for dead. With investors gone and capital hard to come by, most silver miners and explorers are barely limping by. The situation is dire.

But there are still some elite well-managed silver companies that remain in good shape operationally as well as financially. Their stock prices have been beaten to a pulp, reflecting a bleak future where silver prices never rally significantly again. So once silver starts running, these radically-underpriced stocks are going to fly. I suspect we will see them leverage silver prices in a range from 3x to 10x, enormous upside.

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The bottom line is silver is poised to surge big. It is carving a major bottom after a brutal bear market, and investors and speculators have already started to return despite the incredibly-bearish sentiment that's still plaguing this alternative investment. But both American stock traders and futures speculators still have a lot of silver buying left to do to return their exposure to recent norms. And it will likely unfold fast.

As gold soon starts powering higher on the US stock markets and US dollar reversing, the leveraged futures speculators will rush to cover their silver shorts. That self-feeding process will catapult this beleaguered metal higher, attracting in much more capital. And as silver surges, the left-for-dead silver stocks are going to dramatically leverage its gains. They truly are an extraordinary trading opportunity today.