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Lease Rates Show Greater Silver Interest

Commodities / Gold and Silver 2011 Apr 23, 2011 - 02:38 AM GMT

By: Dr_Jeff_Lewis


In December of 2010, we looked at silver lease rates to see how a recent spike might affect metals.  Then, it was out of the norm to see a spike in the lease rate, which often corresponded with a bid to borrow silver for the short-term.  Today, silver lease rates are starting to normalize above zero, which means that demand to borrow silver in the short-term is becoming a constant, and that investors are now starting to price in recent history into the future.

Lease rate data from Kitco implies that leases for silver are beginning to pick-up after a recent spring slump.  The cost to borrow silver for one year now rests at .50%, which shows that investors are seeking a positive return for leasing their silver to others, and investors have in some ways priced in an increase in the cost of borrowing.  Lease rates out to 12-months have exposure to February 2012, which is the time at which most investors are saying the Federal Reserve will begin winding down its Treasury holdings or offer up higher rates to cool the inflation-fueled economy.

The source of the demand for silver leases is necessarily institutional—small investors don’t have the capacity to lease their holdings, and they would probably be significantly less likely to lease silver even with the option—so we expect that this is uptick in lease rates is due to the creation of a synthetic option.  Leasing silver for up to one year allows an investor to sell silver short with financialized instruments to profit on any volatility increase.  If silver drops, then the investor gains on the short, loses on the lease, but realizes a real profit on the net change in volatility.

Forward volatility

Never has volatility been so priced into the market.  Going forward to January 2012, options on the SLV, which may or may not own physical metals, have priced in both a rise to $47 and a fall to $37, implying that there is $5 upside or $5 downside to be had in the next twelve months for a net change of 12%.

Confidence in future volatility is confirmed with the increasing number of options being traded in the $30 call prices and $50 put prices as in the money interest is usually the most confident interest.  In the money options are less expensive on an exposure-basis, but more expensive when downside risk to the individual investor is considered.  Puts out to January 2012 at the $50 strike are trading for roughly $10, which the investor could stand to lose their entire premium paid if the price stays flat for the next eight months, or 20% of the current value of silver. 

It would be reckless to expect that volatility will not be sustained through the summer months, especially in late June and July when Indian demand for the year is realized, and investors hedge their bets on their best estimate of how much silver India will want this year.  Expect the general buying trend to continue on macro issues, but be ready to seize on any short-term correction in the market greater than the $5 priced into the options markets.  It will be here that the best buys are realized, and the best long-term investments are made.

By Dr. Jeff Lewis

    Dr. Jeffrey Lewis, in addition to running a busy medical practice, is the editor of and

    Copyright © 2011 Dr. Jeff Lewis- All Rights Reserved Disclaimer: The above is a matter of opinion provided for general information purposes only and is not intended as investment advice. Information and analysis above are derived from sources and utilising methods believed to be reliable, but we cannot accept responsibility for any losses you may incur as a result of this analysis. Individuals should consult with their personal financial advisors.

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