Rise of the retail trader: could Silver be the next GameStop?

GameStop caught the fascination of traders and the public alike in late January, after a Reddit thread led to a sudden rise in its share price. Now, many believe Silver markets are the next target for retail traders. Here’s everything we think you should know.

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5 things to know about the meteoric rise of GameStop

1.      GameStop was, and still is, a struggling company with a poor fundamental outlook

GME had a share price hovering around $5 last August. Like most brick and mortar retailers, its business has been slowly dying as revenue shifts to electronic retailers and direct downloads. Hedge funds have been selling the stock short (ie. borrowing shares to sell in expectation of a price collapse). However, many retail investors thought the company still had a viable future, and that the market had oversold the shares.

2.      The social media site Reddit is where it all began

Groups of highly motivated retail investors banded together on Reddit, Twitter and other social media sites to focus their buying on shares of GME. They have developed a cult following intent on not just profiting but also inflicting maximum damage on the hedge funds that they believe had manipulated the market lower. The media, politicians, and many celebrities have applauded the ‘David and Goliath’ story. As shares of GME trading as high as $500, it appeared as though the hedge funds had been toppled.

3.       The numbers suggest there is more to the story

GME hit a $20 billion market cap on 28 January. One large hedge fund – Melvin Capital – reportedly lost billions. But who actually profited?

Many retail investors have reported life changing profits on the trade but looking at the trading volumes and the capital flows, it is extremely likely that many hedge funds, proprietary trading firms, and high-frequency traders were also buying shares of GME.

Consider that from mid-August to the end of September 2020, shares had already doubled to more than $10. A SEC filing on 29 September 2020 lists Susquehanna International Group, a well-known proprietary trading firm and electronic options market-making pioneer, as one of the largest shareholders at 6.37%. 

While there is no doubt that the retail trading community played a major role in the epic GME price movement, there were clearly a lot of sophisticated traders and investors on the same side as the retail community all along.

4.       GameStop options contracts are having a huge impact

The price of GME exploded in a classic short squeeze driven by some large short sale positions and also the heavy options activity. Short sellers, such as hedge fund Melvin Capital, had to scramble to buy back shares to cover what they had sold. The problem is that nobody wanted to sell, and this imbalance between the supply of shares offered for sale and the demand from short sellers who need to buy them, caused shares to reach incredible levels.

In addition to short selling, many speculators chose to instead sell call options contracts in expectation that shares of GME would fall back to reasonable levels. Similar to short selling, a short option contract can require the seller to buy shares in the underlying market once the option expires. And once again, there was an imbalance and not enough shares for sale in the market. It appears that much of the short call option activity was focused on short term options that expired at the end of the day on Friday 29 January.

Whether it is short sellers or short option sellers, anytime a trader or investor is forced out of their position due to mounting losses it can drive the price to irrational levels. Eventually those options positions expire as they did on that Friday, and the market slowly begins to normalize. The initial short sellers and short options sellers have been taken out, but they have now been replaced by new market participants attracted to the high prices.

5.      We may not have seen the last of GameStop

Shares of GME settled into a trading range on the 1 February in the mid-$200s. This is still an incredible valuation compared to any fundamental analysis of the company’s earnings or economic prospects, but that doesn’t mean the stock will fall. Something has changed this week, and there is no way to tell if a dedicated group of retail investors, with some help from savvy institutional traders, can continue to drive GME higher at least in the short run.

Why Silver Could Be Next?

Silver is a much, much larger market than Gamestop, which has prompted many to suggest that ‘this cannot happen in silver’. Consider the silver market includes SLV (an ETF), COMEX (futures contracts), LME (futures contracts), interbank bullion markets, and physical bullion markets. The market is quite massive and on the surface, it seems unlikely that a small group of investors could drastically move the market.

However, silver is unique. In 1980 a small group of traders attempted to corner the market in silver and were able to push the price up over 700% to nearly $50/oz. Unlike equities that generally require substantial margin of 50% up to 100%, silver can be extremely leveraged in many trading markets requiring as little as 5% on deposit. This means the effects of a short squeeze can be even more dramatic than in a stock like GME.

The supply of real physical silver is quite limited. The size of the highly leveraged derivative markets for silver are based on a much smaller physical bullion market. If for example, the holders of long COMEX futures contracts attempt to take physical delivery, there could be a massive short squeeze in the silver market as the ‘shorts’ scramble to find supplies that do not readily exist.

The same algorithmic trading strategies that propelled GME could be even more effective in silver, due to a more decentralized market with much different regulatory obligations. When a sophisticated automated trading strategy has multiple trading venues to liquidate their net position, they have the ability to be more patient and allow a short squeeze situation to run its course.

In addition, the same Reddit groups that drove the GameStop obsession have now set silver in their crosshairs. on 1 February, Silver prices were up over 10% at one point, making new highs over $30/oz last seen in early 2013. This could be just the beginning.

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