The Update Case of Silver

Sinclair Noe is the host of “Financial Review” heard on moneyRadio.com and KFNN 1510 AM in Phoenix, Monday-Friday at 4PM MST. Sinclair has temporarily picked up the hosting duties for Pat Gorman’s “Hard Money Watch” radio program on moneyRadio.com and 1510 AM, Sunday mornings at 10AM MST. Mr. Noe has written six books; the most recent include: “Eat the Bankers” and the “Veterans’ Benefits Reference Manual”. Sinclair is the editor of Bank-o-Meter.com. He has also been a featured speaker at our Wealth Protection Conferences in Tempe for the past few years.

The Updated Case for Silver

I want to go back to my presentation at the 2011 Wealth Protection Conference; I spoke about several long-term trends. I think I presented several compelling and accurate predictions for long-term trends. I spent a lot of time talking about my investment pick for the next decade –silver! A friend recently chided me for what he considered an egregious mistake. Last April, silver hit $48.55. As I write, silver is around $29 an ounce. In my defense, I said at the Wealth Protection Conference that silver would most likely fall from the April highs and essentially every other speaker and several attendees at the conference confirmed this prediction. I remind you that my pick was for silver as the investment of the decade. Still, the past 9 months have been challenging for silver bugs. I hope you’ve been buying the dips. I think it will pay handsomely. Here is my updated case for silver.
Precious metals have been in a secular bull market for just over a decade. This is one of the prettiest uptrends you will ever see. Gold just moves higher, year after year after year. There have been pullbacks, but they have been reasonable, fairly orderly, and they should be considered nothing more than a chance to buy more on a dip. This has been about the easiest, most leisurely path to wealth that you can hope for.
Silver has been a wilder ride but also more profitable. Predictably, the speculators showed up, and high frequency traders started playing their tricks on the market, then the exchanges realized the volatility wasn’t quite normal. This past year, the market was anything but leisurely. The Chicago Mercantile Exchange (CME) is charged with maintaining orderly markets, but apparently fell way behind the curve. When the markets started hyperventilating, the CME responded with a noose around the neck and they nearly suffocated the markets. Five margin hikes on silver in eight days isn't orderly; it's a mugging. Just days later, the new Shanghai metals exchange jumped in with its own margin hike, triggering a 15% flash crash. That was followed by a round of put buying in Asia that sparked a gold sell off. The most sensible justification for the margin hikes is that it allowed an orderly retreat for big-money shorts. The only other credible explanation is that the CME and other exchanges were just profoundly incompetent in managing their exchanges.
Even with all the craziness, the gold market turned in another decent, positive year; silver, however, dropped 10% in 2011. I just don’t see any well-made case for an end to the secular bull market in metals. Do you think the giant debt bubble will miraculously self-correct? Do you think the Fed will stop counterfeiting currency? If you answer “no”, that means the silver correction of 2011 is a sweet gift.
Now, let me cover a couple of the trends mentioned in last April’s WPC presentation: the really big debt problem and inflation. The two trends go hand in hand. The sovereign debt problem is truly massive. We don’t yet know how big the Euro debt crisis will be, but we know the Fed and the ECB have already injected over $1 trillion dollars into the various rescue plans and nothing has changed; the Euro hasn’t imploded but nothing has changed. We know the game plan; the Fed directs the ECB on the same course followed after the Lehman Bros. crisis; they will pump money into the banks; they will play a game of extend and extend and extend and pretend. The plan calls for (electronically) printing mountains of cash to keep the financial system afloat.
When economic growth doesn’t keep up with debt and inflation, the result is: 1) quick economic collapse, 2) prolonged deflation or devaluation of the currency to unwind the debt while trying to work through the systemic problems, 3) or a catastrophe (like war) to demolish the debt. Quick collapse, slow collapse, demolition; this has been the course of all economies throughout history. The quick collapse, sometimes called a crack up boom, is painful and shocking and can purge the malinvestment out of the financial system. The dramatic nature of the collapse can create unexpected consequences. In the slow motion collapse, the government will typically try to debase its own currency to repay debt with cheaper dollars; it happened in 1933 and again in 1971. This is our current plan, and it calls for the central bank to respond to the deflationary environment by printing cash and (figuratively) dropping it out of helicopters onto the bankers. Most of that cash gets swallowed up in the black hole of debt, but inevitably, some will work into the economy as inflation.
Everybody debases their currency to ostensibly make exports cheap and imports expensive. Of course, consumers pay up, but nobody cares about consumers. Even the Swiss debased the Swiss franc by 10% in one Draconian swoop to energize sales of chocolate bars. The dollar has been stronger over the past few months, but it is important to understand that currencies trade against other currencies. The dollar isn’t really stronger – it is less weak than these other currencies.
Gold and silver are not hedges against inflation, but more specifically the metals are a hedge against debt default rather and/or devaluation. Inflation is a symptom of a sick currency. Investors may be a tad nervous that their paper money won’t hold its value. Silver will. Physical silver doesn’t have counterparty risk. The central bankers can’t counterfeit silver.
Short-term (6-9 months) I think the silver market is setting up for a significant rally. March silver has moved more firmly into backwardation.  This is extremely bullish for silver. Backwardation means that a futures contract is cheaper than buying the physical good in the cash market.

Silver can be warehoused, so it’s possible to simultaneously buy physical silver in the spot market and sell a future in the futures market. This is known as a “carry” (buy spot, sell future) and this does not have price exposure but there is exposure to the spread, or the difference between spot and future.  Absent a shortage, the March price should be close to the spot price and the cost of carry (interest rate and storage).  March silver should be at a slight premium to spot silver.  This condition is normal, and it is called “contango“.

But that is not the case for March silver (or Jul 2013 and beyond).  Those contracts are priced too low for anyone to make any money carrying silver. Instead, it would be profitable to de-carry silver.  A de-carry is the inverse of a carry.  One simultaneously sells silver, and buys a future against it.  In a normal commodity, backwardation means shortage. The backwardation develops because no one has any of the physical good.  So they cannot decarry it, and the spot-future spread can go deeper into backwardation.

But there are inventories of gold and silver, and for whatever reasons, they choose not to take this free money, or possibly because the inventories are pledged elsewhere; or possibly because we are facing a new dynamic where there are actual inventory shortfalls for investment silver.  In the silver market right now, trust is in short supply.  There are several examples where backwardation has been resolved by sharply rising prices, which coax fresh metal out of hiding. The last example was late 2010 into the early part of 2011. Expect to hear rumors of shortages of physical metals.

Another indicator is the sentiment indicator; basically, when silver falls out of favor, it usually rallies. In the past 10 years, there have been four distinct bottoms; on average, the price of silver rose 33% in the next six months and 54% over the next year.

No guarantees, but I like it when several indicators start lining up for a buy.

Now let’s get to the supply/demand story. HSBC estimates that only 0.14% of investable assets are precious metals whereas Sprott says 0.75%. Both are far cries from the 5% target of traditional portfolio theory. There may be a strong argument that the exchange traded funds, ETFs, such as SLV and GLD have sopped up excess demand among investors. There are still questions of whether physical inventories are in place to match the paper supply. Central banks are buyers after decades of selling. India, Korea, Mexico, Russian, and Vietnam were visibly active. (Rumors abound that big buyers are going straight to the miners, rendering the Comex increasingly irrelevant.) Chavez repatriated his gold to Venezuela, presumably to avoid rehypothecation. The entire MF Global debacle has forced investors to re-think physical delivery and the lack of safety in “paper metals”. The bottom line is that investors looking for a safe haven in the metals should take physical delivery.
Silver is an interesting metal because it serves as real money and also offers industrial applications. Silver gets used up. It is necessary to mine new silver to replace the silver used by industry. Silver is used almost everywhere: electronics, appliances, batteries, medical equipment, solar mirrors, solar cells, water purification, bio-cides and food treatments, photography (yes there are still pictures), and even polyester production. If the economy picks up this year, there will be increased demand for silver. If the economy falters (or if Europe implodes) there will be efforts to pump up the economy and silver should benefit from safe haven status.
More silver is used than is mined. The CPM group says that annual industrial demand (approximately 900 million ounces) exceeds mine supply by 200 million ounces. That gap was filled by the sale of government stockpiles and scrap recycling. The stockpiles are running out. Recycling is almost non-existent. That means there is basically nothing left. It’s estimated that there has been about 40 to 50 billion ounces of silver mined in the history of the world, and about 25 billion ounces are still floating about in some or other accessible form, including jewelry, silverware, and myriad industrial applications.

There are about 1 billion ounces of silver for investment purposes; the ETFs and other funds own about half; individual silver bugs around the world hold the other half. Maybe you have a few silver coins stashed away. That means there is basically nothing left. There is a seriously compelling case that we are running out of silver. I don’t think that will happen but conversely I don’t see a situation where supply overwhelms demand – that will not happen in my lifetime.

Prices move on the margins and in this case, investment silver represents the margin. Gold/silver price ratios of 16:1 are often cited targets based on 1:16 ratio of gold and silver in the Earth's crust. The aboveground stashes, however, tell a very different story. Demand for silver is typically 30 to 60 times greater than demand for gold. There is tremendous buying pressure: the U.S. Mint sells as many dollars worth of silver coins as gold coins. So, the same amount of paper money is flowing into silver as gold, but gold is priced 54 times higher than silver.

There is a definite correlation between gold and silver prices and gold is the more regarded and important market. The correction in both metals has been a little gut wrenching. Let’s look at the gold prices; Gold hit a record $1895 on Sep.5 and then dropped to a low of $1531 on Dec. 29. We have seen four significant pullbacks in gold since 2003; the declines were fast, and the recoveries were slow and steady. The declines ranged from 16% to 29% (the current decline was 19%). The recoveries took between 29 weeks and 75 weeks. Silver moves faster.

Here is the simple story on ratios - at 60:1 you want to buy silver but at 30:1 you want to sell silver. This is based upon trading experience over the past several years; it is not a hard and fast rule and I don’t use these exact levels as buy/sell triggers. When the price of silver climbs to a 30:1 ratio, you can’t be afraid to take profits. This is just a general range. When the ratio gets to 60:1 and I see other indicators lining up for a buy, I feel very confident buying.

Silver is more volatile than gold. Over the last year, silver has seen massive price swings, including an 81% rally and two 30% drops. That forced many traders to liquidate their silver holdings in order to meet emergency short-term requirements. The volatility gives you buying opportunities in physical silver. Embrace silver’s volatility. At some point in the coming decade, you will look back and with the great pride you may boast, “I bought silver when it was under $30 an ounce.”

And if you’re a really smart investor who values honesty, competitive pricing, and excellent customer service you’ll say, “I remember when I bought silver from Pat and Linda Gorman at Resource Consultants.”

I look forward to seeing everyone at the 2012 Wealth Protection Conference.