Profit from Silver's Sudden Weakness
May 03, 2011
– Comments (37) |
RELATED TICKERS: SLW
, SLV
, HL
Opinions about gold and silver are a fiat dime a dozen. If you are invested in this space, are you confident that you have acquired a perspective on these markets that will permit you to continue realizing long-term gains and eventually exit the sector with your gains intact? Have you conducted sufficient research and objective analysis in the process of developing your own long-term forecast for gold and silver prices or related trends to drive those prices? If you have not, you will discover same in the midst of a correction when your conviction is tested. That is the whole point of a correction ... to test the conviction of market participants and shake out the weak hands. The result is a far safer and less volatile space in which to invest. Will you be shaken? If so, when, and why? Or will you not be shaken, and join me in realizing epic gains from this sector going forward?
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For investors who may have just recently dipped their toes into silver for the first time as the metal recorded a new all-time nominal high price near $50 per ounce, I imagine the present volatility might be rather terrifying.
Veteran silver investors who are sitting upon meaningful prior returns are bound to be less acutely concerned, but this brief update is designed to assess the context of these moves for the benefit of both camps.
Consolidation is fuel for the long-term fire
For starters, I am compelled to accentuate the crucial role that periods of intermittent consolidation play within a long-term secular bull market like the one ongoing for silver. Corrections shake excess speculation and leverage out of an advancing market, and ever since the COMEX futures exchange signalled a powerful short squeeze and a rare condition of backwardation, there has certainly been no shortage of frenzy behind the long side of this market. Silver had absolutely skyrocketed, from beneath $27 in late January to nearly $50 in just 3 months! Some measure of pause became not just more likely at the psychological $50 barrier, but downright critical to the interests of long-term silver investors.
Commodity guru Jim Rogers said it best: "I own silver, but if it keeps going up, it could turn into a problem if it goes parabolic." He continued: "I certainly hope silver goes down for a while. I say it as somebody who owns it because if it goes down, I hope I would buy more and if it goes up too much too fast, then I have to sell." I agree wholeheartedly with that sentiment -- indeed I seldom find fault with his market perspectives -- and I welcome recent weakness (particularly in silver mining stocks) as an enticing opportunity to redeploy gains that I locked-in along the way.
Silver's hyper-charged arbitrage
You see, the mining stocks for both gold and silver failed to track the most recent price gains for the metals over the past several weeks. Silver Wheaton (NYSE: SLW) has swung from trading at a well deserved premium to the price of silver, to a substantial discount, and similar weakness throughout the relevant mining shares prompted this Foolish discussion last week. While the iShares Silver Trust (NYSE: SLV) tacked-on some 25% during the month of April alone, the Global X Silver Miners ETF (NYSE: SIL) essentially flatlined. Fools were not the only investors who took notice of that growing disparity in relative market performance between bullion and mining shares.
Hedge fund manager Eric Sprott caused some short-lived confusion Monday when it was revealed the consummate silver bull had liquidated some $34 million-worth of his own firm's Sprott Physical Silver Trust (NYSE: PSLV). To correct any misinterpretation of that action as signalling a change in his bullish outlook, Sprott avowed: "We haven’t lost our enthusiasm for silver". He added: "Every dollar of money that was raised by selling shares of [the Trust]... was reinvested in silver or silver equities." When one takes note of the significant premium over net asset value to which traders had bid the silver trust, the rapid return of greater than 100% realized by Sprott with the stake, and the irresistible underperformance by quality mining shares during the latter weeks of silver's journey, Sprott's decision can be properly viewed as an example of hyper-charged arbitrage.
The golden strategy for long-term silver gains
Fools eager to speculate on the near-term trajectory for silver are bound to be disappointed by agnostic take on the matter. This market is simply in far too volatile a condition to speculate with a reasonable expectation of success; requiring the corrolary that many short-term traders are likely to get burned.
A confluence of enormously impactful crossroads has emerged, and it is capable of driving intense near-term volatility for silver in either direction:
On the one hand, the U.S. dollar has been Bernanked all the way down to threaten an historic re-test of the dollar index's all-time low of 71.32 from 2008; while on the other, a suddenly heightened focus upon acute debt concerns in Europe could conceivably offer a timely, near-term reprieve for the greenback and forestall what I consider an inevitable break to new lows. A dropping euro has proven supportive of precious metals in the past, but I have observed brief periods of confused correlation as the world's focus has shifted back and forth between the dollar and the euro. The Japanese yen is another currency wild card that commands Foolish attention.
Trading action in the COMEX pits over recent months has been dominated, in my estimation, by a growing market distinction between actual physical silver bullion and the leveraged paper proxies that are traded in its stead in many multiples of the available global physical supply. The speed of silver's recent run could well be interpreted as a distress signal, wherein the effective bluff of leveraged paper supply was being challenged by increasingly emboldened longs. The persistent condition of backwardation in silver, still present today even after the latest decline, offers some corroboration of that view. Because futures contracts are highly leveraged on both sides of the battle, the CME Group's third margin increase within the past two weeks triggered a sudden flushing of speculative volume, and may have triggered silver's near-term reversal. One can not rule out further margin increases going forward, so forecasting the timing of a rise through $50 remains highly problematic.
Finally, we are just two months away from observing -- for the first time in financial history -- what happens when a $600 billion program by a central bank to purchase sovereign debt is suddenly fixed at that level even as daunting economic headwinds remain. With the Dow Jones Industrial Average above 12,750, I view the potential for bond market dislocation to disrupt equity markets as a significantly elevated risk; albeit within a tremendously complicated economic landscape where multiple scenarios must be duly considered.
With those and other highly unpredictable, and potentially volatility heightening factors in play, I maintain that speculating as to the near-term trajectory of silver does not warrant our Foolish attention. Rather, my attention is focused upon increasing my silver exposure in a disciplined manner over the course of this increasingly volatile period. I would point out that Coeur d'Alene Mines' (NYSE: CDE) San Bartolome silver mine, and Pan American Silver's (Nasdaq: PAAS) San Vicente mine, for example, have reportedly been cleared as a potential target of mine nationalization by the Morales administration in Bolivia. Low-cost powerhouse Hecla Mining (NYSE: HL), trading beneath $8.25 per share at the time of this writing, stands less than $1 per share above the stock's 2009 high … at a time when silver stood beneath $20 per ounce! You get the idea: I strongly encourage Fools to countenance this silver correction with conviction regarding the long-term trend, and to follow Eric Sprott's example in seeking hyper-charged arbitrage among the miners of silver.
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