Silver’s
fundamentals offer plenty of reasons to be bullish in the coming years.
Relentlessly growing global investment demand coupled with reduced production
is a recipe for much higher prices. With something like 3/4ths of all
the silver mined globally being merely a byproduct, primarily of base metals,
supplies will remain constrained. Investors will have to compete in a
tiny market for this scarce metal.
While
silver’s long-term bullish case is well-known among its investors, this
volatile metal also has incredible near-term potential. In the coming months,
silver is likely to witness exceptional gains. Unfortunately, the
driver of this potential big autumn silver rally is not widely
discussed. Thus many investors and speculators still sidelined since
the panic risk missing out on this rare opportunity.
And ironically,
the stock panic created the silver anomaly that led to this
opportunity. Silver has a long history of
following gold. Silver traders watch gold for trading cues, so gold
action dominates silver psychology. Thus silver typically trades in
lockstep with gold. But during the panic, the extreme fear spawned by
the brutal stock-market selloff spilled into silver. It forced silver
to decouple from gold and plummet far deeper than gold warranted.
I started telling
our subscribers about this anomaly and trading it last October. Already
it has proven a very successful strategy. One new long-term
silver-stock investment we added then, because of this anomaly, is already up
160%! While silver itself fell under $9 in the heart of the panic, it
has averaged $14 in the past month. And the panic anomaly driving these
gains still hasn’t been fully resolved yet. There is more to come.
This whole panic
episode, and silver’s near-term upside potential, is best understood in
terms of the Silver/Gold Ratio. SGR analysis simply divides the daily
silver close by the daily gold close and charts the result over time.
It is very illuminating. I first wrote about this publicly, after our
subscribers had deployed positions, back in early February.
But a lot more investors are interested in silver today than back then.
So if
you’ve been hiding out, following the ostrich
strategy of cowering in zero-yielding cash
instead of multiplying your capital in these once-in-a-lifetime post-panic
opportunities, you really need to consider the SGR’s implications for
silver. And if you’re already trading this SGR anomaly, keep your
capital deployed and watch your gains grow. Although unwinding
gradually, the SGR anomaly hasn’t even come close to being fully
unwound yet. But it will.
This SGR
reversion’s potential silver impact is easiest to understand if we
start in the normal years preceding last autumn’s crazy stock
panic. This first chart compares silver with gold over the last 5 years
or so. The 44 months between January 2005 and August 2008 are the
control period, showing silver’s natural and normal behavior. And
the 4 months between September to December 2008 encompass the panic period
where the SGR anomaly erupted.
In the years
before the panic, silver’s very tight correlation with gold was readily
evident. Silver surged when gold was strong and fell when gold was
weak. Silver’s daily price action mirrored and amplified
gold’s nearly perfectly. Over this 44-month baseline time frame,
94.7% of silver’s daily price action could be statistically explained
by gold’s own. Gold action drove silver sentiment, and hence
silver prices.
But late last
summer, silver started decoupling from gold. There had been minor
decouplings before of course, but they were far smaller and only lasted for
days to a couple weeks on the outside. The silver decoupling witnessed
as the panic unfolded was utterly unprecedented in its magnitude and
duration. Gold was indeed weak, but silver plummeted far faster and
deeper than the gold selling warranted.
If you want to
understand exactly why gold was weak during the stock panic, read my recent
essay on the stock markets
driving gold. In a nutshell, bond-market
followed by stock-market selling led to flight capital flooding into the US
dollar to buy short-term US Treasuries. This safe-haven trade drove the
biggest and fastest US dollar rally ever witnessed. Gold futures traders
saw the dollar skyrocketing and dumped gold. And as gold fell, silver
traders got really scared. Their fears were greatly exacerbated by the
stock panic.
Scared traders
are emotional traders, so silver was sold far more aggressively than yet seen
in this secular bull. Before this surreal fear bubble, silver averaged
$18 in July 2008. By November 2008 in the heart of the stock panic,
silver averaged less than $10. At worst, silver lost a mindboggling 53%
of its value in just over 4 months! It was an epic bloodbath that
understandably broke the will of many silver investors to go on.
But although the
massive panic-driven dollar rally hit gold too, gold’s selloff was
trivial compared to silver’s. At worst at its panic lows, gold
hit a 14-month low. But silver just kept on falling and falling,
spiraling ever lower. At its own panic nadir, silver had plunged to
levels last seen 34 months earlier! Silver does amplify
gold’s moves, but the degree of this panic selloff was still utterly
ridiculous. It defied all logic and reason.
Over that
September-to-December panic span, silver’s r-square with gold plunged
to 52.5%. In other words, only half of silver’s daily price
action was statistically explainable by gold’s own. In light of
silver’s ironclad past relationship with gold, this was madness.
No one had ever seen anything like it before. Not only was silver going
way overboard in amplifying gold’s selloff, but gold was nearly
eclipsed as the primary driver of silver sentiment.
Provocatively, the
stock markets were usurping the silver helm. In October and
November in the bowels of the panic, silver hit new panic lows on 6 separate
trading days. Fully 4 of them happened to be days the S&P 500 (SPX)
hit new panic lows as well. Incredibly none of silver’s
new lows happened on days where gold hit new lows! And even though gold
bottomed in mid-November, silver didn’t bottom until over a week later
on the very day the SPX hit its own panic low.
The idea of the
stock markets driving silver seems odd now, but within the extreme fear and
stress of the panic it sort of made sense. Unlike gold which is usually
perceived as a stable investment and safe haven, silver is primarily viewed
as a speculation. It is a hyper-volatile metal heavily dependent on the
whims of speculative preference. And during the panic, speculators were
so scared that the universal appetite for speculation went negative.
Speculators wanted out of all risky assets, in any market.
So being
highly-speculative over the short term even in the best of times, silver
really bore the brunt of the anti-speculation bias in the worst of
times. Traders wanted out immediately, at any price. It was this
panic sentiment that directly led to the silver anomaly we are still trading
today. Weak gold, coupled with extreme general fear driven by the
plummeting stock markets, ripped the previously-bullish silver sentiment to
shreds.
But the thing
that makes an anomaly an anomaly is its short-lived nature. The more
extreme the psychology that drives prices out of whack, the quicker it will
burn itself out and the anomaly will start to revert back towards
normalcy. Indeed we’ve seen silver do this since the panic
ended. This metal has soared from under $10 to over $14 on balance,
recovering in a nice uptrend.
But this
reversion isn’t over yet. Note that after the panic gold quickly
regained its pre-panic levels between roughly $875 and $975, and it’s
been trading there for most of 2009. Meanwhile, silver is nowhere close
to its own pre-panic levels running between $17 to $19. But it’s
gradually getting closer to reestablishing its decades-old relationship with
gold. So far this year, silver’s r-square with gold has climbed
back up to 81.5%.
Although this
first chart is certainly adequate to make the case that silver is way
undervalued relative to gold today, it is far less precise than a true
silver/gold ratio chart. So as I’ve done periodically since
February, this next chart updates the progress of the SGR. The SGR in
blue is superimposed over the silver price in red.
Since the
SGR-proper yields an unwieldy small decimal (like 0.01464), I prefer to
invert the SGR to wrap my mind around it. The inverse of the actual SGR
yields 68.3, which makes more sense (it is technically the gold/silver ratio,
but viewed from the silver side). Instead of thinking silver is worth
0.01464 ounces of gold, it is easier to think in terms of it taking 68.3
ounces of silver to equal an ounce of gold. Thus, the SGR axis below is
inverted so this measure rises when silver is outperforming gold and vice
versa.
The sheer
magnitude and ridiculousness of the Great Stock Panic of 2008’s impact
on silver is crystal clear when viewed through the lens of the SGR. In
the 44 normal months before the extreme abnormality of the stock panic, the
SGR averaged 54.9. And this mean was based on a fairly tight trading
range between 65 and 45 with no extreme outliers skewing it. This 55
number should be familiar to investors.
If you do any
deep research into silver miners and gold miners, they often report
“equivalent” numbers. A primary silver miner will convert
its gold byproduct to silver-equivalent ounces while a primary gold miner
does the opposite. One metal is rendered in the cash equivalent of the
other. In wading through countless SEC quarterly reports over the
years, I’ve found the number used for this calculation is almost always
55. In the industry, an ounce of silver has long been considered to be
worth 1/55th of an ounce of gold.
But during the
stock panic, speculative zeal reversed so rapidly and radically that the SGR
plummeted to unbelievable depths. Within months after breaking
below its secular support which had held rock-solid for years, the SGR
had plummeted to 84! An ounce of silver was worth just 1/84th of an
ounce of gold. This was the lowest SGR witnessed over this entire
secular bull by far.
During the 4
months ending December that encompassed the stock panic, the SGR averaged
75.8. This was just silly, it made no sense and only persisted for even
that long because silver traders were so darned scared. At Zeal we
started aggressively buying and recommending elite silver stocks, and the
silver ETF, during this panic timeframe because there was no way silver could
stay so depressed relative to gold prices.
These trades have
proven very profitable since. The SGR has been recovering since the
panic and is in a nice uptrend. But as you can see, the SGR still has a
long ways to go yet before silver regains some semblance of normalcy relative
to gold. But make no mistake, it will happen. Since the
early 1970s when gold was freed to trade in the States again, silver’s
relationship with gold has been strong and unwavering.
You can spin a
variety of scenarios for this SGR mean reversion. The most conservative
one is simply to assume that gold remains stable in its post-panic trading
range as it has for many months now and the SGR simply reverts to its
pre-panic average of 55. Over the past month, gold has averaged just
under $950 on close. Gold staying flat and an average SGR implies that
silver will normalize to $17.25 or so, 25% above its levels of this week.
But the SGR mean
reversion probably won’t stop at 55 and gold probably won’t stay
flat, so the near-term bullish case for silver is far more compelling
depending on the assumptions you make. Note above that the SGR’s
secular support was rising steadily for years before the stock panic.
If that line is extended to today, it hits 49 or so. A 49 SGR at $950
gold implies about $19.50, 40% higher from here.
And psychology in
the financial markets seldom stops conveniently at the midpoint, it is like a
pendulum. If you pull a pendulum a long way in one direction, and let
it go, will it stop dead center? Certainly not, its momentum will keep
carrying it well past center in the opposite direction until its energy is
dissipated by nearly reaching the opposite extreme. Silver saw
extreme fear in the panic, among the worst it’s ever seen. Give
the magnitude of this anomaly, I suspect psychology will overshoot well into
greed before it normalizes.
So the SGR could,
at least temporarily when traders get excited, soar far under 55. How
far? Make a guess. It depends on how precious-metals psychology
unfolds, on how quickly discouraged silver investors return, and a myriad of
other inherently unpredictable factors. But take some SGR well under
55, the temporary overshoot, divide a $950 gold price by it, and you get some
seriously exciting silver targets.
On top of all
this, gold isn’t likely to stay flat either. All these
SGR-reversion silver targets get higher as the gold price they are based on
rises. Thanks to the Fed’s record monetary growth during and
since the panic, big inflation is coming.
Few things drive new gold investment like an inflation scare, and we are
going to see a doozy of one sooner or later here. And gold’s
innate supply and
demand fundamentals, including declining
mine production despite high prices, remain very bullish
with or without inflation.
All this is
exciting for silver, but it doesn’t offer clues on timing. But
other factors are coming into play that I suspect will lead to a substantial
acceleration of this in-progress and inevitable SGR reversion in the coming
months. Silver has incredible potential for one of its biggest autumn
rallies ever witnessed. Investors and speculators long this metal and
its elite producers would see huge gains in such a scenario.
Silver ultimately
follows gold, so nothing will get traders as excited about silver as quickly
as a major gold rally. Provocatively, we are just entering the seasonally-strongest time
of the year for gold prices. On average between 2000 and 2008 prior to
the panic, gold rallied 14% between August and February. Off of a $950
average gold price, a similar move this year would carry gold above
$1075. Gold decisively over $1000, highly likely soon technically,
would ignite all kinds of buying in the tiny silver market.
In addition,
remember that the stock panic’s universal dampening of the appetite for
speculation was what led to silver’s panic anomaly. Back in
January I did a historical
study showing that the biggest up years ever witnessed in
stock-market history tend to immediately follow the biggest down
years. 2008’s 38.5% loss was the S&P 500’s worst year
ever. So in January I said we should expect a 25% to 50% gain in the US
stock markets in calendar 2009. It was a very heretical and
controversial bet back then.
But with the SPX
up 10% year-to-date now, 25%+ SPX gains this year seem more plausible to far
more investors. And if the SPX is to achieve even 25% this year, let
alone 50%, it has a lot of rallying to do between now and
year-end. If general stocks rally big this autumn, which is likely, the
universal appetite for speculation will soar and cash will flood in off the
sidelines. Silver, among the most speculative of all commodities, will
be a major beneficiary of any speculation renaissance.
With a big autumn
silver rally very likely, some wonder how to play it. One of the best
ways is in elite silver stocks. While the SLV silver ETF will
match silver’s gains, silver stocks have the potential to multiply
them. Back in March we started gathering data on all the primary silver
stocks trading in the US and Canada. Our initial screens turned up
nearly 100. But amazingly, the total market capitalization of this
entire population was under $7b! It is higher now of course, but
still vanishingly small compared to every other sector. For comparison,
in late March the HUI gold stocks were worth $144b and the SPX $7218b.
So if any capital
at all bids on silver stocks during the coming silver rally, their prices
have to soar. They are just too small to absorb significant
buying. So which silver stocks are the best to own, the
highest-potential? We spent several months earlier this year
painstakingly narrowing down the universe of primary silver stocks to our
favorite dozen. We believe they have the best fundamentals and greatest
potential of all the silver stocks.
In June, my
business partner Scott Wright profiled each of these elite silver companies
in depth in a comprehensive and fascinating 33-page report.
Priced at only $95 for the fruits of hundreds of hours of world-class
silver-stock research, it is a steal. Buy your copy
today and get deployed in elite silver stocks before
silver leaves without you!
We also publish
an acclaimed monthly newsletter, Zeal
Intelligence. It analyzes the financial markets
including silver with the goal of growing our capital through successful
speculation and investment. In it I discuss what is going on in the
markets, why, and how we can capitalize on it through real-world
trades. With the coming autumn looking to be incredibly exciting, now
is the perfect time to subscribe.
The bottom line
is silver remains way too cheap relative to gold. The extreme fear
generated by the stock panic dragged silver down into an unsustainable
anomaly. Since the panic ended, silver has indeed been gradually
regaining ground relative to gold. But despite the progress in this
normalization, this anomaly hasn’t even come close to fully unwinding
yet. But it will, which implies much higher silver prices ahead.
And other factors
are likely to drive an acceleration in silver’s recovery in the coming
months. Gold itself looks very bullish, and growing mainstream
inflation fears could rapidly spark big investment demand. Nothing will
entice sidelined silver traders back in faster than a major gold rally over
$1000. And the general stock markets are likely to rally into year-end
too, fostering a renaissance in speculation. Of course silver is one of
the premier commodities speculations.
Adam Hamilton,
CPA
Zealllc.com
August 14, 2009
Also
by Adam Hamilton
So how can you
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on all the lessons we have learned in our market research. Please
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Adam? I would be more than happy to address them through my
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more information.
Thoughts,
comments, or flames? Fire away at zelotes@zealllc.com.
Due to my staggering and perpetually increasing e-mail load, I regret that I
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though and really appreciate your feedback!
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2006 Zeal Research (www.ZealLLC.com)
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