Silver has endured
a rather tough June so far. After peaking just under $16 on the
2nd, this white precious metal plunged 12% to just over $14 by the
15th. This is certainly a significant decline for less than 2
weeks, so silver traders are anxiously wondering what it portends.
Will silver languish in the summer doldrums again this year?
Perhaps, only time
will tell. But I suspect this year silver will buck its typical
lackluster summer
trend and prove exceptionally bullish. Due to the wildly
volatile market behavior of the past year, silver happens to be in a
very unique position today. It remains seriously undervalued
relative to gold. The ongoing rectification of this anomaly alone
should lead to silver buying on balance in the coming months.
Provocatively, the
gold-price trends are the single most important driver of the silver
price. The reason is simple. Silver investors and speculators all
watch the gold price as well, it is the primary ingredient coloring
their sentiment. So when gold is looking strong, they flood into
silver and bid it up rapidly. And when gold weakens, many are quick
to exit silver. The technical results of this behavior are
striking.
A couple years ago
I did a comprehensive study of the interrelationship between silver
and gold since 1971. As the 7 comparative charts in
that essay
revealed, silver has almost always followed gold?s lead throughout
our entire modern era. Where gold goes, silver follows. History is
crystal clear on this. I like to joke about this nearly-ironclad
relationship by calling silver ?gold?s lapdog?. It irritates some
folks.
This quip is
certainly not intended to denigrate silver, but to illustrate a very
profitable technical truth for traders. I am a long-time silver
investor and speculator. I started recommending physical silver
coins as investments back in late 2001 when this metal languished
just above $4. Some of our best-performing long-term investments
today are elite silver stocks we recommended way back in 2002. I?ve
been long silver, very profitably, since before the great majority
of today?s investors ever considered owning it.
And over this
secular silver bull?s span, I?ve learned that gold is often the key
to gaming silver?s short-term trends. To trade the white metal
successfully, you have to understand the dominating role gold plays
in shaping silver-trader psychology. While silver may temporarily
decouple from gold in rare extreme situations, over time it will
always revert back to following its far-larger and more-important
cousin.
This is exactly
why silver has more potential to rise this summer than in any other
I?ve witnessed in this bull. During last autumn?s stock panic,
silver traders panicked with the rest of the world and aggressively
dumped the metal. Since silver is such a tiny and hyper-volatile
market, this intense selling drove it down much faster and farther
than gold was falling. The resulting unprecedented anomaly persists
to this day.
This peculiar
episode is easiest to understand when illustrated visually with a
chart. The blue line is silver, superimposed over gold in red.
Both metals are rendered on zeroed axes so there is no visual
distortion. I ran the data back several years or so before the
panic, so the baseline behavior of silver relative to gold can be
established before the wild and crazy events of late 2008.
Before the Great
Stock Panic of 2008, silver tracked gold beautifully. When gold was
rallying, traders would flood into silver forcing it to surge higher
and faster than gold. When gold was correcting, silver selling
would drive outsized declines relative to gold. Silver was doing
just what it always had, amplifying and leveraging underlying moves
in gold. And this relationship is mathematical, not just visual.
Between January
2005 and August 2008, a long-term pre-panic span, silver had a
correlation r-square with gold of 94.7%! This is stellar,
unbelievably high as any statistician will tell you. It means that
nearly 95% of the daily price action in silver was statistically
explainable by gold?s own daily price action. We traded this
relationship to much success, studying gold to figure out when a new
upleg was probable and then buying silver and silver stocks to
leverage gold?s run higher. It was great fun.
But during last
autumn?s brutal stock panic, the first
in 101 years,
silver?s very tight correlation with gold suddenly vanished. Silver
actually decoupled from gold, something I never thought I?d
witness. While startling, the reasons behind this extraordinarily
peculiar event offer excellent insight into the perceived nature of
gold and silver among traders today.
The stock panic
terrified speculators. When the S&P 500 plummeted 27% in less than
4 weeks in October, traders rushed to liquidate all risky assets.
They sold absolutely everything, fundamentals be damned, in a
desperate rush to raise cash and end the intense financial pain.
Silver has always been a risky speculation and it was treated
accordingly. It plunged 25% to the very days of that October stock
selloff. Provocatively it even bottomed on the same days as the
stock markets in October and November!
Gold too was hit
in this maelstrom of fear, but to a much lesser extent. Gold is a
classic safe-haven play, a place to protect capital in financial
crises. While the enormous deluge of capital surging into the US
dollar (cash)
weighed on gold, it still weathered the panic better than almost
everything else but the dollar. Traders weren?t as quick to
liquidate their gold as their silver, as it was still perceived as a
refuge in the storm.
The results of
silver being treated as a speculation during the fear bubble, while
gold generally wasn?t, are clear above. When the dust settled, gold
had only been driven down to a 14-month low. But silver, which even
long-time contrarians weren?t excited about holding in the
hyper-fearful panic environment, plummeted to a 34-month low. The
intense fear had driven silver to decouple from gold, an incredible
anomaly.
Silver?s
mathematical correlation with gold was even broken during the panic,
it tended to move with the general stock markets instead.
Universally all speculators were watching the plunging stock markets
for trading cues, so all risky assets including silver mirrored the
S&P 500. Between September and December last year, the months that
encompassed the stock panic, silver?s r-square with gold plummeted
to 52.5%. Gold?s influence had faded dramatically, gold no longer
dominated silver traders? sentiment.
Since those crazy
events, silver has been recovering. Its post-panic r-square with
gold is rising again, up to 81.8%, as gold?s psychological influence
is once again starting to override the stock markets?. But although
gold was soon bid back up to pre-panic levels, silver has lagged far
behind. So many silver traders were hurt so badly during the stock
panic that they are in no hurry to redeploy their remaining
capital. Their reluctance to return has created big opportunities
for us today.
As this chart
illustrates, based on pre-panic history silver should be trading
between $18 and $19 or so given today?s prevailing gold levels.
This is about a third higher from where it was trading earlier this
week. As time continues to dull the psychological wounds from the
panic, as the fear continues to fade, I have no doubt that silver
will reestablish its decades-old historical relationship with gold.
Traders today can ride this reversion higher in silver itself and
the companies that mine it.
A more precise way
of measuring the relationship between silver and gold is the
Silver/Gold Ratio. The SGR simply divides the daily silver close by
the daily gold close. But since the result is a hard-to-digest tiny
decimal (0.0152 this week), I prefer to use the inverse of this SGR.
Also known as the Gold/Silver Ratio, it yields numbers that are
easier to follow mentally (65.7 this week). In other words, an
ounce of silver is worth 1/66th an ounce of gold.
But charting the
GSR natively is misleading when analyzing silver, because when
silver rises this ratio falls. So I prefer to invert the GSR axis
and call it an SGR (which it effectively is at that point), thus a
rising ratio logically indicates relative strength in silver
compared to gold and a falling one relative weakness. When this
blue SGR-proxy line below is rising, silver is outperforming gold.
When it is falling, gold is outperforming silver.
For at least
several years prior to the stock panic, the SGR averaged 54.9. An
ounce of silver was worth 1/55th of an ounce of gold. And this
average was derived from a pretty tight relationship as the SGR line
above shows. The 55 SGR average wasn?t skewed by a few radical
extremes, but driven by a longstanding trading range with relatively
mild deviations from the mean. It was this bull?s pre-panic norm.
But when
speculators panicked last autumn, the SGR plummeted. It shattered a
rising secular support line that had held for years. By the time
the stock panic bottomed in late November, and hence silver bottomed
that very same day because that?s when fear was the most intense,
silver had hit its worst levels relative to gold of its entire
secular bull. Silver was trading under $9 while gold was around
$745, a huge disconnect.
That day at
silver?s nadir, the SGR fell to 83.5. An ounce of silver was merely
worth 1/84th of an ounce of gold! And during the final 4 months of
2008 which encompassed the stock panic, the SGR averaged 75.8.
These were just stupid-low levels that made no sense at all, like
most prices late in the panic. Extreme fear had driven such intense
selling that prices totally decoupled from their underlying
fundamental realities.
But extreme
emotions never last for long, their very intensity soon burns itself
out. And to hardcore students of the markets, even in the very
heart of the panic it was crystal clear that such cheap silver
levels relative to gold couldn?t be sustainable. So we did the only
thing good contrarians can do in a panic, we bought
aggressively and recommended our subscribers do the same. They?ve
been richly rewarded.
As of the latest
Zeal Intelligence, a new long-term investment in an elite silver
stock made in the bowels of the panic had already nearly tripled.
In Zeal Speculator we bought
the silver ETF
when silver was still under $10. We?ve since added more successful
silver trades in both our monthly and weekly newsletters. Trading
this mean reversion in the SGR has already been very profitable, and
it is not over yet.
Back in early
February when I wrote
the original essay
in this series, the SGR was running near 72 which wasn?t much above
the panic average. Today, about 4.5 months later, it is near 65.
Since silver was radically more oversold than gold during the stock
panic, it is rallying much faster than gold emerging out of the
panic. So before this year is out the SGR should again converge
with its 55 historical average.
This means even if
gold does nothing, which is highly unlikely given the
coming inflation
scare, silver has plenty of room to run higher this summer.
Despite recovering considerably already, it still remains way too
cheap relative to gold. At $925, $950, $975, and $1000 gold, the
long-term 54.9 average SGR yields near-term silver target prices of
$16.85, $17.30, $17.76, and $18.21. All of these are nice gains
over today.
But for a variety
of reasons I doubt the SGR will conveniently stop at its average.
First, note the SGR?s rising secular support line above that was
broken by the panic. It showed a long-term tendency for silver to
rise a bit faster than gold. And this makes sense since silver is
such a small market. If investor interest and capital deployed in
gold and silver each grow by a similar amount, silver will rise
faster. If you extend that SGR support line, it hits 50 now and
about 48 by the end of 2009. Let?s call it 49.
At 49 SGR secular
support, at $925, $950, $975, and $1000 gold, silver would trade at
$18.88, $19.39, $19.90, and $20.41. These prices are obviously even
more attractive and much higher than today?s. But even this is
nowhere close to the best-case scenario. Even with flat gold, the
SGR could very well shoot a lot higher than 49, at least
temporarily.
Once a
long-standing equilibrium (a 55 SGR) is disrupted in the markets,
there is usually a countermove in opposing proportion to the
original disruption. Visualize a playground swing. Hanging
straight down is equilibrium. If you pull the swing 1 foot in your
direction and let it go, it will initially swing about 1 foot in the
opposite direction before normalizing. But if you pull it 10 feet
in your direction, a bigger disruption, the counterswing will be
proportionally larger. The SGR was dragged far off equilibrium by
the panic.
So it would not
surprise me one bit to temporarily see the SGR swing proportionally
in the opposite direction. Silver was so beaten down in the panic
that the return of silver speculators will probably drive it far
higher than gold would suggest is prudent. I don?t know how high
the SGR could go in such a silver greed spike, but examine the chart
above and make a guess. We could be in for a major silver spike
before SGR equilibrium is restored, which would be wildly profitable
for those long silver.
But perhaps the
most bullish thing of all about this SGR reversion is that all my
analysis so far assumes gold merely stays flat. But this is very
unlikely. Not only are the
yellow metal?s
fundamentals very bullish today, but the Fed?s recent
doubling of the US
monetary base will soon stoke the biggest inflation fears since
the 1970s. When mainstream investors start reallocating capital
into gold, all bets are off the table on how high silver could go.
Gold is the big silver wildcard right now, and it is an exceedingly
bullish one.
While I own lots
of physical silver, and am still trading the silver ETF, I believe
the biggest opportunities by far in this SGR reversion are in the
elite silver stocks. While silver was sold off far more
aggressively than gold warranted during the panic, silver stocks
were in turn dumped even more aggressively than the dismal silver
prices warranted. Silver stocks, still recovering, remain too cheap
relative to silver today.
Thus we could
easily see a doubling to quadrupling of most great silver stocks?
prices, from here, by the time this SGR reversion fully runs
its course. Add in the first inflation scare of the modern era, and
the gains could be even bigger. Silver stocks are a minuscule
specialized sector with a trivial total market capitalization
relative to not only the broader stock markets but even gold stocks
(which themselves are a tiny sector).
At Zeal we?ve been
trading this SGR anomaly since the heart of the panic. But the
panic was so damaging to silver companies? abilities to raise
capital to finance their endeavors that we needed to figure out
which silver stocks could survive and thrive in this tough
environment. So back in March we launched a comprehensive 3-month
fundamental-research project to find our favorite 12 post-panic
silver stocks.
Our initial
screens turned up nearly 100 primary silver stocks trading in the US
and Canada. Provocatively, back in late March they had a
collective market cap of just $6.8b. This is astoundingly
small! At the end of March the gold stocks of the flagship HUI
index had a collective market cap of $144.1b. And the S&P 500?s ran
$7217.8b. So if anyone gets interested in silver, these
stocks are going to skyrocket. They are just too small to absorb
any meaningful capital inflows.
My business
partner Scott Wright, one of the best commodities-stock analysts in
the world, painstakingly whittled down this universe of primary
silver stocks until we had our favorite dozen. He then wrote an
outstanding new 33-page
report analyzing each of these fantastic silver companies?
fundamentals in depth. It is a fascinating, educational, and
entertaining read, a vast array of research and analysis condensed
into a highly-valuable summary. It is these elite silver stocks we
will trade going forward.
Just days ago, we
published this brand-new silver-stock report. At just $95 ($75 for
Zeal subscribers), it is an amazing value. Even if you are an
accomplished silver-stock analyst, it would take you hundreds of
hours to attempt to replicate this research. And if you haven?t
already spent many years wading through SEC reports, company
releases, and many other arcane sources of information, you?d never
be able to undertake such a complex project. So if you are
interested in elite silver stocks,
buy our new report
today!
As always we?ll
continue to analyze and trade silver and the silver stocks going
forward in our acclaimed
monthly and
weekly
subscription newsletters. While these popular free web essays
outline some of our basic research, it is only in our newsletters
where we tie everything together and launch high-potential stock
trades for the good folks who finance our hard work.
Subscribe today
and see what you are missing!
The bottom line is
silver remains way too cheap relative to prevailing gold prices.
And history strongly suggests this anomaly, driven by the stock
panic, will not persist. Silver needs to rise considerably to
normalize with gold even if the latter stays flat, which is
unlikely. The gigantic money-supply growth and coming inflation
scare should drive incredible mainstream interest in deploying
capital in gold and silver.
While silver
itself will see nice gains in this inevitable SGR reversion, the
gains in the best silver stocks will dwarf silver?s. Not only is
this sector tiny, but investors and speculators largely abandoned it
during the panic. As they return, and traders new to silver stocks
join them, we will see elite silver stocks multiply in value. The
still-unwinding panic aftermath should lead to a far-from-typical
summer for silver.
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