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This last year
for silver has been awesome! After a sideways grind in the $15 to $20 range
for most of the first three quarters of 2010, silver’s September
breakout unleashed a beast that has been nearly unstoppable. By the end of that
breakout month silver blasted through its bull high from early 2008, and has more than doubled since!
As an investor
who’s been accumulating a bunch of this metal for over a decade,
it’s been exhilarating watching my trove grow in value. Our newsletter
subscribers have also been rewarded handsomely, as at Zeal we’ve been
recommending physical silver since late 2001 when it was just over $4. Silver
bullion should be a foundational component of everyone’s portfolio!
With
silver’s incredible gains I was even more excited for the part of my
portfolio that held silver-mining stocks. The companies that are producing
this shiny-white metal should be rolling in the dough with some major profits
leverage. And those next-generation producers should be seeing the values of
their deposits skyrocket.
But while the
gains in silver stocks have been nice, they’re nowhere near what I
expected and have grown accustomed to over the course of this bull.
Considering their risks, these stocks should be delivering positive leverage
to the performance of their underlying metal, and they don’t appear to
be of recent. This is definitely a disconnect based
on historic precedent.
Unfortunately
we’ve seen a similar disconnect in the happenings of silver’s big
brother, gold. Investors have been endlessly frustrated with gold stocks
recently too, and rightly so considering their performance relative to that
of the yellow metal.
Gold stocks are
easily measured as a group via the venerable HUI gold-stock index. And
it’s disheartening to see the HUI at the same level today as it was
when gold was at $1400 in late 2010, and not much higher than where it was in
early 2008 when gold was at $1000. The HUI/Gold Ratio
further demonstrates this disconnect, currently at 2008 levels and well below
its pre-panic range.
While silver
stocks tend to follow the directionality of gold and gold stocks, I was
curious to see how they’ve fared in isolation relative to silver.
Unfortunately since this is such a small sector there isn’t really a
good measure of how they perform as a group. Silver stocks don’t have a
dedicated big-board index, and for a variety of reasons the silver miners ETF
that recently hit the scene doesn’t fit the mold.
It’s of
course easy to scrub an individual stock up against silver, but this still
doesn’t give me the big picture on the health of this sector. For this
reason I decided to run some numbers and come up with my own
“index”. For the components I used 10 top silver-mining stocks
that have listings on major US stock exchanges. And to develop some
perspective I ran the data back to 2003, when silver’s bull officially
kicked off.
As far as
indexes go, the one I put together is simple and incomplex.
All I did was calculate the daily gains/losses of each of these 10 stocks,
and then averaged them together for a daily gain/loss that is applied to the
index. (Note: Not all stocks ran back to 2003 due to either lack of listing
or non-existence. The average daily index gain/loss from 2003 to 2006 is
calculated from all available silver stocks of these 10. By 2006 all 10
stocks are included.)
This
hypothetical index is not a product of fancy formulas, it’s not
market-cap weighted, and it’s not price weighted. It is merely a proxy
on the collective performance of silver stocks as a sector. And for
demonstration purposes I indexed this index to the exact price of silver,
using the first trading day of 2003 as my starting point.
Even though the
starting points are the same, naturally silver and this makeshift index are
quick to diverge as their daily gains/losses differ. And as one would expect,
with the exception of the anomalous 2008 panic silver stocks take the high
road to reward investors for taking the risk. In this example if an investor
bought the metal and the index in the beginning of 2003 and held on to
current, he’d have seen gains of 913% and 1728% respectively to the
highs earlier this year (if I had chosen a different start date, the gains
and visuals would obviously be different).
You’ll
also notice that even though there is separation, the oscillations of stocks
and silver are clearly positively correlated. When silver rises, so do silver
stocks. When silver prices retreat, so do the stocks. And this visual
correlation is supported with an r-square of 93.8% over the course of
silver’s bull. This means roughly 94% of the daily price action of
silver stocks is mathematically explainable by the daily moves of silver.
But while this
positive correlation is great (and expected), and over the long term this
chart shows positive leverage, this doesn’t eradicate that
lack-of-leverage notion over silver’s latest upleg.
Investors have short memories, and usually strut a
“what have you done for me lately” attitude.
So what have
silver stocks done for us lately? Well it has been nearly 12 months to the
day since silver decisively broke above $20, over which time silver stocks as
measured by our index have gained an awesome 118%. This type of one-year gain
ought to make any investor happy!
So why aren’t we happy? Well, over this exact same span silver is up
114%. What have silver stocks done for us lately? They’ve left
investors without any leverage! 1-to-1 leverage is unacceptable considering
the serious risks inherent in these stocks.
Drilling down
on silver stocks’ relationship with silver, I can use this hypothetical
index to run a Silver Stocks/Silver Ratio. The SSSR is exactly what it sounds
like, the index’s daily close divided by
silver’s daily close. And charted over time, this ratio indeed shows
how silver-mining stocks are performing relative to the performance of their
underlying metal.
This first SSSR
chart offers us a bull-to-date view of how silver stocks have performed
relative to silver. And not surprisingly they’ve delivered positive
leverage. One of the reasons I indexed this silver-stock index to the price
of silver at inception is it gives us an SSSR starting point of 1.00x. Though
crude, it’s fair to deduce that a ratio greater than 1.00x
shows bull-to-date positive leverage.
More
importantly is the SSSR gives us an idea of where silver stocks should be
relative to silver based on historic precedent. And one thing that’s
important to distill from this analysis is the effect of the infamous 2008
stock panic. As you can see, the panic had a huge negative impact on the SSSR.
With the panic
such a rare anomaly, it’s prudent to consider the SSSR in a state of
normalcy prior to this historic event. And in the 5 years preceding the panic
the SSSR averaged 1.64x, fluctuating between about
1.30x on the low side and 2.00x on the high side. Another way to look at this
ratio is the silver-stock index closed each day about 64% higher than
silver’s prevailing price.
Well this
normalcy was thrown out the window in the panic. By the time the dust settled
the SSSR had plummeted well below 1.00x, to an
insane bull-to-date low of 0.60x. A falling SSSR can mean one of two things.
Either silver stocks are falling faster than silver, or silver is rising
faster than silver stocks. And with both stocks and the metal aggressively
sold into the panic blood bath, the former scenario was the case in the
SSSR’s decline. Silver stocks got creamed!
Eventually
investors realized the world wasn’t coming to an end, and they gobbled
up silver stocks at bargain-basement prices. At Zeal we were aggressively
buying, and in our November 2008 monthly newsletter we recommended that our
subscribers add a high-quality yet beaten-down silver stock to their
long-term investments. Today this stock is championing our investment
portfolio with a staggering 1001%
unrealized gain!
Not
surprisingly silver stocks mounted a massive rally out of their panic lows.
And as you can tell by the directionality of the SSSR, they greatly
outperformed silver over nearly the entirety of 2009. By the end of that year
the SSSR had climbed all the way back into its secular trend channel. This is
quite impressive considering the extreme panic damage.
Even more
impressive is the SSSR continued to rise, exceeding 2.00x
and touching secular resistance. Silver stocks were rocking in the second
half of 2010, decisively outperforming their underlying metal. But it was at
this point that the SSSR was repelled by its trend-channel resistance. And
this is when investors started raising their fists in fury. Secular trend
channel be damned, how could silver stocks lag considering the action in
silver? This next chart clearly conveys this “what have you done for me
lately” mentality.
Through about
the first three quarters of 2010 the SSSR was slipping marginally lower. And
this shouldn’t come as a surprise considering the state of silver at
the time. Following its post-panic surge this metal bounced around in the $15
to $20 range for the better part of a year. And this sideways action usually
leads to investors pulling out of speculative plays like silver stocks and
putting their capital to work elsewhere.
But once silver
caught a bid in September 2010, investors came back with a vengeance.
Silver’s breakout saw it blast through its March 2008 bull-to-date high
and enter into a massive upleg. And it took a
nearly-straight line to $30 before finally taking a breather.
This type of
action warms the hearts of investors and risk-junkie speculators, and they
aggressively bought silver stocks as silver continued to hit prices that had
not been seen since the brief super-spike of 1980. And as you can tell by the
directionality of the SSSR, silver stocks were handily outperforming the
metal. Investors were being rewarded for the risk they were taking in owning
these stocks.
But
provocatively upon silver’s challenge of $30 the stocks ran out of gas,
and in December the SSSR hit its post-panic apex of 2.24x.
The SSSR’s initial leg down coincided with a brief silver pullback in
January that dropped it down under $27. And in this situation stock weakness
was to be expected. If silver prices pull back, it’s usually risk-off
and time to sell the stocks. Investors can’t expect only one-sided
leverage.
But
silver’s moderate pullback was indeed brief, and before long the metal
was back at $30 with its sights set a lot higher. Amazingly silver proceeded
to go parabolic, not looking back until it challenged all-time nominal highs
near $50. But as you can see, silver-stock investors weren’t as
enthusiastic about these record highs.
When silver hit
its high in late April the SSSR had actually trended down to 1.65x, a 26% drop
from its high. Silver was well outperforming the stocks, and this really had
folks scratching their heads since the metal was going nuts and the stock
markets were strong (the S&P 500 hit its year-to-date high the day after
silvers). It was seemingly the perfect environment for silver stocks to gain
fanfare and leverage the metal to the high side.
Silver stocks
were rising, and the gains were still great, but they ran at a slower clip
than the metal. This SSSR weakness really showed that stock investors
didn’t believe in these high silver prices. And as contrarians
expected, the metal fell sharply on the back side of its parabola.
Silver
eventually found its interim base around $33, and has since launched higher
with gold in what has turned out to be a strange summer precious-metals
rally. So what have silver stocks done in this latest surge higher that has
silver back up over $40? Well according to the sinking SSSR, they continue to
lag. This time they’ve faced big headwinds amidst a sharp stock-market
correction.
So what have
silver stocks done for us lately? Unfortunately, not enough! At $40+ silver
these stocks should be tearing it up. But for whatever reason, whether a lack
of confidence that these levels can hold, the stock-market correction, or an
adherence to historic ratio levels, silver stocks have not given investors
the leverage they deserve and need recently.
Amazingly some
folks have trouble understanding why we need leverage considering the
still-great gains in silver stocks. And indeed this sector has been among the
best-performing of recent. In reality though it is easy to understand this
leverage requirement when you take into account the inherent risks involved
in owning these companies. Just to name a few, mining companies are subject
to geopolitical, geological, operational, and financial risks. Silver has
none of these.
In order to
give investors incentive to own these stocks there must be the allure of
positive leverage. With higher risks investors usually demand higher rewards.
Besides, if the gains aren’t outsized then there is no reason to own
stocks when you can get the same or better returns owning the much-less-risky
physical metal.
And speaking of
risk, this high-risk unbalanced-reward trend is very risky for the
silver-mining industry. These companies heavily rely on retail investors to
buy shares of their stocks and thus fund development and expansion. If
conditions like what we are seeing lately in the SSSR persist, and investors
do lose interest, this could be very dangerous for today’s and tomorrow’s silver companies.
So what are we
to make of this period of silver-stock underperformance? How long will it
last? When will things turn around? Of course as mere mortals all we can do is game probabilities for what the future has in store.
And as a prudent investor it’s critical to pay attention to the many
different driving forces that can influence silver’s interim and
long-term moves.
This makeshift
silver-stock index and resulting SSSR can act as a secondary indicator that
can be used to observe behaviors and perhaps support buying/selling
decisions. And as a long-term investor who holds both bullion and stocks, and
a trader who likes to speculate in stocks, such metrics are indeed important
to consider.
One thing that
the SSSR tells me for certain is that we are in an environment where
individual stock picking is increasingly important. Feeding this ratio is an
index where the gains and losses are averaged across a large group. And as is
usual in averaging, there are some big outliers. Some of the individual
silver stocks greatly underperform the average, and some greatly outperform.
I want to own
the stocks that greatly outperform. I want to get bang for my buck and have
confidence that the hand-selected basket of stocks I own will give me
leverage to silver even though the sector as a whole may not. Silver is still
likely only in the middle of a secular bull where prices ought to eventually
eclipse those highs seen earlier this year. And at these high prices the
miners will be printing the Benjamins. I have no
doubt that investors will take a liking to silver stocks once again.
It’ll be hard not to considering their profits leverage.
Even though
gold is currently overbought, we are
entering into a historically strong season for
precious metals. Perhaps the SSSR is poised to break out of its downward
trend and head back up towards secular resistance when these opposing forces
work it out. For this reason it is important to have your silver-stock shopping list ready. And perhaps it is also
time to trust Zeal to guide your navigation of these crazy volatile markets.
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The bottom line is silver stocks as a group are
performing quite well amidst silver’s spectacular run to historic
highs. But as the SSSR shows, these high-risk stocks currently aren’t
giving investors the positive leverage that is needed to make owning them
worthwhile. This is likely just a temporary disconnect, but it has still
caused some angst amongst investors.
To alleviate some of this angst, it would behoove investors to find
some outliers that are capable of delivering leveraged gains even when the
sector can’t. And though silver is in a state of limbo with the
crosscurrents of entering into a seasonally-strong time of year with gold
overbought, investors need to be ready to deploy at the drop of a hat.
Adam Hamilton,
CPA
Zealllc.com
So how can you
profit from this information? We publish an acclaimed monthly
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that details exactly what we are doing in terms of actual stock and options
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Questions for
Adam? I would be more than happy to address them through my
private consulting business. Please visit www.zealllc.com/adam.htm for
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
am not able to respond to comments personally. I will read all messages
though and really appreciate your feedback!
Copyright 2000
- 2006 Zeal Research (www.ZealLLC.com)
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