Unless you have missed – and i mean, really missed – the last few weeks of action in the silver market, it’s hard not to get excited about the prospects of silver reaching new heights towards the end of 2010. After all, all the indicators are there. You’ve got the economy in the tanks (who said that metals can’t move in a recession?), countries devaluing their own currency, and the never ending black hole of US government spending. Throw in the fact that big brother gold is at all time highs, and you’ve got a bunch of reasons to remain optimistic about silver over the short term. The problem, though, may be an interesting one for once-suffering silver longs: do you really want silver to race to the moon so quickly? The more I think about $25/$30 silver over the next couple months, the more I’m concerned about the health of the market. Here’s why:
1. We want to preserve silver as an investment vehicle, not a trading vehicle.
No, the two aren’t the same. For years, I used to watch the penny stock market. Some of these little stocks would move thousands of percent in days. The stocks would skyrocket higher, have pretty insane pullbacks, and go higher again before eventually petering out back to, or below, where it all started. When the stock was in play, everyone wanted a piece of the company. They pumped out press releases, were overloaded with investor calls, and probably felt pretty good about themselves. Unfortunately, once the magic dies, these stocks become ghost towns. When you establish that an asset is simply a vehicle for quick ins and outs, it is almost doomed to ignore the interests of long term investors. The problem comes down to the market. One of the reasons why gold has been so successful as an asset class is that, while it has outperformed many other asset classes, it is fairly reliable and stable. Once [insert millionaire guru or fund manager here] decides to sell their mega position in gold, there is a real market capable of representing a solid buy-side to that trade. That’s where those little penny stocks fail. When those stocks drop, it’s one of those ‘last one left turns out the lights‘ deals. While silver definitely has a real buy-side market in its current price ranges, there’s no guarantee we have that strong market at $30 anytime soon unless we spend a reasonable amount of time getting there.
2. Manufacturers who use silver are more likely to keep buying in a steady market
I posted this on a forum, got blasted and called a ‘newbie’, but I really believe this. Say you’re a company like Dupont, who is making a killing on their silver-based Solamet metallization paste used to coat solar panels to make them more efficient. Since the paste is probably 75-94% silver (I didn’t look real hard for the specs, sorry!), they are very vulnerable to increases in the price of silver. For example, if the price of silver were to blast its way to $50 over the next few months on some epic run, you’d see a knee-jerk reaction in the price of anything silver-based, likely killing the market for that product. Will solar manufacturers continue to buy silver paste at twice the price, or will you see them hunt for a more cost effective solution? After all, they’ve got margins to worry about too. This is similar to the problem the US Mint is having right now. The cost of a penny is almost two pennies. The cost of a nickel? A staggering 9 cents. Now imagine if we were personally charged to receive change in everyday transactions. For every nickel you were due, you’d get a bill for 4 cents more. You’d look at the absurdity of it, ask why they don’t make the nickel out of something cheaper (hint, they will), and eventually you’d see nickel use decline in coinage circles. Declining use kills demand, which reduces price. The luxury Dupont has? They dont have to wait for legislation. If the price of silver starts to really scare them, they’ll jack that price up faster than a Nintendo Wii at Christmas. Meanwhile, a crop of competitive materials will emerge, eventually replacing silver in that industry altogether. Dupont will have a much better time supporting the raw material if they can consistently forecast its price. Their customers are a lot less likely to take issue with a slow increase. It’s just like the government raising your taxes. In 1963, Indiana had a 2% sales tax. Today, it’s 6%. If it happened in a year, we’d have a run on pitchforks.
3. You probably don’t have enough exposure to silver.
Of course, ‘enough’ is relative to whatever your financial situation is. Even renowned bear Jon Nadler concedes that a ‘core’ 10% asset allocation is prudent. If you’ve got less than 10% of your assets in silver/gold/combination, then you’re not even matching a guy that appears to like silver as much as a root canal. Think about what you’re invested in. Jim Rogers, a better respected authority in the metals market, advises to invest in the tangibles. Agriculture. Water. Metals. Things we need. Things we use. Things that have real cost and real value. They’re not sexy. CNBC isnt going to talk about coffee futures a whole lot, but they’ll talk about Starbucks. I’ve got close friends that are sitting on almost all cash, which is typically seen as an uber-conservative position. Unfortunately, if the dollar ever takes a swan dive, that cash hoard you’ve been sitting on will disappear rapidly. Silver goes up, it goes down, but it never goes to zero. Our currency already concedes that we’re trusting in God, but its also our government, the federal reserve, and who knows how many other foreign banks and funds that we need to have faith in. Silver is precious, but its also extremely functional as an industrial metal. In my opinion, maintaining value is not nearly the leap of faith that we take every day with our dollars. Quite simply, the longer it takes silver to achieve what you think a reasonable valuation is, the more time you have to load up. Maybe not the boat, but at least a nice sized truck.
[image title="darthVader" size="full" id="224" align="center" alt="I find your lack of faith disturbing!" linkto="full" ]
I find your lack of faith.. disturbing!
The price of silver going up is a damn good thing. It keeps the short sellers honest and chips away at a super-inflated gold to silver ratio. That said, I worry about the expectations of the market once this begins to look overheated. If we sit at $20 for six months, that’s okay, because the next time around we’ll have established a solid comfort level at that price zone. ‘Psychological resistance’ can be just as important as physical resistance. If you would have tried to sell me $27 silver on eBay when I first started buying at around the $4 level, I’d of said you were crazy. Fortunately, we spent just enough time in the $10-20 range where it began to be the new normal to be buying silver in the mid to high teens. We’re getting in the area where you could legitimately see $30 offers for eagles (spot + $6 was common the last time I made calls locally) at coin shops. It doesn’t seem that long ago when I could load up on Philharmonics on eBay for $17 or $18 bucks. $30 is definitely a ‘psychological’ resistance point. Fortunately, life has a way of smoothing out those psych-outs through our concept of time. I’m going to keep buying silver, because it’s part of my savings strategy for the future. That said, if and when we see the rally stall or pull back? It’s going to be better for every enthusiast out there over the long run. It’s bound to happen. Understanding why it could, and should, will only position you even better when it does.
You make some good points. However, a lot of the price action lately is probably due to “big money” getting in. Just because they are big doesn’t mean they are traders looking for a pump and dump. It’s a lot more expensive and difficult to buy and sell gold and silver than it is to buy and sell stocks, so I don’t really see the price action as a worry. A big warning sign in my opinion would be if the ETFs SLV and GLD were trading at a premium to the spot price of the metals rather than the reverse. If it happened, it would indicate a lot more speculation and trading by those who aren’t interested in the underlying metals themselves. Also, I would expect the mining shares to go vertical as the prices of the metals go parabolic. That has definitely not occurred at this point.
Also there is the market suppression story. I’m not sure whether it’s possible to verify the truth behind it, but there certainly is every reason for central banks to attempt to keep the price of the metals low so that their worthless currencies don’t appear worthless. On that basis alone I’d say it’s plausible. So part of the price action is probably also related to the metals rebalancing toward equilibrium with the dollar.
One thing you can count on with silver is volatility, and it’s highly unlikely we’ve seen the last of it on the downside.