Tuesday, March 1, 2011

Silver

I have received some emails that are causing me to think I might not have properly explained the silver market for new readers.

Gold is a monetary instrument that effectively stores value.  In times like this you would purchase physical gold in order to preserve purchasing power.  Central bankers kept in power by politicians desperate to keep their power have only one enemy and that is a sound currency or unit of account.  If you must purchase a gold ETF please consider CEF or PHYS as alternatives to GLD as they hold proven allocated metal and I believe very strongly that there could be problems with the authenticity of GLD's holding,  When a more certain alternative exists you should consider it strongly.

There is 17 times as much silver in the earths crust as gold.  Silver has industrial uses but is also a monetary asset.  The silver gold ratio based on price is over 41 today, as compared with 17 in the earth.
The COMEX, a division of the NYMEX, is the primary physical commodity exchange.  Major banking institutions have been allowed to manipulate prices on this exchange by selling short using contracts that are not backed with physical silver.  This is called "Naked Short Selling" and they can do it but if you do it you will be in trouble with the government who's job is to protect them by keeping you out of their way.
These banks have now been backed into a corner in this trade and there is report of the COMEX being liable for delivery of 7 times the silver that they posses, causing the banks to offer 25% premiums for cash settlement of liabilities.  This is only the tip of the iceberg.  You don't need to spend a lot of time "solving" this problem in your head just make the obvious trade.

Here is how to view the silver trade.  Physical silver is great.  It is hard to store but get over it.  Buy some 1,000oz blocks and make an ottoman out of them or something just do whatever you want but get some.  It is in such short supply right now that you might have to wait up to 6wks for delivery.  So, am I making my point yet about where the price is silver is headed?  Also, if you have not realized that the large banks who are short might be managing one of the "physical" silver funds that your inept broker is trying to sell you then maybe you should do some more reading before making the purchase.  If you must purchase a physical silver EFT please consider PSLV as a fully allocated alternative to funds that are managed by the shorts.  Your broker will likely not be familiar with this fund.  Consider asking said broker to read about the fund before making a final decision.  

Silver miners often the most aggressive way to play rising silver prices.  Here is a simple example of how you can drink upstream from the herd in this trade.  Look at a miner's cost of extraction per ounce.  Lets say ABC Co, is pulling silver from their Mexican mine at $9/oz with no debt and the stock has not moved with the price of silver.  You want to get in front of this trade because they are selling that same ounce onto the market at todays price.  I am simplifying this as there can be issues with the company selling their future production at a fixed rate causing them to miss part of the price rise.  There also can be debt considerations, management problems and shareholder dilution just to name a few of the issues that come up in the mining business.

There is an easy way to mitigate these issues.  Pick a couple of blue chips as a base then take the rest of your capital allocated to silver miners and spread it equally over a basket of smaller companies once you have done sufficient homework.  These smaller companies are where your gains come from.  For example, I bought a South American silver miner that had no debt and an $8/oz extraction cost last November just after Thanksgiving.  I bought these shares on the pink sheets because I did not have access to the Canadian exchange.  They have since listed on the AMEX and the shares have risen from $2.07 to $4.65 today.  I am still bullish on the shares because every ounce of silver they produce is more valuable every day in dollar terms.  I can only equate it to running a factory selling 1,000 widgets a day and you are in a period where there is an extreme shortage of widgets and the price continues to rise.  Mining costs are typically 25% energy related so that cost component is rising but not in proportion to the value of what is in the ground.  Your small miners that are well picked will benefit from large producers desperate to fill their pipelines.  In a takeover frenzy you want to be the hunted not the hunter.

Best of luck and don't over think this obvious trade.

Sprott Double Barrel Silver Issue

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