Monday, April 25, 2011

Physical Silver Market Is A War Zone

What is the best way to win a war?  Stay out of it and preserve resources while the warring parties destroy each other.

We have written ad nauseum about the need to own physical precious metals in your portfolio.  These elements are difficult to acquire and most importantly can not as of this time be printed by a corrupt central bank.  Silver is a monetary metal with some industrial uses but acts as an acceptable store of wealth during times of excessive currency abuse.

When we began encouraging readers to think about silver there were two major macro-economic factors that led us to the sector.  First, Bear Stearns held a very large short position in the paper silver market and had effectively prevented any meaningful price rise for years.  JPM acquired Bear in a fire sale back in March of 2008.  We knew for some time that unlimited fiat paper and a finite supply of minerals had an inverse relationship.  This would eventually cause problems for JPM.  The second factor that led us to favor silver was the gold:silver ratio.  The earth's crust contains 17:1 parts silver to gold.  When we were acquiring silver at the most aggressive pace that ratio was over 60:1 in US$ terms.  These two factors made silver our favorite precious metal.

The action in this chart below is somewhat alarming.  Please notice the dramatic price rise and we will explain why it should be considered below:
Chart foriShares Silver Trust (SLV)
As you can see the metal has been on a terrific bull run since late August 2010.  There is nothing wrong with this type of move if you are long the metal at a sensible entry price.  This is now becoming a trade that should not be the beneficiary of any fresh capital until the market settles down.  We would like to be crystal clear that this does not mean selling is reasonable either.

There is a war raging between long and short holders of paper silver futures contracts.  The shorts have access to the central bank's printing press, control over the COMEX warehouses, storage facilities, the exchange and the politicians running the regulatory authorities.  The longs know that the metal attached to their contracts is in very very short supply and if available at all will cause the shorts to pay premiums to meet delivery requirements.

Obviously this is bullish for a physical silver position in the long run.  There is no good reason to unload the position at any price in this environment.  The point here is that jumping into this type of fight is a good way to get your teeth knocked out.

We are entering the summer months which are traditionally a soft trading period for the metals.  Also, the Federal Reserve has decisions to announce regarding how they plan to lie about the continued money printing in late June.  Let's all get ready to feel smart reading the Wall Street Journal's explanation of the fancy new acronym that will be used as cover for the next round of counterfeiting.  While we feel that silver will eventually take out much higher price levels, there are more attractive trades at this time.  Once the dust settles there will likely be another opportunity to add to physical metal holdings.

Consider our last post on Silver Mining Stocks as there are tremendous values available.  These stocks have not kept pace with the metal that they mine.

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