Saturday, January 12, 2013

Silver To Shine Again: Prepare For A Burst Higher

Over the next 12-18 months I'm expecting a major burst higher in Silver which will take the price to new highs, finally cracking through the US$50 nominal record set in January 1980.

If we take a look at the price of Silver over the past 10 years we can see a repeating pattern of volatile bursts higher as the secular bull market plays out:

Click chart to enlarge
If we see a similar rise to previous peak to peak moves (noted on the chart as 80%, 40% & 133% respectively), we can expect the next sharp move higher to take us to somewhere between $68 and $114. 

From the October 2008 low of $9.01 (London Fix prices) the price rallied 5.4x to $48.70 some 2.5 years later. If we saw a similar move this time we would be looking at Silver spot price of $141 around the middle of 2014 (from $26.16 low in December 2011)... that figure lines up conveniently with the inflation adjusted peak from 1980 discussed by Adam Hamilton in this recent article, Real Silver Highs 4:
Silver bearishness has naturally mushroomed following this metal’s rough December.  A growing chorus is declaring silver’s secular bull finished, implying it must have peaked after silver’s dazzling April 2011 surge.  But secular bulls climax in popular speculative manias, which dwarf the silver action of a couple springs ago.  Looking at silver in real inflation-adjusted terms drives home the point its bull is far from over.

For any multi-decade price comparison, adjusting for inflation is essential.  A dollar today is worth a lot less than a dollar in the past.  The Federal Reserve keeps conjuring up new fiat dollars out of thin air, inflating the money supply.  As it grows faster than the underlying economy, relatively more dollars compete for relatively less goods and services.  This monetary inflation bids up the prices of everything.

And to get an idea of what a secular-bull-ending popular speculative mania in silver really looks like, we have to travel back to the last one in early 1980.  Silver peaked at the then-breathtaking level of $48, which no longer sounds extreme.  But a dollar back then went a heck of a lot farther than a dollar today.  The intervening three decades of relentless inflation have greatly eroded each dollar’s purchasing power.

Back when silver’s last secular bull climaxed, the US median household income was under $18k!  Today it is around $50k.  Across the nation new houses averaged just $76k while new cars generally ran less than $6k.  A candy bar cost a quarter.  It is grossly misleading to look at decades-past prices without first converting them into today’s dollars which we all understand.  That creates a righteous apples-to-apples comparison.

Unfortunately the most widely accepted inflation gauge today is the US Consumer Price Index.  Even though it greatly understates true monetary inflation for political reasons, it is still the inflation yardstick that Wall Street accepts.  Using the horribly flawed CPI to recast past silver prices into today’s dollars is actually very conservative.  Since this construct lowballs inflation, it really understates silver’s last mania.

This first chart looks at the last four decades or so of silver prices, showing what a real bull-killing popular speculative mania looks like in today’s dollars.  The nominal (not inflation-adjusted) silver price is shown in red, while the real (inflation-adjusted) silver price is superimposed in blue.  This uses the CPI to recast silver prices in constant November 2012 dollars, the most recent monthly CPI data currently available.

Silver has always been a hyper-speculative metal, which greatly amplifies the magnitude of its popular speculative manias that climax secular bulls.  The terminal ascent of its last one in late 1979 and early 1980 was mind-boggling.  It skyrocketed vertically in a legendary parabola, and then immediately collapsed in a legendary crash.  In today’s dollars, silver’s January 21st, 1980 high was actually over $142 per ounce! Continues...
Real Silver Highs 4
There's a good possibility the bull market does turn bubble over the next couple of years (although that might come later) and I want to be positioned to capture the move whether it ends up just another strong advance or the final parabolic stage...

With the most aggressive move higher in the bull market (over late 2010/early 2011) having occurred in an environment where the US monetary base moved explosively higher with quantitative easing, I suspect the next wave will take us close, if not into, triple digits given the recent introduction of QE3 & QE4. The monetary base is still sitting relatively idle at the moment, but that's likely to change early in the year as I explained in last weeks post (Why hasn't Gold rallied after QE3 / QE4 announced?):
It's probably just taking some time for the purchases to take effect on the Fed balance sheet. In fact the QE4 announcement indicates the additional $45b purchases won't start until the end of "Operation Twist" (FOMC Minutes) which didn't complete until the end of 2012
We are over 20 months into Silver's correction from the April 2011 peak, if the timing of peak to peak moves remains consistent (roughly every 2-3 years) then we can expect a strong rally to commence within the next 12 months with a peak to be expected sometime between mid 2013 and mid 2014.

Silver has been in it's correctional phase for longer than Gold and suspect it will be the metal that is fastest to recover, coming down from the current Gold:Silver Ratio (GSR) level of around 55:

The GSR shows the number of ounces it takes to buy one ounce of Gold, currently the ratio sits at around 54.5 (or around 1.7Kg's of Silver to buy a single ounce of Gold). I don't expect the ratio to remain that high (it has been trending lower for the past several years now) and chances are it could drop to the ratio we saw in early 2011 of around 30 or possibly even lower. If we do see this then clearly holding Silver will prove favourable although I would always recommend holding some Gold as well (no doubt we could learn a thing or two from central banks who stockpile Gold, but not Silver).

If we see Gold head to $2300-2400 this year, a possibility I muse in last weeks post:
After dropping to a low of $1303 in late January 2011 (POG was around $1350 at time of QE2 announcement on November 3rd, 2010), the price proceeded to rally, peaking at $1920 just over 7 months later, a 47% move. I think it's likely that we see similar strength in Gold over 2013, a rally which is likely to push Gold well above $2000 and perhaps as high as $2300-2400.
Then a GSR ratio of 30 gives us a potential target for Silver of around $76-80 in 2013 (although a peak of the next major up leg may not come until 2014).

Tiho of 'The Short Side of Long' had this to say on Silver in a recent post (on precious metal expectations for 2013):
The same cannot be said about Silver. If you hold a view that almost all assets make a new all time high during a secular bull market, as I do, than you probably also find it interesting that Silver remains very attractive. Today, Silver trades at $30 which is 40% lower than the last record at $50 from 1980. Furthermore, adjusted for inflation, Silver's January 1980 peak of $50 in today's money value is well above $100. So one could make an argument that Silver is actually more than 70% below its all time high and has a chance in getting to a triple digit territory before the secular bull market ends.

And with such inexpensive prices on a relative basis, this is where the opportunity lays ahead. During the 1980 peak in precious metals, Silver managed to reach a ratio of 16 ounces per 1 Gold ounce, as it outperformed Gold in the final panic spike. If I am correct in predicting a precious metals frenzy in the coming quarters and years ahead, Silver could become incredibly overpriced. Today, the ratio stands at 54 Silver ounces per 1 Gold ounce, which tends to be a historical average. Even though I am not sure if we will once again see 16 to 1, like we did in 1980, it is very possible that Silver could reach much lower ratio than where it trades today.
He also posted this chart which shows Silver to be oversold on the sentiment readings (a good contrarian indicator showing it's a good time to be adding to positions):

Click chart to enlarge
The above chart would suggest that even if the bottom isn't in (at $26), any further decline would likely be a final capitulation and very short lived (I think the bottom is in and higher prices are imminent). 

The below price chart suggests we have some support forming in a trend line drawn from the mid 2012 lows:

Click chart to enlarge
It's probably going to take some momentum for Silver to break through the $50 level, so I expect the initial thrust in 2013 to take us into the $40's before further consolidation to wipe out the bullishness in order for the price to continue climbing.

Gann Global's James Flanagan recently presented the following chart (from this presentation) which shows a median rally for Silver would take the price 40% higher into the low $40's in the next 4-5 months:

Click chart to enlarge
With my expectation that Silver will see it's next major move high in the next 2 years I decided to use some riskier securities in order to benefit from the rally. I have been selling down some numismatic coins I'd hoarded over the years (can't bring myself to sell any low premium Silver while spot is under AUD$30!) and raised money elsewhere in order to fund a 5-10% position (of entire portfolio) in January 2015 SLV Call Options (bought some last week and will be adding to this position over the coming week or two). 

I can almost hear the cries from the hard money crowd that SLV is only "paper silver" and will become worthless, but there is some serious money to be made if it plays out as I expect (and no paper/physical price break down occurs over the period I'm holding). I will be using options for leverage as opposed to junior mining stocks as I did during 2009-2010. I did well with some of the Silver explorers, holding CCU (ASX) from 6c and selling out between 60c and $1, SVL I bought at 8c and sold out at 35c, to name a couple, but the mining stocks turned south a couple of years ago and haven't yet returned to their former glory (and I lost a chunk of the early gains over 2011-2012, although still well up overall). Not to say Gold/Silver stocks won't eventually recover but I'd rather speculate without company specific risks to worry about.

You can read more about options on Investopedia, but here is a basic definition:
An option is a contract that gives the buyer the right, but not the obligation, to buy or sell an underlying asset at a specific price on or before a certain date. An option, just like a stock or bond, is a security. It is also a binding contract with strictly defined terms and properties.
I have discussed them previously on the blog. I have made and lost capital with stock options, but never previously bought options on the US market for which I needed to open an account at OptionsXpress.

I've been accumulating $38 & $50 January 2015 Call Options in SLV for around $2.30 and 90c respectively. If Silver was to hit $68 (before expiry) which is the lowest of targets provided above, each option with $38 strike would be worth $30 (having paid $2.30 that's roughly 1200% profit), each option with $50 strike would be worth $18 (having paid 90c that's roughly 1900% profit). Purely as an example if someone put $5k into each (50/50 between the $38/$50 call options) and closed the positions when Silver hit $68, the $10,000 would have been turned into around $165,000. That is the sort of leverage they provide, but on the flip side should Silver not be above the strike price when they expire in January 2015 (if you haven't sold out for a profit prior) then you lose your entire capital (whatever you paid for the options, in this example $10,000).

Further to risk of complete loss (if options expire out of the money), the options are traded on the US market so your funds are converted into and out of USD (from AUD, for Australian based readers), there is the potential the gains aren't as significant if the AUD has appreciated further against the USD (or profit would be higher if AUD has dropped).

This far from covers every angle of options and the risks involved such as time decay and other factors, but perhaps provides some context to the reasons for using them (the leveraged profits possible) if you expect a particular outcome. And at the end of the day the only capital at risk is the 10% I'm prepared to forgo should the Silver rally I'm expecting not eventuate.

It's been a pretty boring 18 months for the Silver speculator/investor (at least for those holding longer term positions), but the next 12 months brings about conditions which are likely to change that. Potential price targets I think we could hit in the next 12-18 months vary between $68 and $141, I think it will land somewhere in the middle, but no doubt as it rises I will post my opinion on the blog as we go.

You can follow me on Twitter. I'm usually sharing links and opinions daily (@BullionBaron). You can also CLICK HERE to signup for free email updates.


 Buy bullion online - quickly, safely and at low prices


  1. I've been very itchy to get back in and thought I'd missed the boat when silver went to $35 again a few months ago. I'm considering gambling a cfd or option on ig markets in aus. I'm not as optimistic that we will see $50+ but am very hopeful of $40+ which is still a nice profit in a few months

    1. I agree there is a short term opportunity as well as the potential longer term rally. Unfortunately IG Markets didn't have options exposure as far as out as I wanted (hence opening the OptionsXpress account). I think there is a good chance we see $40+ by mid year.

  2. agree with your sentiments

    you can extend that trend line on graph 5 to the lows to 2008

    definitely a good time to buy, very little, if any, downside risk at this point in time.

    if this play out as we expect might be worth liquidating a percentage of holdings for reentry under 40s, hopefully as low as 35s.

    1. Yes you are right and IMO that trend line is likely to hold (false break a week ago), if it doesn't though it could be a particularly nasty correction before resuming the climb higher.

  3. While I agree that up trend is likely, do not forget that we live in controlled markets. If there is enough drive/will in the Government, they can turn gold/silver trend downwards. There are many tools available to them to do so.
    Invest only as much as you can afford to loose!

    On the side note, disregarding research and reasons offered above, if AUD will be driven down to 0.6 over the next 18 months, this will make Silver shine even if it's price on international market will remain stagnant.

    1. I have been expecting a lower AUD for awhile now and it's proven more resilient than I could have imagined, but yes a lower AUD could protect to downside or have a larger impact on upside if we see a big drop.

  4. $75-$90 is my call in the next few years, though as you mention if this the bubble phase... then I'm going with $200-$500. Either way, I sold some between $40-$48 and bought back about 3-4 times that much physical below $30 with big buys around $27 (thank you very much, lol!).

    Loaded up on junior miners and was looking for something else...

    Thanks for pointing out the options, didn't even come up for me. I generally only play puts due to time degradation, but those Jan 2015 leap calls are looking good!

    Good luck friend!

    1. Thanks. Likewise sold around 30% of my Silver between $42-46 and bought back $26-29. Would have been nice to sell all and buy back, but can't win them all.

      The options offer amazing leverage if we see $50+ Silver in the next 2 years, but of course not everything plays out as we expect it to, so you have to be prepared to take the hit if things don't go your way.