Another Reason for Silver Bulls to Hate Me

by Marc Lichtenfeld, Investment U’s Senior Analyst
Wednesday, July 13, 2011: Issue #1555

On April 27, I recommended that investors take steps to protect their silver profits. The article appeared one day before the top.

Investors who bought the October $40 puts on the iShares Silver Trust (NYSE: SLV), as I suggested, nearly tripled their money in two weeks… now I’m back with a new idea.

That ETF holds 9,500 metric tons of silver or 306.5 million ounces. That’s equal to more than one-third of worldwide fabrication demand in 2010 and nearly half of all the silver mined in 2009. And those levels are down from when the ETF was at its peak in April, when it held over 11,000 metric tons.

The argument could be made that:

  • The rising price of the ETF created more demand for silver, influencing the price of the metal.
  • This demand made the ETF go higher, which raised the price of silver some more.
  • And this cycle basically fed on itself until the music stopped in late April.

So in other words, a financial instrument was responsible for much of the increase in the price of silver… not real demand.

But that was then. This is now.

What’s the play on silver today?

Fundamentals and Technicals Point Towards Buying Gold and Shorting Silver

I’m still no Jake LaMotta (Robert De Niro in Raging Bull) on silver. But I’m not a precious metals bear, either. The trade I like right now is to buy gold and short silver.

Here’s why:

  • Fundamentals

If our politicians continue to play partisan politics over the next few weeks and investors worry that the debt ceiling won’t be raised, you should see demand for gold increase. While that doesn’t necessarily mean a decrease in demand for silver, I’d expect gold to be the dominant metal in that scenario.

While some investors think of both gold and silver as safe havens during times of panic, many more simply think of gold.

Additionally, during the financial collapse in 2008, gold and silver tanked along with all other assets. When they did, gold held up much better than silver, falling 29 percent peak-to-trough while silver slid 59 percent.

Furthermore, once both metals rebounded, gold actually finished 2009 higher than its 2008 peak, while silver was still five percent below. It wasn’t until things had calmed down in 2010, that silver went parabolic.

  • Technicals

The SPDR Gold Trust (NYSE: GLD) is only a few points away from its high and looks to be trying to get back above the trend line. It’s had higher lows and after the last low it bounced right back – a sign of strength.

The SPDR Gold Trust a few points awy from its high

Silver, on the other hand, isn’t nearly as strong. After the large drop in late April and early May, the ETF has tread water. Furthermore, the 50-day moving average is curving lower, which is never a good sign. In the past few months, SLV has attempted to climb above the 50-day moving average and failed.

Since June, SLV has been making lower highs and lower lows, another bearish sign.

iShares Silver Trust showing bearish signs

Gold and Silver: A 10-Year In-Sync Precious Metal Duo

Lastly, look at how gold and silver are performing relative to each other. For over 10 years, gold and silver pretty much moved in tandem, with the occasional significant outperformance by one or the other. You can see that each time outperformance became meaningful, the two metals usually got back into sync relatively soon or even switched places.

NYSE: GLD vs NYSE: SLV performing relative to each other over 10 years

But then looked what happened starting in late 2010. Silver went parabolic, not only in price, but also relative to gold.

NYSE: GLD vs NYSE: SLV - Silver goes parabolic -relative to gold

If the past is any guide, the performance of gold and silver should return to their historical relationship. Perhaps gold simply catches up to silver. But given silver’s meteoric rise, I’d expect them to meet halfway, with gold continuing to rise and silver continuing to fall.

Long Gold/Short Silver: A Portfolio Hedge Providing Positive Results

For investors who want more gold in their portfolios, but don’t want to be too heavily weighted towards precious metals, long gold/short silver is a good hedge that should provide positive results…

And even if I’m wrong about silver going lower, gold looks like it should outperform silver, providing investors upside to any rise in the metals while lowering the risk of being overly exposed.

Good investing,

Marc Lichtenfeld