Tuesday, December 1, 2009

Investors Guru Small Cap Stock Observer

Is Silver Set to Rocket Higher - much more than gold prices, in percentage terms?

The Intrinsic Value of Gold - it all boils down to confidence and trust

Firstly, I should point out that Investors Guru, and I expect most of our members, tend to be on the bullish side of gold, silver and precious metals. This is as true now as it was in 1995 when we started this site, and even during our investment hibernation for most of the Bush years - that was mainly just a sidelining stance until that administration's fiscal, debt, housing, currency and economy smash-up derby concluded.
I should also clarify that when I refer to those lost years, for investment purposes that is, this is not just political opinion but rather a reference to look at any stock index chart from the end of Clinton to the end of Bush - the point is they are all down, as we expected! If there was a Bush upside, it's for gold - again as we expected.
Many now believe, us included, these lost years have set the stage for the greatest gold and precious metals markets in history. However, finding a rational consensus for a short, mid and long-term $X dollar gold target can be daunting. After a few hours of web browsing the topic, you will start to wonder which sources you can trust. Various gold bugs and gold conspiracy sites post volumes in support of their gold targets that can range from $2000 and up, to even tens or hundreds of thousands $USD per ounce. On the other hand, you wonder how much you can trust various governments and financial industry sources on the topic, such as central banks and the Fed, the IMF, gold councils and various brokerage metals analysts' reports etc.
If you decide government and financial industry pages are to be trusted, you might also remember who got us into this mess - the debt crisis, currency crisis, housing crisis etc. And I don't remember any Wall Street analyst predicting any of these bubbles, at least not before they popped. There are some sources that claim a good gold price prediction track record, but then fall short of providing any tangible gold information until some amount of your paper or plastic money is paid.
Further, it seems that some of these sites base their conclusions on not much more than psychic or astrological readings, while others are basically a rear-view history or math lesson on where gold prices have been, as the only real support for where prices are heading. I guess the point is that everyone seems conflicted, so tread carefully.

Golden Millennium - since Y2K, gold has been the only money worth trusting

We continue to believe that as gold was putting in its price bottoms in 2001 that a perfect storm was already forming, which continues and has accelerated today on many fronts, in support of higher gold and precious metals prices. Our members are well aware of the many reasons for this, most notably the current devaluation of the $USD and possibly other fiat paper currencies, to the probable re-emergence of high inflation to possible hyperinflation at some point forward.
This report focuses on the gold/silver ratio and how it may be useful to identify a silver opportunity in particular, if gold prices continue to go higher. In other words if you understand which factors and trends affect gold prices, and you believe a bullish case can be made, then perhaps there is an even better case for comparables such as silver.
To stay on the gold/silver ratio topic, we won't go into the various gold price-influencing factors in too much detail. However, I just mentioned that gold usually does well when paper currencies are weak or when high inflation is expected. My main observation on these points are that the $USD is historically low and expected by many to go even lower - which only makes sense with all the fundamental dilution represented by the many trillions of dollars issued or borrowed recently, with only the US governments' tarnished good faith promise as collateral.
As for inflation, all we read or hear in the mainstream media says that it is low and expected to remain low, as will interest rates, for the foreseeable future as a result of the financial crisis. So if there's no inflation, why did oil and gasoline, flour and bread, to even vegetables such as tomatoes, cucumbers, potatoes and corn prices all double to quadruple or more over the past few years? No wonder they quote inflation "excluding food and transportation", but what about similar increases in the cost of drugs and education etc., to even your property taxes?
My question is when they quote inflation as less than 1% or even negative, what the heck are they referring to as their basket of items that make up our inflation rate? Can you think of a single staple item that has gone up by only 1% over that time? More importantly, why doesn't mainstream media ask these questions? My point is that we should consider common sense financial indicators, like our grocery or gas receipt, or our financial statements - at least as much as a media sound bite.
Lately it seems a reporter will say that inflation and interest rates are low and will stay that way because of the global recession that won't end until 2010, but in the next breath that Australia and Israel are already raising interest rates and others may have to do the same - because of higher inflation. They say the dollar remains strong and that China, India and the Middle East are eager to accept more, and in the next breath that over the past few years the purchasing power of the dollar versus the Euro and other currencies has fallen 40% - do you really believe they are happy losing 40%?
With all the booms and busts, or bubbles and pops if you prefer, this leads us then to ask when will there be an overall paper money loss-of-confidence? I mean how many economic bubbles will the average American tolerate, before simply giving up and hiding what little money or credit remains - into gold or the mattress? Keep in mind that 70% of the US economy depends on these average citizens continuing to keep up with the Jones and spend. Housing prices have traditionally only gone up, so the housing bubble pop may prove to be the real eye opener for millions of Americans - the catalyst as a spending behaviour game changer.
Even those who were lucky enough to avoid or recover from the housing bubble, might see the writing on the wall this time in regards to the ever building debt bubble formed at every level of government, and start asking when it all might finally pop. Sceptics will argue that the markets always climb a wall of worry, and they are right, but when does that wall become insurmountable? At the average Joe level, so many have suffered from losing their investments or retirement savings, higher credit costs or loss of availability, mortgages now underwater or in foreclosure, and the loss of a job or risk of it disappearing - all over a very short period of time.
Those who think that systemic debt contagion is limited to just the US or UK may point to emerging markets that are booming as a safe haven. Ask anyone who bought Dubai stocks or bonds lately how that's worked out. My point is not just that the average Joe is starting to question who they can trust - governments and banks don't trust each other!

The Golden Uptrend - and Its Silver Lining

Over Any 10-Year Period, Stocks Always Outperform Gold - don't they?

In condolence to all these real losses, and a major loss of confidence, the same political and financial pundits now point to the V-shaped bounce off the March 2009 lows of any stock market's chart as proof that its ok to invest and spend again. And of course they claim the growth rate of inflation, deficits and the debt, and the fundamental values of the economy and the dollar are all sound and manageable.
This might not matter for those already wiped out, but if you were smart and lucky enough to survive each bubble and financial crisis of the last decade, then you might already be thinking gold's uptrend has stayed the course and continues to look solid. Compare any US stock index chart of the last decade to the following gold chart.

January 2000 to November 2009 - London Gold Price Chart
Not surprisingly, mining and exploration stock indexes tend to follow the overall expected trend of the underlying metal being explored for or mined. However, shares in individual mining and exploration companies may perform significantly better, or worse, due to a wide range of factors. This includes managements abilities to efficiently raise capital, control marketing and operating costs, discovery success, to even political risks depending on where mining activities occur. Many other factors may come into play.
For those that do succeed, everything seems to be positioned in gold's favor. For years many central banks were selling gold in favor of US dollars, but now appear to be buyers of gold again. For example, recently the Reserve Bank of India bought half of the gold sold by the IMF, and the Central Bank of China is reportedly buying. And don't forget the sudden wildcards that can spike the price of gold overnight - such as political uncertainty, corruption, war or any destabilizing situation.
Not only is demand up, gold production and supply has been falling since 2000. In addition to central bank sellers now becoming buyers, for years there was a perceived overhang supply of gold in the market from gold miners selling gold not yet produced into the futures markets. One key signal for us that the secular gold trend was finally turning higher again, after 20 years in the doldrums, was after NEM Newmont Mining announced early this decade that they had ended all gold production hedging.
This fall we got one of the bullish gold signals you can get, when T.ABX Barrick Gold announced they were paying billions to close out all forward gold sales. Barrick has been one of the largest, if not the largest, forward seller of gold. They would sell almost all of their production forward, which worked well for years - until a few years ago. Why all the sudden urgency, worth paying billions? Just stop writing new contracts and let your existing hedge-book expire, or deliver the gold - unless of course you expect gold prices to move considerably higher in the short or near term.
Further, new gold discoveries are not keeping up with demand, and even the ability to put proven resources into production may be difficult. Future input costs such as volatile oil prices and credit availability need to be factored into business models, before a production decision can even be made. My point is the gold tap cannot be turned on quickly in response to a spike in gold prices, as it takes years to put a proven gold resource into production - on top of the years it takes to find it.
I'm not saying gold will outperform most US stock indexes. I'm just pointing out that contrary to what many financial planners are taught to say, that gold can and did outperform stocks by a wide margin over the past decade. However, other than a new punitive gold law, or the discovery, acceptance and implementation of an inexpensive, abundant and environmentally friendly new energy source to replace oil, I don't see any sustainable scenarios that can derail this secular gold market.

The Gold / Silver Ratio - silver may rocket higher if history repeats

Like any investment, gold alternatives should also be evaluated - for some risk diversification within the investment class, or to possibly enhance overall performance. Silver especially, and to some extent platinum, palladium and other precious metals are the obvious comparables, but the case can even be made for base metals, diamonds and other gemstones, or even commodities such as oil - to provide some correlation within very large portfolios.
The gold/silver ratio is simply the price of gold divided by the price of silver, or how many ounces of silver are equivalent in US dollars to one ounce of gold. Gold and silver prices generally trend up and down together, but there are times when the gold/silver ratio gets way out of sync. In other words, once you recognize the overall long-term gold trend, significant further upside may be found by also identifying how the gold/silver ratio will react to this gold trend.
As you see in the table below, the gold/silver ratio was set at 15 until the mid 1800's, but has steadily moved up from there. Not only has gold and silver increased in dollar terms, but gold has also increased relative to silver. This in itself is not favorable to silver over gold, until you understand why and when the ratio has swung to one extreme or the other.
There have been times when the gold/silver ratio was close to 100 and other times when it was lower than 15. For demonstration purposes only, if gold prices stayed the same and you had bought silver when the ratio was 100, and sold when the ratio contracted to 15, you could have theoretically made (100 / 15) * 100 = 666.67%. However gold prices do change, these ratio changes are extreme, and losses are just as severe if the ratio expands instead of contracting.
I believe there is support for the gold/silver ratio contracting during secular bull gold markets and expanding during bear gold markets. In other words, when gold is in a major bull market, silver can outperform. The table below loosely correlates this, although the top half of this table is from when gold prices and the gold/silver ratio were fixed by government and not fully deregulated until 1972.
I also believe the best secular bull gold market to look at is the late 1970's to 1980. The comparisons to today are uncanny, with record oil prices and the US auto industry again in shambles. Then it was the Iran Hostage Crisis, and Chrysler at risk; today it's the Iran Nuclear Crisis, and GM in bankruptcy. Again we have trade and fiscal deficits, debt at all levels of government, job losses and unemployment, a falling currency and a deep recession - all at record levels or the worst since WWII.
The main difference then is that inflation hit over 14%, with an even higher bank rate and mortgage rates over 20%. Today they say inflation and interest rates are 0% - unless of course you have a credit card, eat groceries, or drive a car. The real question is how long will it be before all those cheap trillions sloshing around today, again cause 1980-style inflation and interest rates?
Ignoring 14% inflation and 20% mortgage rates for now, shouldn't gold prices today have appreciated by at least the average inflation rate since 1980? If the government's normal target inflation rate is around 3%, and then applying this rate to the 1980 gold high of $850, this suggests that an equivalent inflation adjusted high today might be approximately $2,003. For silver starting at $52 this works out to $123 per ounce.
I'm not suggesting $2,003 as a gold target or $123 for silver. All I'm saying is that if $850 was the previous gold high in 1980, and if you believe like we do that the forces behind this bull gold market will be at least as powerful as during the 1980 bull gold market, then it only reasons that the current bull gold market might put gold at an equivalent high in today's dollars, adjusted for the affects of inflation over the past 29 years. In other words, if you believe that $850 dollars in 1980 is equivalent to $2,003 dollars in 2009, then it's not much of a stretch to believe that $850 gold in 1980 might be equivalent to $2,003 gold today.
If you see this as purely coincidental or conjecture, you surely must agree that a direct relationship exists between the value of the $USD and gold priced in US dollars. An inverse correlation can be shown that when the dollar persistently goes down versus other major currencies, then the price of gold usually goes up, and vice versa.
An indirect correlation can also be shown for major commodities like oil, still priced in US dollars - at least for the time being. Historically oil has traded at about 15 barrels per ounce of gold, however there are times when the ratio falls out of sync and one commodity appears expensive compared to the other. For example, in 1980 gold topped out at $850 and oil topped out at $40, which is 21 barrels of oil per ounce of gold. Oil was at all time highs but seemed cheap compared to gold. However, when gold first hit $1,000 an ounce in 2008 at about the same time oil made new highs at over $140 a barrel, gold seemed cheap versus oil this time, at only 7 barrels of oil per ounce of gold.
These ratios are not perfect indicators, but today we can see that the gold/oil ratio has normalized again at 15, with gold at $1175 and oil at $75 ( 1175 / 75 = 15.66 ). So why can't this work for the gold/silver ratio to indicate if gold or silver is undervalued compared to the other, and what is the normal gold/silver ratio? Again this is tricky because gold prices and the gold/silver ratio were fixed at one time. Here are some notable gold/silver ratio highs and lows since 1980:
Gold/Silver Ratio - Lows: 1980 = 14.9, 1998 = 40, 2006 = 43
Gold/Silver Ratio - Highs: 1991 = 99.8, 2003 = 80, 2008 = 84.
The table below explains how the gold/silver ratio was once fixed by law at 15, and for the 20th century it averaged 47.1. It also says that at the peak of the Nelson and Bunker Hunt silver crisis in 1980 that silver was as high as $49.45 and the gold/silver ratio was as low as 17. If memory serves, I believe the high was actually $52, and the gold/silver ratio as low as 14.9.
The point is that silver is a small enough market that just two Texas billionaire brothers and a few Arab oil buddy's could corner it, at least until anti-trust lawyers became involved. This also shows how the price of silver can skyrocket even beyond gold (in percentage terms), and that it is possible for the gold/silver ratio to fall as low as 15 again during a bull gold/silver market.
The next notable gold/silver ratio low was 40 in 1998. Correct me if I'm wrong, is that when Warren Buffett and Bill Gates each started buying around 130 million ounces of silver? I'd love to know what/who made them sell out by 2006, as the fundamental reasons for holding gold and silver were never better. Everyone makes mistakes and in any event, based only on the above sketchy scenarios, a first guess at a low gold/silver ratio might be argued somewhere between 15 and the 20th century average of 47.
Gold currently is $1,175 and silver is $18.30, a ratio of 64.20. It seems strange that the ratio is 17 higher than the 47 average, at a time when gold is making new highs almost daily. Last year when gold made new highs at $1,030, silver traded as high as $20.86, a gold/silver ratio of 49. I would argue the ratio should have contracted to around 40 at least by now - or $1,175 / 40 = $29 silver. Even a ratio of 47 would put silver to at least $25 by now, instead of $18.
In other words, I believe silver should be somewhere between $25 and $30 right now, at $1,200 gold. But I also believe gold could go to at least $2,003 if this bull gold market plays out like in 1980. If it does, I can only guess if/when the gold/silver ratio may finally contract, which I would place my best guess right now at a ratio of around 30, or around $67 an ounce. Some may think that's crazy, but this is only $15 or 29% higher than the 1980 silver high - not even adjusted for inflation!
If 1980-style inflation rates of 14% are mixed into the equation, I can only speculate where prices may eventually top out. Historically, hard assets like gold, silver and other precious metals have been one of the few asset classes that protects capital and actually benefits, while the value of other investments get ravaged, during periods of high inflation.
But I also believe the case can be made for an even stronger bull gold market this time, because all the same old crisis' seem worse this time, and there are several new crisis'. In other words, is there more or less oil used and available today than in 1980 (with no real solution for either close at hand); are the debt, fiscal and trade deficits better or worse now than in 1980 (inflation adjusted, as a percentage of GDP, GNP, per capita, or expressed in whatever terms you prefer); are there more or less dangers and fear today than in 1980 (war, disease, pollution and global warming); are families better or worse off today than in 1980 (crime, divorce, education, health care, life expectancy, savings, net worth, weekly hours worked, incomes needed per household, years to retirement etc.); and is the US dollar stronger or weaker than it was in 1980 (and where is it headed). And I don't believe a banking crisis or housing crisis existed back in 1980 anywhere close to today.
In closing, I believe we are in the mid to early innings of a secular gold trend. More importantly, if I'm right silver could do even better. Instead of poor mans gold, I prefer to call silver "Wise mans gold".
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The following information about silver is from Wikipedia.org.

Silver as an investment

Silver, like other precious metals, may be used as an investment. For more than four thousand years, silver has been regarded as a form of money and store of value. However, since the end of the silver standard, silver has lost its role as legal tender in the United States. (It continued to be used in coinage until 1964, when the intrinsic value of the silver overtook the coins' face values.)

Silver price

The price of silver has been notoriously volatile as it can fluctuate between industrial and store of value demands. At times this can cause wide ranging valuations in the market, creating volatility.
Silver often tracks the gold price due to store of value demands, although the ratio can vary. The gold/silver ratio is often analyzed by traders and investors and buyers. In 1792, the gold/silver ratio was fixed by law in the United States at 1:15, which meant that one troy ounce of gold would buy 15 troy ounces of silver; a ratio of 1:15.5 was enacted in France in 1803. The average gold/silver ratio during the 20th century, however, was 1:47.
YearSilver price
(avg. US$/ozt)
Gold price
(avg. US$/ozt)
2009 (as of Nov 3)16.441059.5664.45
From September 2005 onwards, the price of silver has risen fairly steeply, being initially around $7 per troy ounce but reaching $14 per ozt. for the first time by late April 2006. The monthly average price of silver was $12.61 per troy ounce during April 2006, and the spot price was around $15.78 per troy ounce on November 6, 2007. As of March 2008, it hovered around $20 per troy ounce. However, the price of silver plummeted 58% in October 2008, along with other metals and commodities, due to the effects of the credit crunch.

Factors influencing the silver price

Private and institutional investors

* From 1973 the Hunt brothers began cornering the market in silver, helping to cause a spike in 1980 of $49.45 per troy ounce and a reduction of the gold/silver ratio down to 1:17.0 (gold also peaked in 1980, at $850 per troy ounce). However, a combination of changed trading rules on the New York Mercantile Exchange (NYMEX) and the intervention of the Federal Reserve put an end to the game.
* In 1997, Warren Buffett purchased 130 million troy ounces (4,000 metric tons) of silver at $4.41 per troy ounce (total value $572 million). Similar to gold, the silver price has more than doubled in value against the United States dollar since December 2001. On May 6, 2006, Buffett announced to shareholders that his company no longer held any silver.
* In April 2006 iShares launched a silver exchange-traded fund, called the iShares Silver Trust (NYSE: SLV), which as of April 2008 held 180 million troy ounces of silver as reserves.

The large concentrated short position

The CFTC publishes a weekly Commitments of Traders Report which shows that the four or fewer largest traders are holding 90% of all short silver contracts. Furthermore, these four or fewer traders were short a total of 245 million troy ounces (as of April 2007), which is equivalent to 140 days of production. According to Ted Butler, one of these banks with large silver shorts, JP Morgan Chase, is also the custodian of the SLV silver ETF. Some silver analysis have pointed to a potential conflict of interest, as close scrutiny of Comex documents reveals that ETF shares may be used to 'cover' Comex physical metal deliveries. This leads analysts to speculate that some stores of silver have multiple claims upon them.
On 2008-09-25 The CFTC finally relented and probed the Silver Market after persistent complaints of foul play draw the still-skeptical Agency to investigate.

Industrial demand

The use of silver in items such as electrical appliances and medical products has increased since 2001. New applications for silver are being explored in batteries, superconductors and microcircuits, which may further increase non-investment demand. The expansion of the middle classes in emerging economies aspiring to Western lifestyles and products may also contribute to a long-term rise in industrial usage. Even so, due to the advent of digital cameras the enormous reduction in the use of silver halide-based photographic film has tended to offset this.

Methods of investing in silver

Silver Bars, Coins, Rounds, Certificates, Accounts, Spread Betting, Derivatives, ETF's and investing in Mining Companies, are the most common ways to invest in silver. Within each of these categories of silver investments there are several choices, for example:
Exchange-traded funds (or ETFs) represent a quick and easy way for an investor to gain exposure to the silver price, without the inconvenience of storing physical bars. The silver ETFs are:
* iShares Silver Trust (NYSE: SLV), launched in April 2006 by iShares.
* ETFS Silver Trust (NYSE: SIVR), launched in July 2009 by ETF Securities.
* Central Fund of Canada (TSX: CEF.NV.A, NYSE: CEF), which has 45% of its reserves held in silver with the remainder invested in gold.
* In September 2006 ETF Securities launched ETFS Silver (LSE: SLVR), which tracks the DJ-UBS Silver Sub-Index, and later in April 2007 ETFS Physical Silver (LSE: PHAG), which is backed by allocated silver bullion.
* PowerShares DB Silver (AMEX: DBS), holds its worth in futures contracts for physical delivery, which are later sold to silver consumers in order to roll over expiring contracts to contracts further from expiration.
* ProShares Ultra Silver (NYSE: AGQ), seeks daily investment results, before fees and expenses, that correspond to twice (200%) the daily performance of silver bullion as measured by the U.S. Dollar fixing price for delivery in London.