Silver and what I look for in contrarian investing
Eric King
July 19, 2003Some outstanding points are made in the Puplava article.
Just want to mention a few before my brief thoughts on contrarian investing:
Dow/Silver ratio bottomed in 1980 at 18 to 1 which means that it took 18 ounces of silver to buy one share of the Dow. At the peak recently in silver it took an unbelievable 2,526 ounces of silver to buy one share of the Dow !!!
The Dow/Silver ratio has clearly turned down in favor of silver, but still stands at an incredible 1,938 to 1.
The average ratio over 100+ years at the bottom was around 80 to 1, so for silver investors this indicates tremendous upside and this is what Russell was referring to recently in his commentaries on silver !!!
Another ratio is the Gold/Silver ratio. It is currently at 73 to 1, meaning it takes 73 ounces of silver to purchase an ounce of gold.
This ratio bottomed in 1980 at 16 to 1. Richard Russell has stated publicly many, many times that he believes the price of gold is headed to $3,000/ounce. You can do the math, but one subscriber sent an email to RR which was published indicating that gold at $3,000 and a Gold/Silver ratio of 16 to 1 would put silver at $187.50/ounce !!!
The Gold/Silver ratio historically has been at a ratio for many thousands of years of around 12 to 15 to one.
The United States had literally billions of ounces of silver stockpiled after World War II. As the Chairman and CEO of Pan American Silver wrote to RR the other day (which was published) the massive "strategice stockpile" which the United States possessed after World War II is now completely gone and stands at "ZERO."
Comex inventories which stood at about 330 million ounces in 1980 are now down to 106 million of which over 60 million ounces are already spoken for by investors.
Above ground stockpiles which were around 2.5 to 3 billion ounces in 1980 have been reduced according to all documented sources (which RR mentioned) to only 500 million ounces of above ground stockpiles.
We have been running documented deficits for over 14 years and this is why these stockpiles have been disappearing and are near crisis levels.
Richard Russell was correct in saying the world will run out of above ground silver in 5 years or less, as the average deficit has averaged well over 100 million ounces/year.
This silver is consumed and lost forever. Just one example of this is when your computer keyboard ends up in the dump eventually, the 12 cents or so of silver are not economically feasible to retrieve, so it is lost forever and will never be recovered. There are many, many other examples which I will not go into, you get the idea.
Another ratio is the Housing/Silver ratio which over the last 100+ years peaks at around 20,000 and bottoms at an average of 5,000 (3,000 in 1980).
What that means is that at the peaks it typically takes 20,000 ounces to purchase a "median" priced home. Today the average home purchased in silver stands at an amazing level of around 50,000, meaning it takes around 50,000 ounces of silver to purchase the "median" priced home !!!
A final point is that the lag times on new mining for silver is around 5 years so it won't matter if the price spikes significantly because it takes an enormous amount of time to get new mining projects under way. Any increase of silver mining on existing projects would negligible and not worth discussing in my opinion.
Those are the facts and those are the types of things I have always looked at as a professional investor/trader in order to make profit.
In summary it is quite obvious to me that those ratios are way out of whack and will cycle back down the other way (where they have typically bottomed) and I will be moving capital allocated to silver investing out of silver at that time and into some other type of investment which will be unloved (out of favor) and which the ratios will favor at that time (such as real estate and stocks).
On a final note I remember when I was buying up substantial chunks of oil stocks (primarily drillers) back at the end of 1999, early 2000.
One of the things that fascinated me was the way all of the insiders I talked to seemed to think the price of oil was going lower. I remember at about $11/barrel for oil the Venezuelan Oil Minister was in Florida at the time telling people he saw $2 to $3/barrel in the future for oil.
As I said I was talking to insiders at major oil companies who knew I was investing very heavily in their stocks and they were asking me, "Where do you think the price of oil is headed?"
I would answer them by saying, "I am not an oil trader, but it looks to me looking at 100 year charts for the price of oil that it is headed for $35 to $40/barrel of oil."
There were many other bullish factors which I will not get into which later revealed themselves.
I'll never forget the CFO who was with the # 2 land driller for 28 years responding by saying, "You are alone on an island with that prediction."
Within 12 months of that conversation in early 2000, oil skyrocketed in price (faster than I expected) to the $35 to $40 area.
That particular stock PTEN eventually traded from 2 5/8 to around $43/share.
Others I had loaded up on such as OIL (now merged) went from a low 5 1/4 (yes I was filled there for some of my purchases) to about $50.
There were many others I had, but the point I am trying to illustrate is those are the types of contrarian plays which have been successful for me and greatly increased my net worth.
For the record I always sell too early, sometimes way too early (smile).
People don't have to follow me on silver, I just wanted to give some of the types of things which I look for when investing/trading (because I will also trade while holding my core positions).
There are so many ways for investors to make money in the world markets, but I have repeatedly mentioned silver on this board because it seems so very obvious to me.
I don't know where the price of silver is headed, but rather will look at the ratios to determine my sell points, as well as fundamentals.
For what it is worth it is generally always worth while to go against the herd (smile).
Eric King
July 12, 2003
Investors on the Richard Russell discussion board continue with more questions regarding silver. There is dramatically increased interest in silver since Richard Russell has become a "silver bull"; here are more of the questions:
Q: Given RR's bullish sentiment towards silver; where is the demand for silver coming from? It certainly is not coming from the photograph industry.
A: Structural deficits have existed in silver for 14 years. There is very little above ground silver left and RR was correct in saying we are going to run out of silver. Silver will explode in price as a result of the deficits, especially when investor demand takes off and exacerbates the already precarious supply/demand situation.
Q: Being an industrial metal, what industry is consuming it?
A: Silver is in almost everything. Look around your house, the inside of your telephone, your refrigerator, your microwave and on and on. This is a link to Jim Puplava's fantastic article on silver, a must read and would be an excellent source of info for you:
http://www.financialsense.com/stormwatch/oldupdates/2003/0702.htm
Q: Eric...I wonder if you have an opinion re the huge number of Silver calls outstanding for the month of December?....you have stated that you believe a "Silver crisis" will be here shortly....are you able to publicly state your "timing" reasons....either way I indeed appreciate your comments.....and would say "thanks tons" but even my sense of humor balks at doing so!!..??
A: Ronald, a significant event happened earlier this year in the silver market, Barrick (ABX) announced they were getting rid of their "hedge" book in silver.
ABX was net short the silver market to the tune of 42 million ounces. They announced they were going to accomplish this by "delivering" into the market 13 million ounces and by purchasing the other 29 million ounces in the futures market.
Almost immediately after this announcement call options in two months at the end of the year were purchased for a total of roughly 30 million ounces.
I believe that ABX did this because they wanted "insurance" in case the price of silver exploded. If silver exploded they were limited to losses of $6.00 and $7.00 strike prices which is the price at which the call options were purchased.
You may ask, well what accounts for the other millions and millions of ounces? Good question.
The answer in my opinion is other producers with hedges immediately said to themselves, we need to get out of our hedges if ABX is exiting and followed a similar "call option" strategy in order to give them the necessary time at the end of the year to clear out their hedges.
By the way, ABX paid approximately 1.2 million dollars for the 29 million ounce hedge protection. Not a bad price to pay to allow them to get out relatively unscathed.
Q: Thanks Eric for the detailed explanation....what continues to puzzle me is who and why would any one sell them that many calls...unless they in some fashion were protected from a huge potential loss from a sharply rising Silver price???....I'm sure you know better then I the nature of floor brokers and market makers....but this does not seem like the kind of risk they would normally take.....naked short thousands of calls at $6 and $7 dollars???.....it does seem to me knowing the reasoning of the other side of these calls would be knowledge worth having....I like others are aware of Buffets Silver holdings....he's the only one I'm aware of that could accommodate these purchases without serious losses....
A: It is a very dangerous game for whoever is selling those calls. If silver remains muted until December they are ok and pocket the 4 million bucks or so of profit. If silver takes off and breaks out above $6.00 and eventually $7.00 an incredible explosion in the price of silver could occur as the parties who sold those options scramble frantically to get "long" to offset all of those "calls" in order to protect (hedge) themselves.
My thoughts are that the market would become very disorderly as buyers would continually "lock limit" up silver during many trading sessions with the trapped call sellers panicking as they will in fact be trapped.
That is not a prediction, just one possible outcome for folks to consider.
Having said that, I think all parties involved would feel just fine if silver traded in a very muted price range until December. It would allow hedgers to cover their shorts at a cheap price and call sellers to simply take the money to the bank.
Ah, "the best laid plans of mice and men" (smile).
Q: Eric, I have difficulty believing someone or some entity would take the huge risk involved in selling that many calls without being hedged in some manner....$4 million is a goodly amount of premium to pocket however $7 Silver and they are out $25 million....$8 Silver they are out $75 million.....do you think the sellers of those calls are naked call sellers???....if so, as you say this will be a sight to behold if they are forced to cover.....
A: I do not believe they are hedged, in fact I believe just the opposite, and they are as naked on those positions as the naked short sellers who cap the price of silver - what a game (manipulation).
Their losses grow incredibly large if in fact silver does take out $7.00 and you are right when you say, "if so, as you say this will be a sight to behold if they are forced to cover."
I would just like to caution everyone on the BB to the possibility that as Albert said we could get a low for gold (I would like to add silver to that as well) in August.
If this is the case, I believe that may very well be the last chance to buy cheap silver. I think buyers here are smart regardless because as Ted Butler says, "dimes to the downside, dollars to the upside." Investors in silver require only one thing to make significant gains on their investment - PATIENCE!
Having said that, silver could obviously simply take off and that would be it for the shorts, but like Albert and David Morgan, I am looking for possibly one more final pullback in August.
Q: If silver is going to go through the roof, would investing in the Central Fund of Canada Ltd. (CEF) be a good way to ride the wave up. To Eric. Thanks
A: Had to call Ted Butler with this one. The fund (CEF) is composed of half silver and half gold, so it is ok for that reason.
They are about to have a pure gold play on the NYSE where each share is 1/10 ounce of physical gold.
Hopefully shortly after the gold ETF starts trading they will introduce a pure silver ETF, which Ted says would potentially be incredibly successful as the price of silver takes off.
Q: A breakout to the upside this month as seen on the weekly chart would call for a sell off back to test the break out area in August as you suggest....that would be a normal expectation....however if the price of Silver has been artificially held back the correction may be very mild....reason being ...."Don't mess with Mother Nature"...and those that do are usually taught a painful lesson...for the rest of us true believers "She" demands patience from us before our reward.
A: Ronald, you are right again and that is why RR is correctly recommending that people take a position in physical silver/silver stocks right now!
Yes, we may get the August pullback, but then again as you suggest silver may simply fly!
Q: Eric...I have posted this before but perhaps this is a good time to repost....if Silver's price had followed the percentage rise of the cycle 30 years ago ....price this July early August would be $9.30 an oz......February of 2004 price would be $18.75 per oz.....you have taught us well that the fundamentals are much more potent this time around.....
A: As Russell says, "Silver may be the cheapest thing around."
Q: What are the thoughts on natural gas prices---looks to me they are going to not go down much. Even Greenie seems concerned over the price of the stuff ---thanks
A: We are experiencing a natural gas crisis. "We've talked for years about the coming natural gas shortage," Bob Simpson, chairman of XTO Energy of Fort Worth, a big natural gas producer, said recently. "Well, it's here."
Federal Reserve Chairman Alan Greenspan warned the House Committee on Energy and Commerce that the natural gas shortage poses a threat to key U.S. industries.
There is a coming silver crisis because of the price suppression on the Comex. Silver is needed to produce a tremendous amount of industrial necessities and to build out the infrastructure of booming countries such as China and India.
When the silver crisis comes we will be having this exact same conversation; however the difference is that the lag time on new mining projects for silver is about 5 to 7 years. If it is rushed possibly 36 months - Talk about a coming crisis!
Q: Eric....on the weekly chart beginning July 15th 2002.....Silver has formed a huge 5 wave triangle that appears to be complete.....it is acting as though it wants to break lose and run...it's chomping at the bit and having difficulty selling off....it will be very interesting to see if it can be held back here.....I know I am not the only one who sees this triangle and knows what it portends.....surely there are those with mucho money who are now picking up their bullish interest.....anyone who can read and interpret a chart knows the potential when the 5 wave triangle is complete....I have not seen many triangles that take this long to complete...some but not many.....the longer it takes the bigger the ensuing move, usually.....if the manipulators, whoever they are can bust this they are really very powerful....they would then be making the market do whatever they want it to.....if they are that powerful then they can make and break a primary trend at will....I seriously doubt that they can...the primary trend is made by the MAN upstairs expressing his will thru us mortals....his messenger is MOTHER NATURE and we know this for a fact..."DONT MESS WITH MOTHER NATURE"!!!
A: Ronald, on the phone right now with David Morgan over at silver-investor.com (interviewed each week by Jim Puplava). Let me quote him directly, "I've always stated that the market is bigger than any manipulator and eventually the market will break to the upside."
"Currently I'm concerned that this might be the top for 4 reasons:"
1. COT (commitment of traders) the funds are being managed again here and I think it will work again, but at some point it will fail."
2. Sentiment is too bullish (not the consensus numbers) but rather my own proprietary study."
3. Seasonality, normally get a spike high in July and a low in August, will it take place again this year?"
4. Gold - non-confirmation. We cannot rule out that gold's performance is indicating the typical summer lows just ahead."
David said it is very tricky here because of the four factors listed above. He believes that we will see a temporary low and if he is right about an August low that could be the end of the price suppression.
Of course he is extraordinarily bullish long-term on silver!
David and he just wanted to add one final thought, "I agree with Richard Russell that you should buy as much (precious metals) as you can buy and still sleep at night. All of my subscribers hopefully have their core position intact and should only trade 20 to 25% of their positions."
Neither Richard Russell or David are saying put 100% of your money in PM's, I believe RR only recommends 10% currently and David recommends 10 to 20%. With the current environment David is recommending a more aggressive 20%.
Q: As you know, bull markets do everything possible to keep you off the bulls back, even if you are a bull - he will throw such violent corrections at you that make you want to get off - the downward corrections in a bull market are usually more intense and severe then most of the upward action, which is slower and more gradual.
A: So true and equally tough to accomplish is timing when to sell and exit the market. It will be extremely difficult in my opinion.
Q: I did buy some silver from Certified Mint. Bill Haynes guided me to purchase 100-ounce bars. It sure is a lot easier to carry a few 100-ounce bars to the bank than one 1000-ounce bar! Will have to rent a larger safety deposit box, silver is much more bulky than gold. Am still not sure how silver fits in if the more and more likely deflationary scenario unfolds. Bill Haynes feels that inflation/deflation silver goes up as commodity or store of value. Any-way very much appreciate the advice-- thanks
A: In my opinion there will be deflation in the form of falling real estate/equity prices, however there will at the same time be inflation in the form of higher prices for imported goods as the dollar continues what will be a multi-year slide.
Silver could very well be the # 1 investment once again by the end of this decade just like it was by 1980.
One comment, for folks who are concerned about weight, the fact that RR mentioned that 1,000 ounce bars weigh about 80 pounds, another option is to purchase 10 - 100 ounce bars for every 1,000 ounces you wish to purchase.
Two advantages to doing this, first is that the average weight would be about 7 pounds for each bar.
Second is the fact that you can buy so much closer to the spot price than you can buy purchasing Silver American Eagles.
Let me give you an example.
Let us use a closing price on silver of $4.79.
To purchase Silver American Eagles you would have to pay roughly $6.20/one ounce coin, which translates into about a 30% premium over the current spot price.
To purchase 100 ounce bars, you would pay 32 cents over spot price of $4.79 or roughly $5.11/ounce, or about 6.7% over spot price, significantly smaller premium over Silver American Eagles.
A $10,000.00 purchase would net the following total of silver using the above prices for Silver American Eagles and the 100 ounce bars:
Silver American Eagles = 1,612 ounces
100 ounce silver bars = 1,957 ounces
The purchaser would end up owning 21.5% more silver by purchasing the 100 ounce silver bars over the coins.
Regardless of which option buyers choose I believe that they will have unbelievable profits before this silver bull market ends (smile).
One Final Point
Remember when you purchase physical silver always pay in full and take delivery, NEVER USE LEVERAGE !
Eric King July 12, 2003
July 8,2003
The following Q & A took place on the Richard Russell discusion board. I found that investors had many questions about investing in silver, here are some of them.
Q: In looking at the short, medium and long term charts of silver there appears to be tremendous resistance at about $5.00 an oz. There also appears to be signs of double bottom and reverse head and shoulder trading patterns in the metal.
What are the buying signs for silver other than the DJIA to silver ratio being extremely high and the Gold to Silver ratio is historically very high. Are there some supply and demand situations that are not obvious to someone that has not historically followed silver?
In looking at the charts of the metal and the producers it appears that if silver could break out above $5.00 the metal and the producers shares could have a huge run.
A: Silver above $5.00 is a massive breakout!
Going back to 1980 there was around 2.5 to 3 billion ounces of silver above ground and the Comex wherehouses contained above 300 million ounces of silver and yet silver was able to break above $50 an ounce!!!
Today above ground stockpiles of silver have dwindled to almost nothing and Comex wherehouse inventories are down to 106 million ounces of which 66 million ounces are already spoken for.
Silver consumption has been outstripping supply for 14 consecutive years!
I think that we are very close to a silver crisis unfolding. Silver is absolutely essential to industry and to the build out the infrastructure of countries.
When the price of silver really begins to take off it is important to know that it is price inelastic. As an example, very little silver is in a computer keyboard. So if the price rises from $5 an ounce for silver to $50, the producer may go from having 12 cents of silver in a keyboard to $1.20. They simply raise the cost of the keyboard by $1.00 - big deal. The same applies to telephones, refrigerators, etc.
Also, most all of silver supply is a result of being a by-product of other metal mining such as lead, zinc or gold for instance.
As the price rises, the mining companies won't necessarrily respond with more silver mining because their business plans are focused on other metals and silver is just a simple by-product of their core mining functions.
Q: Which of the producers do you think represents the best pure play on a silver run above $5.00 an oz? How would you prioritize investing in the silver mining industry? Who has the best leverage to capitalize on a higher metal price?
A: I am a value-oriented investor and for you and others I am going to come clean about why I trade gold and silver stocks but am extremely hesitant to make any significant bets on miners (outside of trading).
I believe that the majority of these mining companies are run by crooks (but not all of them).
I also think many of their balance sheets are scary at best.
I also have a hard time figuring out the real earnings and cash flow of these companies which I believe is extremely important in determing the "true" value of any company.
Benjamin Graham and his disciple Warren Buffett believe in determining the "true" value of companies before investing and I just think it is very difficult with mining companies.
Also, Warren Buffett placed his bet in 1997/1998 by purchasing 129.8 million ounces of physical silver. I doubt you will see Berkshire Hathaway take any postition in any mining shares.
I do not believe I am more intelligent than Warren Buffett and therefore have followed his lead by purchasing (so far) over 3 tons of physical silver.
I recommend physical silver over silver stocks for that reason.
Having said all of that, of course there is more leverage in silver stocks, but also more danger, an example being CDU which was recently more than chopped in half going from a high of $2.69 to 55 cents (ouch)!
I hope that helps you understand where I am coming from on silver stocks.
Q: I admire your persistence in sticking with silver even when others doubted—including RR. Since physical industrial demand would fuel the rise in silver price, rather than its use as a store of value, I would think Silver bars would be best investment, rather than coins? For a small time speculator—myself, what would your advice be? Where to store in house, bank or storage unit (with old medical charts)? 1000oz bars or 100 oz bars? Who to buy from and who would you sell to? Each bar would have to be assayed before selling?
A: In the end, investor demand will make the price of silver really explode. I think any silver is good silver. Having said that, I believe 1,000 ounce bars are the best way to invest in silver for the reason you mentioned. When the silver crisis emerges I believe industrial producers will pay a premium in order to get ready to use 1,000 ounce bars as Comex defaults on deliveries will be rampant. Also, with 1,000 ounce bars you can buy them extremely close to the spot price of silver.
Q: Perhaps coins like Eagle, would be easily traded, with known value, due to standard and recognizable coin related traits, unlike items which could be of variable quality, i.e, bars.
A: Both coins and bars are extremely liquid. The advantage of Silver American Eagles over bars is that in a meltdown situation the coins would be much easier to barter with vs bulky bars.
Having said that, Silver American Eagles must be purchased at a healthy premium at say 35% over spot price. 1,000 ounce bars on the other hand can be purchased at pennies over "spot" and the bid/ask spreads are narrow.
Either way I believe investors in physical will have magnificent gains before the bull market in silver is over.
Q: My one question is, I've seen comments from time to time, mostly on the gold sites, by those who seem keen that everyone should have some bags of "junk" silver coins, probably stored at home for emergencies.
Like you I think it's unlikely (though not impossible) that gold and silver will be confiscated (even less likely in the case of silver). I also don't think things will get to the state that one will need to barter for survival. That being the case, what are your thoughts on owning a bag or two of old U.S. silver coins? Or would it make more sense to just own the bars as you say and perhaps some silver American Eagles as a supplement?
A: Junk bags of silver is a great idea. They can be purchased with a relatively small premium over spot price and are an excellent idea. Junk silver bags for those who don't know are pre-1965 silver U.S. minted half dollars, dimes, etc. Let me just say there is nothing wrong with Silver American Eagles either, one of the most beautiful coins ever minted, I just wanted to point out that there is a hefty premium (roughly 30 to 35%) above the spot price.
Having said that, with where the price of silver is most likely headed (much, much higher) in the coming bull market, investors buying any silver will be extremely happy in the long-term.
It is also very easy in an estate to pass on precious metals to children or grandchildren, etc.
Q: Thought these bags might be a problem in case one wanted to sell?
A: Bags, bars, coins all extremely liquid.
Silver Where to Keep It?
Some have asked where to store silver, home, bank, etc? That is a very personal choice and it varies from person to person.
For myself, I have vault priveleges at one of the safest banks in the United States, according to Weiss Rating Systems, and this is where my silver is stored. No, the bank doesn't lease or swap silver. So I choose to pay to have my 3 + tons of silver stored at my bank.
I did not want the silver stored where I live in case I am robbed.
There were 9,000 bank failures from 1929 to 1933, so if you choose this option for yourself, please make sure that you pick as solid an institution as possible. In the book Conquer the Crash, Prechter shows the 2 safest banks in each state as rated by Weiss.
Having a small amount of silver at your house in case of emergency is not a bad idea either.
If you choose to store silver or gold at your house please put an intensive amount of thought as to how you will hide it from thieves. I don't have any advice on this as I did not choose this option.
I would not leave my silver in a co-mingled situation in an institution that engages in leasing or swapping. I will not go into this any further except to say that you may find your silver is not there when you request it, so in the end you are stuck with paper and a lawsuit in what may be a crumbling institution.
Obviously paying to have your silver or gold stored even in a safe institution can still end badly if the government chooses to confiscate individuals gold and silver. This would make the home option or overseas storage a better option. I do not anticipate that the government will confiscate either gold or silver so that explains my personal decision with my own situation.
Having said that always keep in mind that the United States or another nation may choose to "appropriate" or "nationalize" it's own nations mines so that could even end badly for investors.
Hope that helps whoever was asking.
Silver, one final point
Silver went up roughly 38X in price during the last bull market in precious metals.
Nobody knows how silver will perform in the coming bull market, but the fundamentals have never been better for silver than they are today.
Folks who decide to purchase physcial silver should take delivery and SHOULD NOT USE LEVERAGE in their physical purchases! Always pay in full.
Eric King
July 8, 2003
July 2, 2003
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